Message Font: Serif | Sans-Serif
No. of Recommendations: 0
hi hewitt,

I am still having difficulty with some of your concepts.

I see that Investment in Fixed Capital is mereley the difference between depreciation and capex. Don't forget that you need more than the Statement of Cash Flows to determine capex.

Here is my difficulty

In the book page 58, you wrote, "when working capital increases from one year to the next, a firm has made an investment in working capital. This too is a use of cash that does not appear on the accrual income statement.'

I don't get it.

If a company starts the year with the following balance sheet.

Cash 1000
receivables 1000
prepaid 1000
Inventory 1000

current assets 4000

Current liabilities 1000

Hence, working capital is 3000.

at the end of the year, assume the company had sales of 1000 for cash. And also collected the 1000 in receivables. Assume company paid off payables with the accounts receivable collection.

Then you have the following balance sheet.

Cash 2000
receivables 0
prepaid 1000
Inventory 1000

current assets 4000

Current liabilities 0

Hence, working capital is 4000.

Working capital went up 1000. How is this a use of working capital? Why would this be considered an investment in working capital. In this simple example, all is good. I don't get it.

I think you were trying to identify that this could be a warning sign for when current assets could be disguised with aggressive accounting.

For example, percentage increase in recievables over revenues, could mean lenient credit terms or under use of allowance account. Percentage increase of Inventory over revenues could mean that inventory is building and not being sold, etc etc.

Back to the point, I just think I am missing something, as I am having trouble interpretting the methods.

also, how would your method work with the shifting of current assets to long term assets. For example, maybe an accounts recievable due in 60 days, being converted to a 5 year note recievable. Here you would have a decrease of working capital. If I am reading your words correctly, it would seem that the decrease in working capital is a positive, when indeed the economics of the event has worsened and the potential for loss has increased.

thanks for any answers you might have.


ps. here are a few ratios that I use (amongst many others) in my analysis.

Here are just a few of the many items we look at in financial statements:

a. Compare earning to consensus estimates

b. Compare earnings, revenues, margins, SG&A, and cash flows to prior periods.

c. Consider the following calculations

1. Allowance for DA / Accounts Receivable

2. Allowance for DA / Sales

3. Change in Net Income / Change in Cash Flow

4. EPS / Debt per Share

c. Look at tax rates. did earnings change because of tax rate changes.

d. Look at shares outstanding. Watch carefully for dilution. Look at Statement of Cash Flows for true operating and free cash flow.

e. Look at "one time charges". If they are recurring in nature, consider using them as normalized expenses.

9. Seven Deadly Sins of Corporations

A. Recording revenue to soon

B. Recording bogus revenue

C. Boosting one-time gains

D. Shifting current expenses

E. Improperly recording liabilities

F. Shifting revenue forward

G. Shifting special charges

the following 2 are fool ratios

11. Flow Ratio - a measure of working capital efficiency.

Flow Ratio = (Current Assets - Cash and Short Term Investments) s/b < 1.25
Current Liabilities - Short Term Debt

12. Cash King - a measure of cash flow

Cash King = Free Cash Flow s/b > 10%

19. Various Cash Flow Ratios

a. Operating Cash Flow (OCF) = CF from Operations/ Current Liabilities

b. Funds Flow Coverage (FFC) = EBITDA / (Interest + Tax adjusted debt repayment + Tax adjusted Preferred Dividends)

c. Cash Interest Coverage = ( CF from Operations + Interest Paid + Taxes Paid) / Interest Paid

d. Cash Current Debt Coverage = ( operating Cash Flow - Cash Dividends) / Current Debt

e. Capital Expenditure = CFO/Capex

f. Total Debt = CFO/ Total Debt

g. Cash Flow Adequacy (CFA) = (EBITDA - taxes paid - interest paid - capex)/ Average annual debt maturities over next 5 years

Print the post  


What was Your Dumbest Investment?
Share it with us -- and learn from others' stories of flubs.
When Life Gives You Lemons
We all have had hardships and made poor decisions. The important thing is how we respond and grow. Read the story of a Fool who started from nothing, and looks to gain everything.
Contact Us
Contact Customer Service and other Fool departments here.
Work for Fools?
Winner of the Washingtonian great places to work, and Glassdoor #1 Company to Work For 2015! Have access to all of TMF's online and email products for FREE, and be paid for your contributions to TMF! Click the link and start your Fool career.