Supply Chain Vector [Electronic resources] : Methods for Linking the Execution of Global Business Models With Financial Performance نسخه متنی

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Supply Chain Vector [Electronic resources] : Methods for Linking the Execution of Global Business Models With Financial Performance - نسخه متنی

Daniel L. Gardner

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Working Capital

Regardless of company, industry or business model, working capital is one of the first calculations an analyst performs on an organization's financial statements. Oddly enough, although companies place a great deal of emphasis on working capital, few people outside of financial circles understand its real meaning or what supply chain activities are behind its derivation. Working capital is defined as the difference between current assets and current liabilities. That is certainly easy enough to calculate, but what does it mean? Essentially, working capital determines a company's ability to meet short-term obligations with current assets.

As shown in Table 13.2, it seems that working capital has improved (from $756 million in Y1 to $804.6 million in Y2) or that the company had an additional $48.6 million to cover debt in Y2 than it did in Y1. This is a dangerous statement to make even in the most dysfunctional of companies and is especially true in the case of NikoTech. The mechanics of working capital are much more complex than the calculation would indicate, and to really understand what a company should try to accomplish with working capital, the concepts of utilization and liquidity must be part of any discussion on the subject.

Table 13.2: Y1 and Y2 Working Capital

in Millions




Working Capital




In the realm of working capital, utilization determines how well a company is managing its current assets relative to the amount of current liabilities it has in the period under consideration. An organization wants to have enough in current assets to cover short-term obligations, but too much money tied up there may mean that those assets are not being utilized properly. In this light, a company wants to align the amount in current assets with the amount it has in short-term liabilities, constantly working toward a working capital of zero.

The rationale behind this philosophy is that lower working capital translates to a better ratio of assets to liabilities, thus creating the ability to dedicate excess assets to more productive activities. The attitude of a company toward working capital has a lot to do with its aversion to risk, but regardless of company philosophy, the relationship between this figure and supply chain execution is another cornerstone of the overall operating model.

Returning to the NikoTech case with a fresh perspective on working capital management, the analyst can peel back the operational onion to get to the real drivers of this once innocuous calculation. Again, the working capital calculation for Y2 is $1.212 billion - $407.4 million, or $804.6 million. This means that after meeting all of its current obligations, the company still has $804.6 million in assets. A conservative financial policy is always admirable, but even in the staunchest of organizations this figure would be interpreted as out of balance. An understanding of this imbalance and its effect on supply chains requires knowledge of not only utilization but also the importance of liquidity to NikoTech's current assets.

When dealing with assets, liquidity can be defined as the immediacy with which they can be converted to cash. This definition has important implications for supply chain execution and working capital because some assets, by their very nature, are more liquid than others. Cash, for example, is as liquid as an asset can get. Marketable securities are also highly liquid because they can be converted to cash almost immediately. Liquidity becomes a bit more viscous, however, when one considers accounts receivable and inventories.

Accounts receivable are somewhat liquid, depending on how old and, hence, how collectable they are. Inventories, on the other hand, are the least liquid of current assets, because they must be converted into finished goods, sold, billed and collected. Based on the analysis of NikoTech's operating cycle, there is no need to elaborate any further on how long a process that can be. With a view toward utilization and liquidity, a vertical analysis of Y2 current assets will shed additional light on the issue.

Analysis of NikoTech's Y2 current assets in Table 13.3 reveals that cash and marketable securities only account for 8% of the total. This means that accounts receivable and inventory account for 92% of the entire section, with receivables at 37% and inventory at an alarming 55%. Whereas current assets originally seemed to cover current liabilities, the picture is beginning to take on a darker complexion from a liquidity perspective. As current liabilities come due, NikoTech is much more dependent on converting receivables and inventory to cash to pay bills than on being able to pay bills directly from cash.

Table 13.3: Vertical Analysis Y2 Current Assets

Actually, cash on the balance sheet decreased in Y2 by $177 million, which would lead one to believe that overall working capital may decrease as well. However, the growth in inventory and receivables was so great that it netted out the reduction in cash and still increased by $48.6 million. Now from a liquidity viewpoint, receivables and inventory surface again as the evil twins plaguing the underlying performance of NikoTech. An important component of working capital analysis is liquidity, and vertical analysis is a quick and valuable tool for putting the figure in the proper context. Two other tools that augment the study and provide another look at working capital are the current ratio and quick ratio.

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