• Sharebar

Please dont tell me to google it, as I've already done it. read tens of websites and I still cant get my head around it. I know WC is a product of inventory, receivables and payables. In other words inventory+receivables-payables=WC. But what does this shit actually mean? (things like WC increases, decreases, etc) I'm looking for some simple explanation here. Your help is much appreciated!

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Comments (15)

  • DeighTrader's picture

    working capital is capital the firm has to "work" with ... in other words, its not just paper capital ... think CA- CL

  • MagicKarp's picture

    What?

    It's Current Assets - Current Liabilities.
    'Current' means lasting for a year or less, or the 'operating cycle', whichever is longer.

    examples of CA: cash (less restrictions), receivables (less allowance for doubtful accounts), inventories, prepaid expenses, supplies
    examples of CL: payables, unearned revenue, bonds payable (within a year), interest on bonds payable

    The 'operating cycle' is the time between when supplies for making the product are received and when cash for the sale of the product is received.

  • paradox71582's picture

    Working capital from a practical standpoint just means stuff that the company needs to buy in order to have a "buffer" during operations. For example if you were operating Apple you would need to sink cash into producing IPhones as an inventory to ensure you don't have stockouts.

    Because a company doesn't just buy the initial inventory - they maintain that level for some period of time, working capital is like an investment in time zero, which you can 'sell' at the end of the project life when you don't need the inventory anymore.

    Similar premise occurs with other elements of working capital like AR/AP - you don't immediately get paid and don't immediately pay your vendors, so as production and sales ramp up you have a buffer of unpaid and uncollected invoices.

  • KevinNYC's picture

    This is incredibly lazy. What do you plan to do when you start working and actually have to use your brain?

  • Barboone's picture

    You want to be an I-Banker?!?! go to a pizzeria and ask the owner and then multiply his explanation by a couple of billion dollars. You will get a grasp of what working capital is in a big company.

    "The higher up the mountain, the more treacherous the path"
    -Frank Underwood

  • wamartinu's picture

    When I will start working I will ask the people that I am working with what the fuck WC is. Till then, I'm gonna use this forum for advice. I've already done research about this and got a multitude of confusing/different answers.

  • Chech4's picture

    Read a fucking book. Or learn how to use google, or maybe both would do you some good.

    Gang, Gang, Gang

  • jhoratio's picture

    warmartinu,

    I will answer your question, but know this: just because you "googled it" or "read tens of websites" [sic], doesn't mean you have exhausted your research options. Go to the goddam library and read a fucking book - hopefully one that's more than a paragraph in length. You "read...websites." Congratufuckinglations.

    Now, to perpetuate and reward your laziness:

    Imagine, as I often ask people to do, that you desire to enter the hypercompetitive soft-drink market by opening up a lemonade stand. What will you need to do this? Do you just stand there like a nincompoop reading tens of websites about it? How will you get lemonade? How will people know you're in business?

    First you need a stand. Then some land to put it on. Then a sign so people know where you are. Then a cooler for ice and shelves for other items. These pieces of equipment represent your invested capital. They show up as Property, Plant and Equipment on the balance sheet. To the extent you buy them with your own money or with borrowed money, the claims on those assets are shown as equity or debt. Still with me?

    OK, let's serve some lemonade. Wait - we have no fucking lemonade to serve! This is a problem indeed! Now, will the fucking lemonade fairy come down from the sky with fresh cups of lemonade for you sell or do you think you'll have to go shopping again? ....I'll wait for you...no, I'm afraid that's not correct, you will in fact have to make some additional purchases if you plan on making any money. No one is going to pay you just so you can smile at them standing in front of your sign.

    You will need to buy cups, water, lemons, sugar, ice. Everything that goes into creating a serving of lemonade. David Ricardo (he is a famous economist who wrote very good books on the subject) talks about the relative "speed" with which capital investments are exhausted, and from here was born the concept of working capital. Basically, working capital is the amount of money you need to operate the business after the investments in fixed assets have been made.

    So you go and buy $100 worth of materials. The store gives you a bill and tells you to pay in 30 days. On the 10th day, there's a run on your stand and you use up all the materials selling lemonade making $150. Each time you made a sale, you gave the customer a bill and told them to pay in 30 days. 20 days pass and your bill is due at the supply shop. Hmm, what to do? You sold all your supplies but still haven't gotten any money from your customers. You need to pay the store $100.

    Now this may be a cause some unpleasant tingling in your forehead, but let's think about this for a second. The day before the bill was due, your AR was $150, your Inventory was $0 and your AP was $100. So, technically, your net working capital (NWC) was $50. The day after you paid your bill, (AR = $150, Inv. = $0, AP = $0) so NWC was $150. Hey, it went up! What does that mean!? These fluctuations in and of themselves are not very important. The thing to understand is this: if all goes smoothly, there are exactly 10 days that you have to come up with financing for $100 - this is the span of time between when you owe the store and when you get paid by your customers. THIS $100 FOR 10 DAYS IS WHAT YOU NEED TO OPERATE YOUR BUISNESS! THIS IS WORKING CAPITAL!!! In order to operate your business at the current level of activity, in addition to the investment in PP&E, you will need to invest or borrow $100 for a period of 10 days.

    Obviously in a real business, these transactions are happening continuously, but hopefully you can derive some insight here. If you plan to grow sales, you will have to buy more materials and spend more money. So you will have to be able to finance a larger amount of purchases. If your larger, more cantankerous customers are slow in paying bills, then you will have to finance the larger amount for longer. If the store is feeling generous and offers you 60 to pay instead of 30, then perhaps you will get your money from customers before you even need to pay the store! Negative NWC! This is in fact what Dell Computer has been able to do - in a steady state, they require no working capital at all as their customers essentially finance the operation. This isn't the norm though, as usually a business will usually have a positive value for NWC that will require financing for a certain period of time.

    Hopefully, this has helped you, although I get the feeling you stopped reading after the second paragraph. "This shit's too long, man. I'm gonna go play some Halo."

  • In reply to jhoratio
    WallStreetOasis.com's picture

    jhoratio:

    OK, let's serve some lemonade. Wait - we have no fucking lemonade to serve! This is a problem indeed! Now, will the fucking lemonade fairy come down from the sky with fresh cups of lemonade for you sell or do you think you'll have to go shopping again? ....I'll wait for you...no, I'm afraid that's not correct, you will in fact have to make some additional purchases if you plan on making any money. No one is going to pay you just so you can smile at them standing in front of your sign.

    .....
    Hopefully, this has helped you, although I get the feeling you stopped reading after the second paragraph. "This shit's too long, man. I'm gonna go play some Halo."

    Silver banana for delivering a highly entertaining and clear description of working capital. This is what makes WSO go round.

    Thanks

  • In reply to wamartinu
    brassmonkee's picture

    wamartinu:
    When I will start working I will ask the people that I am working with what the fuck WC is. Till then, I'm gonna use this forum for advice. I've already done research about this and got a multitude of confusing/different answers.

    Why are you going to throw a fit because you don't understand the simple concept of working capital?

    In all these websites, did you read: http://en.wikipedia.org/wiki/Working_capital

    That is more information than anyone at work is ever going to give you.

  • IB_Hustla's picture

    haha this was hilarirous..

    WC is basically your ability to charge people for your product/service, and get paid from them as fast as possible, and reconcile your A/R/Inv balance etc, while on the liabilities side, your goal is to take as long as possible to pay money back to your suppliers for the the product/service they sold you to create your product/service that you deliver to your customers.

    This is a very boiled down explanation, because your CA/CL accounts have far much more detail than what I explained, i.e. debt financing/accruals and shit like that, but I hope you get the general idea. Collect cash from your customers as fast as possible, pay cash out to your suppliers as slow as possible.

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  • contrarian_in_thought's picture

    If you ain't buy side what are you doing on Wall St.? Gimme something good sport...