LBO models - NWC
Do you need to model out NWC as number of inventory days etc and then project out NWC, or is it acceptable to simply take it as a % of revenue, COGS etc. and then project forward? Would be a big time saver but don't know if accepted
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Depends if a big part of your thesis is on operating working capital line items changing considerably. For example, if you think cash conversion cycle composers (DSO, DIH, DPO) will change substantially, then you'd better model it in, since it will have a non-trivial effect on FCF. In particular, a lot of practical work done in LBO situations is to improve NWC, meaning the efficiency coming from a net decrease in NWC from year to year results in sources of cash to pay down debt.
If the bulk of the work is really on a revenue growth, financial engineering, or operating leverage / margin expansion story, then you can get away with putting NWC as % sales (it will still have a non-zero effect on FCF this way). But be aware that even sectors where you exclusively care about growth metrics such as rule of 40 (such as SaaS/tech at VC/GE-type investing), you still care a lot about the balance sheet. Deferred revenue, for example is a big chunk of these companies' sheets.
Thanks but not the question I was asking
Did you even read my response?
The answer is "Depends if a big part of your thesis is on operating working capital line items changing considerably."
Good luck getting into the industry.
Any chance any of you guys can help out please? Would be much appreciated. Basically the question is if unclear from the brief, do I fully need to work out DSO, DIH, DPO for my NWC calcs and then convert back to a $ figure, or can I simply calculate the % of Rev/COGS applicable for the line item and project this out to skip a step? The number of days doesn't really give you much except for a more intuitive metric it seems to me - unless its expected/critical for timed LBO models?
@Rover-S @Tamara_S @TheBuellerBanker
Not sure why this would be a big time saver? You're going to need the detailed NWC sooner or later anyway. Unless you're doing a 15-min back of the envelope exercise, you should use DSO, DIH etc. Just having NWC doesn't tell you anything, you want to see how each part of the NWC moves over time. The calculation itself shouldn't take you more than a few minutes; it's the classification of each line item that takes time, especially if there are a lot of grey-area things that fall between NIBD or NWC.
Edit: and if you're gonna do the shortcut, I'd definitely use % of sales, rather than % of COGS.
Thanks, so just to make sure we're on the same page - what i mean is for instance the following:
1) Build a NWC schedule for each item. E.g. Current DIH = (average inventory / COGS) * 365
2) Take the NWC schedule and project it out on your balance sheet. I.e. Projected inventory = DIH / 365 * COGS
My question is, why don't you just go (AVG inventory / COGS) = x%. x% * projected COGS = projected inventory? Why do you need to make a cash flow conversion schedule etc. if you can just literally project the whole thing out on a single row? Seems like a waste of time? It's not a huge time saver but I can use every minute i can get at the moment..
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