Sunday, September 24, 2006

How do You Measure Working Capital?

In my September 17th posting I offered a simple definition of working capital – the difference between current assets and current liabilities. Money tied up in working capital is money not available to grow the company.

The benchmarks that many companies (and their lenders) use to evaluate how efficient a company is with its working capital includes days sales outstanding, days payables outstanding, days inventory outstanding and days working capital. Here are the calculations of these definitions as shown in the September issue of CFO Magazine .

How Working Capital Works

Days Sales Outstanding: AR/(net sales/365)
Year-end trade receivables net of allowance for doubtful accounts, plus financial receivables, divided by net sales per day.

A decrease in DSO represents an improvement, an increase a deterioration. Companies marked with an asterisk have securitized receivables, which can artificially improve DSO without changing actual customer-to-cash processes. The survey eliminates this distortion by adding receivables back on the balance sheet before calculating DSO.

Days Payables Outstanding: AP/(net sales/365)

Year-end trade payables divided by sales per day.* An increase in DPO is an improvement, a decrease a deterioration. For purposes of the survey, payables exclude accrued expenses.

Days Inventory Outstanding: inventory/(net sales/365)

Year-end inventories divided by sales per day.* A decrease is an improvement, an increase a deterioration.

Days Working Capital: (AR + inventory - AP)/(net sales/365)

Year-end net working capital (trade receivables plus inventory, minus AP) divided by sales per day. The lower the number of days, the better. In the charts, a DWC change of -X% represents an improvement (even if DWC itself is negative), while a DWC change of +X% represents a deterioration. The percent change is marked NA (Not Applicable) if DWC moved from a positive to a negative number or vice versa.

*Note: Many companies use cost of goods sold instead of net sales when calculating DPO and DIO. The Hackett-REL methodology reflected on the working-capital charts uses net sales across each working-cap component to allow a balanced comparison across each DWC element and provide true comparison between industries. Reported sales have been adjusted for acquisitions and disposals during the year.

Does your company use these or similar calculations in measuring working capital?

Click here to read "Matchmaking for Business Loans" or to read "Interest Expense Reduced by Over 50%!"

Related Tags:

No comments: