Days of Working Capital
The term days of working capital refers to a calculation that allows an investor-analyst to understand if a company is using its working capital efficiently. Since the metric can vary by industry and may exhibit a seasonal effect, this ratio is best used as a benchmark and / or tracked over time.
Days of Working Capital = Working Capital / (Net Sales / 365)
- Working capital is equal to current assets (accounts receivable plus inventory) minus accounts payable.
- Net sales represent revenues minus returns, allowances, and discounts. A company’s income statement will typically report net sales / revenues.
Liquidity measures allow the investor-analyst to understand the company’s long term viability in terms of fiscal health. This is usually assessed by examining balance sheet items such as accounts receivable, use of inventory, accounts payable, and short-term liabilities. One of the ways to understand the overall liquidity position of a company is by calculating their days of working capital.
As is the case with other liquidity metrics, days of working capital subtracts accounts payable from current assets, which provides a better indicator of liquidity than metrics such as sales to current assets. Since inventory on hand will vary by industry, this metric is best used as a benchmark or tracked over time to look for an unwanted pattern. In addition, inventory and sales oftentimes exhibit a seasonal effect.
The manager of a large mutual fund would like to assess the liquidity position of Company ABC. He believes the days of working capital would provide a good understanding of the company’s position relative to its competitors. He asked his analytical team to calculate this metric over time for Company ABC in addition to benchmarking the measure against several of the company’s direct competitors.
The analytical team identified the benchmark value as 55 days. The table below contains Company ABC’s information over the last three years.
|Year 1||Year 2||Year 3|
|Net Sales per Day||$295,180||$339,288||$407,145|
|Days of Working Capital||59.91||46.79||41.95|
While Company ABC’s days of working capital were initially better than benchmark, the data indicated a sharp increase over the last three years. Based on this analysis, the manager asked his analytical team to take a closer look some additional liquidity metrics.