Enjoyed this video? Then please subscribe to the channel, and watch the related videos on working capital management ru-vid.com/video/%D0%B2%D0%B8%D0%B4%D0%B5%D0%BE-c5iigcEppZw.html and managing accounts receivable DSO (Days Sales Outstanding): ru-vid.com/video/%D0%B2%D0%B8%D0%B4%D0%B5%D0%BE-duN0BAY9Q8s.html
Could you elaborate on what you meant by saying that negative working capital is a good thing? isn't it a bad thing as it means that the company doesn't have enough current assets to meet its current liabilities?
Glad it was helpful! Thank you for watching and commenting! Please subscribe, and watch the related video on working capital management as well: ru-vid.com/video/%D0%B2%D0%B8%D0%B4%D0%B5%D0%BE-c5iigcEppZw.html
Awesome! Happy to help. Please be aware that not everybody defines working capital in the same way. More on that in the related video: ru-vid.com/video/%D0%B2%D0%B8%D0%B4%D0%B5%D0%BE-c5iigcEppZw.html
It just clicked for me when you described how third parties are literally financing the operations as working capital with outstanding payables that are unearned revenues in MS' books. Your channel is amazing. Vielen dank!
Hi, thank you for your clear explanation of the working capital! I appreciate the work and effort you put in your videos!! I've a question, I hope you can answer me. In my financial analysis class, the teacher talks about working capital but also working capital need (or requirement). But I really cannot understand what's the difference between both. And he said that a negative working capital is bad since this means that the company hasn't enough cash to pay it's short term debts. However a working capital need that is negative means the company has enough operating sources to finance its operating cycle. I'm a little bit confused about the difference between both notions and their formulas 😓
Hello! Thank you for your kind words. I am not sure what your teacher is talking about either. I can try to make guesses, but it would be better to ask him or her directly. Also make sure you ask what he or she is including in their scope/definition of working capital (in terms of which balance sheet line items are in the calculation), as that is not a uniform definition. And lastly, check whether your teacher has ever worked in the real world on managing working capital as a finance or business person. Textbook world often differs from real world business. For example.... Working capital tends to get defined in textbooks as the current assets on a company’s balance sheet minus its current liabilities. Current assets include items such as cash, marketable securities, accounts receivable, inventory, and prepaid expenses. Current liabilities include items such as short-term debt, accounts payable, accrued liabilities, and deferred revenue. There is a much more practical definition, used in everyday business life, that focuses on those items that are (in real life) often the largest in amount: accounts receivable, plus inventory, minus accounts payable. See my video on working capital management: ru-vid.com/video/%D0%B2%D0%B8%D0%B4%D0%B5%D0%BE-c5iigcEppZw.html There is more than one way to think about working capital, look at what the company really needs, and only then decide how working capital fits into the picture. Furthermore, "good" or "bad" are very subjective. For example, textbooks will suggest that a current ratio (a ratio to measure liquidity, related to working capital management) above 1 or even 1.5 is desirable. I can make the case that 0.5 is great, as well as the case that 2 is great. It all depends! See my discussion of current ratio, featuring the numbers of McDonald’s, Microsoft, Verizon and Walmart ru-vid.com/video/%D0%B2%D0%B8%D0%B4%D0%B5%D0%BE-dkiSWO2OYho.html My apologies if you are now "confused at a higher level". ;-) Just wanted to give some example of how the real world has a lot more dimensions and a lot more trade-offs (for example between selling price and credit terms, which affects DSO) than any teacher without real world experience can imagine. I made a fun video about inventory management based on my experience in a multinational company ru-vid.com/video/%D0%B2%D0%B8%D0%B4%D0%B5%D0%BE-DZhHSR4_9B4.html and one on Days Sales Outstanding (collections performance for accounts receivable) ru-vid.com/video/%D0%B2%D0%B8%D0%B4%D0%B5%D0%BE-duN0BAY9Q8s.html
If working capital is negative, then the sum of accounts receivable and inventory is smaller than the amount in accounts payable (using a simple example where those three are the only items of working capital, which is correct for most but not all companies). In business terms, your suppliers (accounts payable) are financing your business more with "free loans" than you are providing free loans to customers (accounts receivable) and holding inventory. See also my video on working capital management ru-vid.com/video/%D0%B2%D0%B8%D0%B4%D0%B5%D0%BE-c5iigcEppZw.html and my discussion of the current ratio ru-vid.com/video/%D0%B2%D0%B8%D0%B4%D0%B5%D0%BE-dkiSWO2OYho.html
@@TheFinanceStoryteller one more thing i just check Oracle's Financials on their website. They have Accrued compensation and related benefits and Deferred revenues so will we include them. If so then here is the working AR 4576 - AP 534 - Accrued comp 1,390 - Deferred Revenue 9875 = -7,223 so suppliers and customers are sponsoring their business
I would suggest to calculate Oracle's working capital in a similar way to how I calculated Microsoft's working capital as an example in the video. It is not uncommon for software companies to have a negative amount of working capital, due to deferred (unearned) revenue ru-vid.com/video/%D0%B2%D0%B8%D0%B4%D0%B5%D0%BE-SNguYyKrqL4.html
@@TheFinanceStoryteller Thank you for your reply. Let me try and explain, perhaps my terminology was incorrect. I am trying to understand that before any corporation begins its activities (any industry; from software to manufacturing), considering that its creditors will be paid after X days, and its debtors will pay in Y days, How does the firm ascertain how much finance/cash is needed on a monthly basis to actually run the business? Since Cash inflows and Outflows will not be immediate, how does it ensure that it doesnt run out of pocket?!
First of all, raising enough capital to cover the development, prototyping and commercialization stage of their growth curve, as well as the intense working capital need during early growth and scale up. As a start-up X is likely to be shorter than Y, something that is often underestimated. It is also advisable to do a sensitivity analysis on key variables: what if the "go live" is delayed by several months, what if the R&D effort is 10% over budget? Three suggestions of videos on aspects of this: 1) Revenue, profit and free cash flow in the business plan ru-vid.com/video/%D0%B2%D0%B8%D0%B4%D0%B5%D0%BE-FC0ZODWFzpo.html 2) Cash flow patterns across a business lifecycle ru-vid.com/video/%D0%B2%D0%B8%D0%B4%D0%B5%D0%BE-UGd2llFBiMA.html 3) Cash flow forecasting in Excel ru-vid.com/video/%D0%B2%D0%B8%D0%B4%D0%B5%D0%BE-XVWV1hIsiUs.html Hope this helps!
Happy to help! Important to add that however you do the modeling, keep in mind to update along the way with latest data, latest insights, latest timing, etc. Work in iterations, and incorporate what you learn along the way.
I agree that the idea of negative working capital being a good thing is not intuitively clear to everyone. Here's an example. Situation A: accounts receivable $200, inventory $100, accounts payable $50. Working capital is $200 + $100 - $50 = $250. As assets exceed liabilities, the company has to finance the net $250 by either debt or equity. Situation B: account receivable $100, inventory $50, accounts payable $200. Working capital is $100 + $50 - $200 = ($50). The "free loan" from suppliers through accounts payable exceeds the sum of what is needed to provide "free loans" to customers (accounts receivable) plus inventory. Negative working capital situation. Great for cash flow! Apple's working capital is similar to situation B above. Learn more in my videos about working capital management: ru-vid.com/video/%D0%B2%D0%B8%D0%B4%D0%B5%D0%BE-c5iigcEppZw.html
Thank you very much, Christine! Take a look at the sequel on working capital management as well: ru-vid.com/video/%D0%B2%D0%B8%D0%B4%D0%B5%D0%BE-c5iigcEppZw.html
As working capital = Current assets - Current liabilities. You are saying that negative working capital is a good thing, to have negative working capital, Current liabilities should be greater Current assets. But if Current assets are less than Current liabilities then Current ratio ( = Current assets/ Current liabilities) will be less than 1. Which means company will face liquidity issues. So, don't you think it's bad to have negative working capital?
Hi Krishan! You are following your textbook too much. It's better to study real world companies. Sometimes it is bad to have negative working capital, at other times it isn't. Here are some examples of very well run companies (without liquidity issues) that have a very high or very low current ratio: ru-vid.com/video/%D0%B2%D0%B8%D0%B4%D0%B5%D0%BE-dkiSWO2OYho.html
That depends..... Do you want to live in the world of textbooks, or in the world of real companies? Working capital tends to get defined in textbooks as the current assets on a company’s balance sheet minus its current liabilities. Current assets include items such as cash, marketable securities, accounts receivable, inventory, and prepaid expenses. Current liabilities include items such as short-term debt, accounts payable, accrued liabilities, and deferred revenue. There is a much more practical definition, used in everyday business life as well as in my videos, that focuses on those items that are (in real life) often the largest in amount: accounts receivable, plus inventory, minus accounts payable. See also the video on working capital management: ru-vid.com/video/%D0%B2%D0%B8%D0%B4%D0%B5%D0%BE-c5iigcEppZw.html
just confused. from investopedia vids, higher working capital is better. the higher the current asset than current liability the better. means you have more than enough current asset to cover current liability
Working capital tends to get defined in textbooks as the current assets on a company’s balance sheet minus its current liabilities. Current assets include items such as cash, marketable securities, accounts receivable, inventory, and prepaid expenses. Current liabilities include items such as short-term debt, accounts payable, accrued liabilities, and deferred revenue. There is a much more practical definition, used in everyday business life (and this video), that focuses on those items that are (in real life) often the largest in amount: accounts receivable, plus inventory, minus accounts payable. See also my related video on working capital management: ru-vid.com/video/%D0%B2%D0%B8%D0%B4%D0%B5%D0%BE-c5iigcEppZw.html If you want to compare current assets to current liabilities, then the current ratio is the thing to look at: ru-vid.com/video/%D0%B2%D0%B8%D0%B4%D0%B5%D0%BE-dkiSWO2OYho.html
That's a very good question, which is difficult to answer. I don't think there are any "absolute" levels of working capital that are too high or too low. If a company wants to generate more cash flow from operating activities, then one way to do that is to decrease the amount of working capital, in that case the working capital "starting point" would be too high. If a small/startup company wants to grow rapidly, it might be increasing working capital as a result (more sales lead to more invoices sent to customers, which lead to more accounts receivable | having availability of product in multiple locations leads to more inventory), therefore the working capital "starting point" would be too low and working capital is increased. "Too high" is therefore a function of the strategy and goals of the company. See also my video on working capital management: ru-vid.com/video/%D0%B2%D0%B8%D0%B4%D0%B5%D0%BE-c5iigcEppZw.html
@3:20 I was always confused about CCC when units were in days. However, seeing in it from the balance sheet in $ units the CCC formula makes much more sense. Thanks.
Sir, why haven't u considered cash and cash equivalent in current asset? because on yahoo finance i see them considering cash in calculating working capital. Is that wrong!
Hello Mr Nikhil! Sadly, there is no unified definition of working capital, but different definitions are in circulation. I stick to the one that I find most useful and actionable, and that we used when I worked at General Electric: accounts receivable + inventory - accounts payable, and in some business also minus progress collections (deferred revenue). Using that definition, if working capital goes down, then cash goes up, and vice versa. See also my video on working capital management: ru-vid.com/video/%D0%B2%D0%B8%D0%B4%D0%B5%D0%BE-c5iigcEppZw.html Working capital tends to get defined in textbooks as the current assets on a company’s balance sheet minus its current liabilities. Current assets include items such as cash, marketable securities, accounts receivable, inventory, and prepaid expenses. Current liabilities include items such as short-term debt, accounts payable, accrued liabilities, and deferred revenue. There is a much more practical definition, used in everyday business life, that focuses on those items that are (in real life) often the largest in amount: accounts receivable, plus inventory, minus accounts payable.
Very educational channel, thank you very much for the excellent class! I am having a question about gift card liabilites here . A company has a negative working capital, and the explanation I got is that the company has tons of gift card liabilities. But what I don't understand is that when they received the cash from the sales of gift cards, the company in the same time records the cash as a current asset, right? So gift card liabilities don't explain the negative working capital...That is what confused me. Could you please help me with this ? Thank you so much!
Excellent question! Gift cards that have not been used by the consumer yet are a type of deferred revenue. You will find the answer to your question in my video on deferred revenue, more specifically the Home Depot example and the T-accounting for the journal entries. Two hints: think through the journal entry when the gift card is sold to the customer (what is the debit, what is the credit), and realize that negative working capital means that the sum of accounts receivable and inventories is smaller than the sum of accounts payable and deferred revenue. Hope this helps. I have not given you a direct answer, but hopefully I am leading you on the right path to find it out for yourself. If you need more help, just let me know. Here's the link to the video on deferred revenue: ru-vid.com/video/%D0%B2%D0%B8%D0%B4%D0%B5%D0%BE-SNguYyKrqL4.html and here's the link to a related video on revenue recognition: ru-vid.com/video/%D0%B2%D0%B8%D0%B4%D0%B5%D0%BE-816Q6pOaGv4.html
It’s indeed will be recorded in the current asset. So the deferred revenue does not change the working capital. It’s important that this video stated its way of calculating working capital is different I suppose. While the most conventional way of WC is the difference between current asset and current liabilities.
sorry, isn't working capital simply current asset - current liabilities? This means cash, prepaid expenses, other liabilities are included. Why do you exclude them in 3M example?
Hello! There is no single unified definition. Working capital tends to get defined in textbooks as the current assets on a company’s balance sheet minus its current liabilities. There is a much more practical definition, used in everyday business life, that focuses on those items that are (in real life) often the largest in amount: accounts receivable, plus inventory, minus accounts payable. If you use the latter, then if working capital goes down, cash goes up. I go through a lot of presentation materials from the investor relations websites of large multinational companies, and all of them use that second definition, or a variation thereof (i.e. things like deferred revenue can also get deducted).
Do you offer a premium subscription via patreon or RU-vid? I'd be happy to participate and get more of the valuable knowledge you share with the community!
Thank you very much for the kind words! I consider that a huge compliment. :-) All my videos are free to watch on RU-vid. My premium offerings are classroom trainings and/or webinars customized to the client (i.e. focusing on the financial statements of the company and competitors), as well as business simulations. For viewers (e.g. Certified Public Accountants) interested in receiving CPE credits for watching the videos, I partner with online learning platform illumeo, www.illumeo.com (discount code Devroe10).
"you could argue that items such as prepaid expenses on the assets side, and accrued payroll on the liabilities side may also be considered 'in scope' " Why you didn't include? i don't understand you said "in scope"
That is a very good question! Some companies do include them, others don't. I prefer to exclude these items, as they are in most cases immaterial (not big enough to matter), and they are more of an accounting nature (allocating cost between current and future periods correctly) rather than something that operational management can influence directly (like the core working capital items accounts receivable, inventory, and accounts payable). Does that make sense?
If working capital goes up, then cash goes down, so it would decrease your cash flow. See also my video on CFOA (Cash From Operating Activities) vs net income ru-vid.com/video/%D0%B2%D0%B8%D0%B4%D0%B5%D0%BE-SX6tDy7YPgc.html
Working capital tends to get defined in textbooks as the current assets on a company’s balance sheet minus its current liabilities. Current assets include items such as cash, marketable securities, accounts receivable, inventory, and prepaid expenses. Current liabilities include items such as short-term debt, accounts payable, accrued liabilities, and deferred revenue. There is a much more practical definition, used in everyday business life, that focuses on those items that are (in real life) often the largest in amount: accounts receivable, plus inventory, minus accounts payable. I use that latter definition.
Thanks for watching! Have you seen the related video on working capital management ru-vid.com/video/%D0%B2%D0%B8%D0%B4%D0%B5%D0%BE-c5iigcEppZw.html as well?
Nice to hear that! Thank you! I have follow-up videos on working capital management ru-vid.com/video/%D0%B2%D0%B8%D0%B4%D0%B5%D0%BE-c5iigcEppZw.html and inventory management ru-vid.com/video/%D0%B2%D0%B8%D0%B4%D0%B5%D0%BE-DZhHSR4_9B4.html that might be interesting to watch as well.
Hello Prasanna! I think my follow-up video on working capital management might do just that: ru-vid.com/video/%D0%B2%D0%B8%D0%B4%D0%B5%D0%BE-c5iigcEppZw.html
Most welcome! Related videos on individual items within working capital in this playlist: ru-vid.com/video/%D0%B2%D0%B8%D0%B4%D0%B5%D0%BE-DZhHSR4_9B4.html&pp=gAQBiAQB
Happy to help! More videos on the various aspects of working capital management in this playlist: ru-vid.com/video/%D0%B2%D0%B8%D0%B4%D0%B5%D0%BE-DZhHSR4_9B4.html&pp=gAQBiAQB
Great to hear that, Jaleesa! I have some related videos on for example inventory management ru-vid.com/video/%D0%B2%D0%B8%D0%B4%D0%B5%D0%BE-DZhHSR4_9B4.html and days sales outstanding ru-vid.com/video/%D0%B2%D0%B8%D0%B4%D0%B5%D0%BE-duN0BAY9Q8s.html as well that might be helpful to you too.
In my textbook it says working capital should be positive. Working Capital = Current Assets - Current Liabilities. My textbook says a positive working capital is a good thing, and negative working capital is not good.
Working capital tends to get defined in textbooks as the current assets on a company’s balance sheet minus its current liabilities. There is a much more practical definition, used in everyday business life, that focuses on those items that are (in real life) often the largest in amount: accounts receivable, plus inventory, minus accounts payable. If your working capital is negative according to that latter definition (accounts payable is bigger than the sum of accounts receivable plus inventory), then your suppliers are granting you more credit than the sum of the credit you are granting to your customers plus holding inventory for customers. Isn't that a great way as a business owner to finance your business? The author of your textbook seems to have a limited perspective on real world financial statements. The real world is much more varied than the reductionist mind of a textbook writer can understand. Take a look at my discussion of the current ratio to get some more perspective: ru-vid.com/video/%D0%B2%D0%B8%D0%B4%D0%B5%D0%BE-dkiSWO2OYho.html
Happy to help, George! Take a look at my walk-through of the Walmart balance sheet, I think that illustrates some of the learning points nicely: ru-vid.com/video/%D0%B2%D0%B8%D0%B4%D0%B5%D0%BE-eIjCaeNm-Vk.html
Great! It's a very very important one, as a company's profit does not equal its cash flow, unless working capital is managed very well: ru-vid.com/video/%D0%B2%D0%B8%D0%B4%D0%B5%D0%BE-c5iigcEppZw.html
If you want to maximize cash flow, then the lower the working capital would indeed be the better. However, that's not necessarily the best solution in all possible situations, as my video on working capital management discusses: ru-vid.com/video/%D0%B2%D0%B8%D0%B4%D0%B5%D0%BE-c5iigcEppZw.html
This is my first video on your channel that i have watched. And thank you for giving me this conceptual clarity. Will sure watch the other stuff you have put. Also I wanted to ask whether there are other channels you recommend who can give such concise understanding of finance concepts. Actually I am a CA student so I really wanna understand the basic concept what I am learning.
Welcome to the channel! Have a look at my follow-up videos on working capital management, DSO, current ratio, etc. as well: ru-vid.com/video/%D0%B2%D0%B8%D0%B4%D0%B5%D0%BE-c5iigcEppZw.html If you go my channel, you will see various tabs: videos, playlists, community, etc. One of these tabs is channels, where I placed the link to some related channels that I think are worthwhile. Have a look!
Hi David! See my video on working capital management: ru-vid.com/video/%D0%B2%D0%B8%D0%B4%D0%B5%D0%BE-c5iigcEppZw.html I use the practical definition of working capital, used in everyday business life, that focuses on those items that are (in real life) often the largest in amount: accounts receivable, plus inventory, minus accounts payable.
@@davidroldan6007 Of course! That's the best part of running a RU-vid channel: getting people to think about the ideas you are sharing. I love to get questions, and try to reply as soon as I can. Please subscribe, and spread the word!
I thought working capital was current assets minus current liabilities in this case wouldn't it be 169,662-58,488=111,174 for Microsoft? In regards to working capital.
A big part of Microsoft's current assets consists of short term investments, I would hardly call that "working" capital, as it is not needed for Microsoft's day-to-day operations. Working capital tends to get defined in textbooks as the current assets on a company’s balance sheet minus its current liabilities. Current assets include items such as cash, marketable securities, accounts receivable, inventory, and prepaid expenses. Current liabilities include items such as short-term debt, accounts payable, accrued liabilities, and deferred revenue. There is a much more practical definition, used in everyday business life, that focuses on those items that are (in real life) often the largest in amount: accounts receivable, plus inventory, minus accounts payable, and minus (in the case of Microsoft and many other tech companies) unearned/deferred revenue.
could you please explain what changes in working capital represents. ik your just comparing two years but I don't understand it, for example why it shows us in the cash flow statement
Hello John! Here's an example. Working capital balance at January 1st $90, consisting of receivables $80, plus inventory of $30, minus payables of $20. Working capital balance at December 31st of $100, consisting of receivables $70, plus inventory $40, minus payables of $10. The change in working capital balance is $10 increase, which means an additional $10 is "stuck" in various places on the balance sheet, while what it really wants is to be cash. Therefore, negative effect of working capital on cash flow, shown as changes in working capital (10) i.e. cash outflow, or one level lower: change in receivables 10 as balance is down therefore cash is freed up, change in inventory (10) as balance is up therefore cash gets tied, and change in payables (10) as balance is down (suppliers getting paid) therefore less "free financing" from the supplier. Does that make sense?
But how come Negative Working capital is a good thing? ru-vid.com/video/%D0%B2%D0%B8%D0%B4%D0%B5%D0%BE-XvHAlui-Bno.html When they have more Current Liabilities rather than liquid current assets (cash), so they have not enough cash to cover their day to day operations.
Microsoft (like many of the tech firms) is an unusual case... they have so much cash, cash equivalents and short-term investments, that I would not worry too much about their ability to cover their daily operations! But in general you are right.... having low or negative working capital is great from the perspective of generating free cash flow, but is dangerous in terms of liquidity. It's a trade-off between efficiency and robustness, or in other words asset utilization and asset strength. See my video on the current ratio that discusses the dilemma: ru-vid.com/video/%D0%B2%D0%B8%D0%B4%D0%B5%D0%BE-dkiSWO2OYho.html
Could you elaborate on why at 1:40 the cash flow is higher for option B than option A? In both cases the same amount of money will be paid (ie the same amount of money will flow) if I am not mistaken.
In option B - High Turnover of inventory due to J.I.T (which corresponds to greater mobilization in Sales Revenue) coupled with Customers paying cash on delivery (which is minimizing or eliminating the effect of potentially Outstanding Accts Receivable) means Cash Resources are generated faster in the operating cycle. Also, bcoz of J.I.T - inventory, holding costs will reduce significantly which means many expense line items will be reduced resulting in greater profits. In option A - Pay suppliers Cash on Delivery - so cash immediately goes out. Hold high inventory levels - high inventory is parked in the Balance Sheet. This increases inventory holding costs as well (as opposed to option B). Plus, it also corresponds to lower Sales Revenue Generation compared to option B because inventory is a driver of Sales. Grant customer 45 days credit - contributing to stagnant Accts Receivable. So the money which supposed to be ours is stuck with the customers. All of this above strains Cash Resources. To conclude - if you consider the very short term - option B generates Cash Resources quicker than A. So B is a safer strategy.
Amount of money paid is the same, however the timing of the incoming and outgoing payments is different, and that's what working capital management and cash flow management tends to be mostly about.
Working capital tends to get defined in textbooks as the current assets on a company’s balance sheet minus its current liabilities. Current assets include items such as cash, marketable securities, accounts receivable, inventory, and prepaid expenses. Current liabilities include items such as short-term debt, accounts payable, accrued liabilities, and deferred revenue. There is a much more practical definition, used in everyday business life (and my videos), that focuses on those items that are (in real life) often the largest in amount: accounts receivable, plus inventory, minus accounts payable. So be very careful with definitions, as there is no "universal" one! With the definition of working capital that I use: the lower the working capital, the higher the cash flow (which is a good thing). For pros and cons of high and low working capital, see my related video on working capital management: ru-vid.com/video/%D0%B2%D0%B8%D0%B4%D0%B5%D0%BE-c5iigcEppZw.html
Cash doesn't want to get stuck in the warehouse as inventory, or as an open invoice in accounts receivable. Cash wants to be cash, which the business can spend.
Hello Neha! Working capital is the total amount of capital invested into your company’s operating cycle (day-to-day operations). If you want to learn about the relationship between working capital (accounts receivable, inventory, accounts payable) and shareholder capital (equity), then please watch my video on the relationship between income statement and balance sheet: ru-vid.com/video/%D0%B2%D0%B8%D0%B4%D0%B5%D0%BE-wZdaVEX41WQ.html
The comments are one of the best things of being a RU-vidr! :-) It gives a good indication of whether viewers find the videos relevant, and what else they might be interested in. Plus I love to help wherever I can!
in the example you gave you said that working capital is inventory + trade receivables - trade payables, isn't that the definition of working capital requirement instead?
I have not heard anybody use the term "working capital requirement" before. My definition is based on how the term working capital is used in the real business world.
Hello Damien! Not completely sure what your question is. In the business world, working capital is mostly defined as accounts receivable (assets) + inventory (assets) - accounts payable (liabilities). Textbooks might give you a broader definition of current assets minus current liabilities, but that is not very practical in everyday business use. See also my video on working capital management: ru-vid.com/video/%D0%B2%D0%B8%D0%B4%D0%B5%D0%BE-c5iigcEppZw.html
@@ahmedxh Hello Ahmed! After watching the "Working capital explained" video above, I would recommend my video on "Inventory turnover" ru-vid.com/video/%D0%B2%D0%B8%D0%B4%D0%B5%D0%BE-uhJV5fbVNYE.html and the video on "accounts payable and accounts receivable" ru-vid.com/video/%D0%B2%D0%B8%D0%B4%D0%B5%D0%BE-x_aUWbQa878.html and the one on "deferred revenue" ru-vid.com/video/%D0%B2%D0%B8%D0%B4%D0%B5%D0%BE-SNguYyKrqL4.html All of these are elements of working capital. Enjoy!
@@TheFinanceStoryteller Why is cash (a current asset) not considered in your working capital equations? Shouldn't it be current assets minus current liabilities?
@@jas18320 There are multiple definitions of working capital in use. Working capital tends to get defined in textbooks as the current assets on a company’s balance sheet minus its current liabilities. Current assets include items such as cash, marketable securities, accounts receivable, inventory, and prepaid expenses. Current liabilities include items such as short-term debt, accounts payable, accrued liabilities, and deferred revenue. There is a much more practical definition, used in everyday business life, that focuses on those items that are (in real life) often the largest in amount: accounts receivable, plus inventory, minus accounts payable.
Hi Keshav! That depends. In the business world, working capital is mostly defined as accounts receivable (assets) + inventory (assets) - accounts payable (liabilities). Textbooks might give you a broader definition of current assets minus current liabilities, but that is not very practical in everyday business use. See also my video on working capital management: ru-vid.com/video/%D0%B2%D0%B8%D0%B4%D0%B5%D0%BE-c5iigcEppZw.html
Interesting thought, but I have never heard any cases of that happening. I don't think it would be appropriate, as some contracts are deferred over multiple years.
What you need to look at is the change of the working capital balance year-over-year (between one balance sheet and the next). The most common definition of working capital out in the real world of corporations is receivables plus inventory minus payables. If receivables go up from one year-end balance sheet to the next, then cash flow goes down (the money is "stuck" in unpaid invoices). If inventory goes up, then cash flow goes down as well (the money is "stuck" in the warehouse). If payables go up, then cash flow goes up (it is taking longer to pay suppliers). My follow-up video on working capital management has more discussion of the drivers of these: ru-vid.com/video/%D0%B2%D0%B8%D0%B4%D0%B5%D0%BE-c5iigcEppZw.html Also, my case studies of the cash flow statement walk through this: ru-vid.com/video/%D0%B2%D0%B8%D0%B4%D0%B5%D0%BE-YiU_DXlLZ4s.html
Congratulations. You are very didactic. I have one question: You mentioned that a negative working capital means your customers and suppliers are financing your daily operations. Is it always true or its just for the case when you have unearned revenue?
Thanks for the kind words!!! It certainly helps to have a large amount of deferred/unearned revenue, but some companies like Walmart ru-vid.com/video/%D0%B2%D0%B8%D0%B4%D0%B5%D0%BE-eIjCaeNm-Vk.html or Apple ru-vid.com/video/%D0%B2%D0%B8%D0%B4%D0%B5%D0%BE-J_1F8GoLOI8.html get to zero working capital or negative working capital even if you exclude deferred/unearned revenue.
If possible, can you give some examples of working capital in energy sector? Is it correct to assume the energy sector would prefer lower working capital? Many Thanks
When you talk about "the energy sector", I can think of 3 types of players: 1) utilities companies that run a power plant to produce electricity, 2) oil and gas companies that extract products and sell them, and 3) companies that build and sell wind turbines, gas turbines, compressors, etc. I do not have a lot of experience in the energy sector, the most notable was to interact with companies in the 3rd category (producing turbines). Their most important challenge in the field of working capital is to maximize the customer prepayments ("deferred revenue", "progress collections") and to build and install the turbine as fast and accurately as possible, to transfer the asset to the customer (companies in the 1st and 2nd categories). Hope this helps!
