Dec 6, 2012|
Without cash, how liquid is your company?
Working capital is calculated by subtracting current assets by current liabilities. The rule of thumb is that positive working capital means that a company is able to pay off its short-term liabilities.
What is the average amount of working capital needed by a company is calculated by dividing the net working capital figure by net sales of a particular year. It may be noted that this is an average figure and as such only gives an indication.
In majority of the cases, the key components in the calculation of working capital are debtors, inventories and creditors. Cash would form a substantial portion of the networking capital in some cases. But since it is idle cash, it is not really 'working' for the company. How much cash is needed for day to day operations depends on the company and the sector it operates in. Managements tend to keep idle cash on books for safety. These funds are usually invested in highly liquid and safe assets, thereby earning quite low returns.
Working capital cycle plays a vital role in business productivity. It is a measure of the company's efficiency in managing its operational costs. It is calculated by dividing the working capital by the net sales and multiplying the result by 365. To make this calculation more meaningful, we would be required to remove the cash (and cash equivalents) from the current assets figure. This is how we arrive at a figure called the non-cash working capital.
How can one look at non-cash working capital?
It is common practice to compare the non-cash working capital to the revenues of each year. If the figures is an increasing one, the trend indicates that the company is finding it difficult to receive payments or that its inventory is moving slower. It could also be inferred that the company is making payments faster than it is receiving cash (or unblocking) thereby reducing the denominator.
If this figure is in a decreasing mode, it indicates that the company is able to convert its debtors and inventories into cash at a faster pace (as compared to earlier). Or, it could indicate that the company is increasing its time to pay its suppliers (creditors).
Investors could also compare and gauge the absolute changes in non-cash working capital to the absolute change in revenues and compare these figures. While one may find a trend over a long term, short term blips would be occurring more often. There would be instances when the absolute change in working capital is negative. This means the company has been able to lower its current assets figure - inventories and debtors - and thus released blocked cash.
Let us take up an example to explain this further.
Data Source: ACE Equity
|Cash and Bank
|Other Current Assets
|Short Term Loans and Advances
|Long Term Loans & Advances
|Other Non Current Assets
|Total Current Assets
|Other Current Liabilities
|Long Term Provisions
|Other Long Term Liabilities
|Short Term Provisions
|Total Current Liabilities
|Working capital (WC)
|Non-cash working capital (NCWC)
|WC/ Net sales
|NCWC / Net sales
|Change in NCWC (a)
|Change in net sales (b)
The data in the table above is of standalone numbers. It may be noted that because of the Britannia Industries'change in accounting standards of companies during FY12 (and thereby the FY11 numbers in latest annual report), we have included the non-current accounts to make comparison with historical numbers more comparable. In addition, the 'Other Current Liabilities' figures have been adjusted in FY11 and FY12 to make the numbers comparable to the previous years.
As you can see, the company's operating performance improved substantially over the past five years. From its working capital cycle being about 54 days in FY08 reduced to 21 days.
Britannia's non-cash working capital (after reducing cash and current investments) also improved to about 1% of net sales over the years.
Also the absolute change in non-cash working capital divided by absolute change in net sales reduced over time, indicating that the company required lesser non-cash working capital to generate more sales.
||Devanshu Sampat (Research Analyst) has a degree in commerce and nearly 5 years of experience in equity research. He draws inspiration from successful value investors across the globe and constantly endeavours to refine his own unique stock picking approach. While a firm advocate of the principles of value investing, he believes in adapting a versatile investing strategy in response to varying market conditions. Devanshu contributes to our Megatrend investing service The India Letter.
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