pillars of wall street - financial statement analysis - working capital Flashcards
sections of balance sheet
current assets and current liabilities (i.e. working capital)
non-current assets and liabilities (assets that will be received or liabilities that will be paid in greater than one year)
financial assets and liabilities (your equity and debt)
current assets
cash and other assets that can be converted into cash or used up in one year’s time
presented in order of decreasing liquidity (cash is first, then accounts receivable, then inventory, etc.)
current liabilities
obligations that will be satisfied within one year
working capital
working capital = [all current assets of firm] - [all current liabilities of firm]
not enough working capital may indicate liquidity problems
too much of it means there may be an inefficiency in your business model (too much inventory, for instance)
operating working capital
aka net working capital
traditional definition of working capital (current assets minus current liabilities) is irrelevant
operating working capital = [current operating assets] - [current operating liabilities]
the focus of operating working capital is on the core operations of the business at the exclusion of the financial components
tells us how cash is being used in the business and what the everyday investments of running the business are
helps you assess how efficiently company is operating
signals company’s short-term liquidity
the reason to exclude the financing piece is because this is driven by management decisions and can be changed; they are not indicative of the core operations of the business
positive operating working capital vs. negative operating working capital
positive means current operating assets exceed current operating liabilities; in order for this to be true, there needs to be funding in the form of either equity or debt (typically debt)
negative means current operating assets are less than current operating liabilities; negative operating working capital provides funding
whether a company has positive or negative OWC is not a bad thing; what matters is how a company utilizes its assets and liabilities in comparison to its peer group (this is called bench-marking)
common operating working capital accounts
CURRENT OPERATING ASSET ACCOUNTS:
AR - sales made that you have not collected payment for yet
inventory - items you are ready to sell
prepaid expenses - expenses you’ve already paid for services that you have not used to their full benefit thus far
CURRENT OPERATING LIABILITY ACCOUNTS:
accounts payable - what you have to pay your suppliers
accrued expenses - payroll, benefits, insurances
deferred revenue - example is airlines: passengers pre-pay airfare for a flight that is well into the future
days ratios
all of the following formulas follow the general form of [balance sheet line item] / [income statement line item] * 365
receivable days = AR / sales * 365 –> tells you how long it takes for company to collect on a sale after its made
inventory days = inventory / COGS * 365 –> tells you how long it takes to turn your inventory into a sale
payable days = accounts payable / COGS * 365 –> tells you how long the company to pay its supplier
cash conversion cycle
AR days + inventory days - AP days = # of days of funding either required or provided
if the result is positive, the formula gives you number of days of funding required
if it is negative, it gives you number of days of funding provided
