Operating Working Capital and OCF Explanation?
Having trouble wrapping my head around OWC and how it affects the CFS statement.
If OWC goes up, current assets are going up versus current liabilities.
The company then requires funding, since liabilities are a source of funds.
This means company has cash going out the door to go towards this OWC.
So if OWC increases, it is then deducted in the CFS.
If it decreases, it is added back in the CFS.
Am I thinking about this right? Is there any other way to help solidify my understanding?
You got it right! From the way in which you say it, I think that you don’t have the process interiorised and that you have to think step by step to get to that conclusion, but don’t worry, it is normal when first learning that concept.
i think that it would be good for you to think on the business side of it. When you calculate OCF, you want to see how much cash can the busines generate from its operating activities, excluding investing & financing.
how does OWC (FYI usually it’s called Trade Working Capital, TWC) fit here? Well, just think about the elements that compose it: Inventories + Receivables - Payables. For it to go up, increase in Inventories and receivables has to be bigger than increase in payables. To simplify things, intuitively, when you build up inventories, you have to pay for them, so that’s cash out. When your receivables increase, that means that you have are selling stuff but not getting paid for it. That stuff that you are selling has a cost to you, so you can think that overall that means cash out. (Oversimplification, but just for the sake of interiorising the mechanics of WC inflows/outflows). Then the liability side: if your payables increase, you are consuming stuff but not paying for it. So you can use that stuff to generate your own revenue, meaning cash coming in.
So if you put all that together, if WC is increases, that means that the value of your inventories + the stuff that you sell but don’t get paid for is higher than the stuff that you buy but don’t pay for during a given period. So you have tu fund that difference with cash.
there are businesses that are intrinsically WC positive, meaning that as they grow, WC sucks more and more cash so it needs more and more funding. There ate others that are WC negative, the typical example being supermarkets: you sell for cash always so you don’t have receivables and you buy with very good terms (ie you can pay quite late) from suppliers given that you have certain size and negotiating power. So as supermarkets grow, their WC will become more and more negative, meaning that it will generate cash from WC and will be able to fund other parts of the business (maybe capex, interest expenses, opex.. anything).
i hope it helped
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