Be careful of accounting definitions
- The accounting definition of working capital = current assets – current liabilities.
- On the surface this has very little meaning.
- Current assets & liabilities could contain items that is not related to operations.
- Know your numbers so you know your business
Working capital: Internal Vs External
- Working capital is used to evaluate the efficiency of cash management in meeting the demands of the direct cost of goods/ services.
- The more certain we are, the less working capital we need.
- The more uncertain the more you need on hand
- If you half operating cycle, you half working capital need
- The whole point of WC management is to determine whether the company has enough cash to pay off short term operating liabilities as they come due.
- Bad working capital management further reduces profitability due to limited cash for further investment
- The goal is optimization and not maximization
Download the excel template in the video here: Profitability Vs Liquidity.xlsx