Working capital
Net working capital = current assets − current liabilities. At the invented Al Wadi Foods: 430 − 250 = 180 million. It is a broad measure of short-term liquidity, and it does not mean all 180 is money tied up in inventory and receivables: current assets include cash of 80, and current liabilities include a short-term loan of 100. To see the cash tied up in the operating cycle, we look at operating working capital: inventory + receivables − payables = 200 + 150 − 150 = 200 million, with details varying by business. That amount has to be funded from profit, shareholders or loans.
Three periods in days
Average = (opening balance + closing balance) ÷ 2. The cycle = inventory days + collection days − payment days.
Why it matters
During those 86 days the company has paid its supplier and not yet collected from its customer. As sales grow, the money tied up in that gap grows with them. So a fast-growing, profitable company may still need loans: the profit exists on paper while the cash is still on its way.
The cycle can shorten in several ways: selling inventory faster, collecting sooner, or getting longer credit from suppliers. Any big change from one year to the next deserves a question, especially a sudden jump in collection days.
Compute the cycle for a real company
Take any company's income statement and balance sheet from the disclosure archive and compute the three periods and the cycle for two consecutive years.
Check yourself
1. Inventory days 60, collection days 30, payment days 45. How long is the cycle?
2. Collection days jumped from 40 to 90. What does that usually mean?
Summary
- Net working capital = current assets − current liabilities; the cash tied up in operations is closer to inventory + receivables − payables.
- Cycle = inventory days + collection days − payment days.
- A long cycle needs funding, and grows as sales grow.