Weighted Working Capital
The term weighted working capital refers to a calculation that allows an investor-analyst to understand the change in working capital relative to sales from year to year. Typically, a negative value would indicate a more efficient use of working capital, while a positive value indicates a decline in efficiency.
Weighted Working Capital = Current Year’s Working Capital – Prior Year’s Working Capital x (1 + % Change in Revenues)
- Working capital is equal to current assets (accounts receivable plus inventory) minus accounts payable.
- Change in revenues represents the increase or decrease in revenues in the two periods where working capital is being examined.
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 weighted working capital.
As is the case with other liquidity metrics, weighted working capital removes accounts receivable from current assets, which provides a better indicator of liquidity than metrics such as sales to current assets. The weighted working capital metric allows the investor-analyst to understand the change in working capital relative to the change in sales revenues over time. If a company is becoming more efficient in the use of working capital, this metric will results in a negative value. If a company is using working capital at a rate that is higher than the rate at which revenues are increasing, the value will be positive.
The manager of a large mutual fund would like to assess the liquidity position of Company ABC. He believes the weighted working capital would provide allow him to understand if the company is becoming more efficient in their use of working capital over time. The fund manager asked his analytical team to calculate Company ABC’s weighted working capital. The analytical team pulled the last two annual reports for Company ABC, and the table below contains Company ABC’s information over the last two years:
|Prior Year||Current Year|
The change in sales revenues would be calculated as:= ($123,840,000 – $107,740,800) / $107,740,800, or 14.9%
Calculating the weighted working capital then becomes:= $15,876,923 – $17,685,200 x (1 + 14.9%)= $15,876,923 – $17,685,200 x 1.149= $15,876,923 – $20,327,816, or ($4,450,893)
The negative value for the metric indicates working capital is growing at a slower pace than revenues, which means Company ABC is using working capital more efficiently.