Thoughtful ways to model Working Capital
Hey All,
So I’ve been running into some issues while building operating models for some of our portcos (Rx focused). When modeling working cap I’m running into issues where A/R, inventory, AP, etc. build or decrease heavily based on the monthly fluctuations of revenue or COGS.
Does anyone have other ways they think about forecasting working capital more thoughtfully than just taking an average historical % of sales or DSO, etc? Looking to have a more accurate build of working capital in our operating models.
Thanks in advance.
Call your portco's head of FP&A and have them walk you through their financial forecasting methodology. You can probably simplify their approach to the level of granularity you need.
Our portcos are all LMM deals all 2 years out of bankruptcy, Article IXs, etc. with most being $100M rev, so no FP&A group. As associates were fairly involved in portco management and our finance teams are typically pretty weak.
Next place I'd go is your CFO/CEO to see how they budget. If you don't trust them see if your firm has advisors with industry expertise and ask them how they'd forecast. Last option would be to call some bankers in the sector and look at sell side models for inspiration.
+1, have always struggled with this
Lol no suprise these companies went bankrupt, cant even provide AR guidance
Basically get an experienced yet pragmatic operator to support you guys. Could be a venture partner or so. Sometimes big 4/small consultancies have some senior guys who are from the industry (not finance guys) and have seen much.
We had one helping out with an almost insolvent sub of a company on its way to IPO. These guys were on daily cash flow analysis, with each outflow almost tied to single invoices. With the help of this SR guy we looked into building logic into a model. Not just inventory days times cogs or sales, but flooring a min. Investory Level, dynamic stocking etc. not overly detailed stuff, but more down to how actually life at the shop floor looks like. Was quite robust.
In another restructuring case in automotive we took an old guy from a big four. Next to his input for Rx measures, his views were gold on improving inventory and payables assessment and modelling. Very impressive, how much of an actual difference an experienced executive (not necessarily old) can bring clarity in thinking (not only to us, but to the portco and it's owners, a fund with limited experience in RX or automotive).
You need to dive deeper into the actual line items making up each working capital item. Then you need to understand what those line items ACTUALLY relate to.
As a simple example, one portfolio company I worked with treated regulatory subsidies as an account receivable once they got approval for the subsidy. Those large, lumpy subsidies had a very concrete payout period of 90 days, and were completely unrelated to revenue. If you had just focused on historical % of revenue, that A/R figure would jump all over the place, but it was completely irrelevant for that item. When projecting W/C, we had to reverse that out, create its own schedule based on anticipated subsidies, and then model out that way. There will be dozens of items with similar issues at play, and the only way to figure them out is to do a deep dive.
How many ucc liens does the company have on working capital :p
Case by case. Build out separate schedules for the necessary line items. For example, accounts receivable could be beginning period AR plus additions less collections. Perhaps the company targets a weekly $ amount of collections and the quarterly ar build is a percentage of sales.
Laborum et ipsum eius perspiciatis labore impedit. Veniam culpa amet possimus earum ut a eum dolore. Et ea ducimus necessitatibus et. Consequatur omnis est officia et rerum cupiditate optio.
Ut sed possimus quibusdam quia. Eos ut iure voluptas accusantium. Voluptatem accusamus est at necessitatibus.
See All Comments - 100% Free
WSO depends on everyone being able to pitch in when they know something. Unlock with your email and get bonus: 6 financial modeling lessons free ($199 value)
or Unlock with your social account...