Tricky Question: Working Capital
Company A has $1000 sales. Sales increases to $2000 (so by 100%)
AR: 1 day
AP: 90 days
What is the gain in NWC?
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Lol, is this a real interview question? I'd just say that the effect on NWC is $1000 up on day 0 and $1000 down on day 1, all else equal (which also seems ridiculous, but there's no other information).
Thank you! Yes it is, no other information. Could you elaborate? I am having trouble converting the revenue into the AP/ AP figure.
If I did this in real life I would do as the poster below and treat the AR as cash sales and say that the effect on NWC was 0. No deal-driven buyer would ever argue you on this unless they're stuck up pricks, in which case I would probably tell the analyst on the other side that we could fight over it with a broken pool stick.
This is a dumb question, 1 day DSO might as well be cash sales so shouldn’t really change NWC on an increase in sales. You’d need to ask for more information on inventory turns to know how NWC responds.
I wonder if the below works: 1) Sales=$1,000 --> A/R=1x365/1,000=2.7 2) Sales=$2,000 --> A/R=1x365/2,000=5.5
I don't have COGS to compute A/P and I don't have Inventory but assuming COGS grow proportionally and are 50% of sales: 1) A/P=90x500/365=123.3 2) A/P=90x1,000/365=246.6
This business looks like, say, a grocery store - customers pay you immediately, but you can pay suppliers on credit. Therefore, i would assume the Inventory will have also more days to stay in the shop before it gets sold. For the sake of example I will take 45 days. 1) Inv = 45x500/365=61.6 2) Inv = 451,000/365=123.3
Therefore, in case 1 (sales=$1.000) NWC=2.7+61.6-123.3=-59 Case 2 (sales=$2,000) NWC=5.5+123.3-246.6=-117.8 Therefore, we can conclude that NWC improves with sales growth, with proportional impact on liquidity ( 2x sales reflects in 2x NWC)
I am not a big expert in NWC, therefore appreciate if people who are more familiar with the concept can comment whether it makes sense?
Thanks!
You're calculating the average NWC here. I don't think there's a point in dividing by 365 and going through the entire exercise. Your calculation only holds water if COGS increase proportionally with sales, which is often not the case. The marginal cost of selling 1 more product x is often a convex curve where marginal costs are decreasing to the point where it is close to, or equal to, the purchase price for the grocery store.
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