Session 2 Flashcards
How do you calculate working capital?
Working Capital: (shareholders equity + non-recurring liabilities) - non-recurring assets
OR
Working Capital: (shareholders equity + the long-term loans) - the fixed assets
What does it mean that a company has negative working capital?
It means that the company does not have great short term liquidity and the company needs to be taken into account based on their industry and economic activity.
How do you calculate working capital?
Current assets(Except cash)-Current Liabilities (Except bank overdrafts)
OR
Accounts Receivable + Inventory
- Accounts Payable
AR + I - AP
Why do Americans only have one working capital?
Working capital is long term analysis.
The operating Working capital is short term.
Seeing Americans only look at the short term horizon, they do not distinguish the two and call OWC the WC.
What does the Operating Working Capital represent?
It indicates the power relationships and strategic positions
How does OWC show power relationships?
If people trust you will pay because you are a strong player, you will have more accounts payable.
If not the suppliers will push you to pay before.
Same thing with customers. If you can force the retailers to pay in advance is because they need you more than you need them => lower accounts receivable
What does it mean if your Operating Working Capital is above Zero (OWC > 0)?
The business needs the related amount to supplement the financing of its operations (Most frequent case)
What does it mean if your Operating Working Capital is equal to Zero (OWC = 0) ?
The company has a good turnover of stocks, short duration of accounts receivable, longer duration of accounts payable.
What does it mean if your Operating Working Capital is below Zero (OWC < 0)?
⇒ A favorable strategic factor for the development of the growth policy.
⇒ A sign of managerial efficiency in a business with low inventory and accounts receivable (which means they operate on an almost strictly cash basis)
What do the turnover ratios describe?
3 ratios describe the short term policy of the company
What are the three turnover ratios?
Accounts Receivable Turnover ratio (DSO)
Accounts Payable Turnover ratio (DPO)
Inventory Turnover ratio (DIO)
How do you calculate the Accounts Payable Turnover ratio (DPO) ?
[Accounts Payable / Cost of Sales or Purchases (incl. VAT)] × 365
How do you calculate the Accounts Receivable Turnover ratio (DSO) ?
[Accounts receivable / Sales (incl. VAT)] × 365
How do you calculate the Inventory Turnover ratio (DIO)?
[Inventory / Sales (excl. VAT)] × 365
When do we use the AR turnover ratio (DSO)?
We want to know how long do customers take to pay us.
When do we use the AP turnover ratio (DPO)?
When we want to know Duration of payment of the suppliers’ liabilities
When do we use the Inventory turnover ratio (DIO)?
Duration for the company to sell its inventory
How do we calculate the Cash Conversion Cycle (CCC) ?
Days of inventory
+Days of Accounts Receivable
– Days of Accounts Payable
DIO+DSO-DPO
What does the Cash Conversion Cycle (CCC) tell us?
The number of days it takes for a company to turn its resource inputs into cash.
What are the three income elements?
Operating income
Financial income
No recurring items
What is Operating income?
The difference between operational activities costs and revenues.
The income derived from the main business activity (operating cycle)
The most relevant indicator of the profitability of a company.
What is Financial income?
The result that follows the modes of financing business activities
It represents the cost of financing
Highlights the financial burden of the business
What is Non-recurring income?
Derived essentially from the sales of some fixed assets
basically independent from operating activities
What are common size financial statements?
Income statement items expressed in % of sales (dividing each item amount by the sales)
