Corporate Finance

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Corporate Finance

Working capital in 1999 = 320 – 220 = 100

Working capital in 2000 = 531 – 353 = 178

Change in working capital between 1999 and 2000 = 178 – 100 = 78

The net working capital thus calculated may be compared with other companies in the industry group and
find out if the company is generating enough sales for the investment in working capital and take necessary
action to correct the situation. Remember that cash flow from operations is affected by investment in working
capital. The higher the investment in working capital, the lower is the cash flow.

Cash flow from operations = PAT + Depreciation + amortization –/+ (increases)/decreases in NWC

Another subtle impact is that the company will have lower level of cash available for debt service since
CADS = cash flow from operations + existing interest expense.

Operating Cycle

A manufacturing activity is characterized by a cycle of operations consisting of:

• Procurement of raw material, components, stores and spares for the manufacture of the product,


• Conversion of raw material into finished goods,


• Storage of finished goods before they are sold,


• Sales on credit to customers, and


• Collection of cash from customers.

The time elapsed between cash outlay and cash realization by the sale of finished goods is the length of an
operating cycle (Exhibit 14.1).

Exhibit 14.1 Operating cycle

Time taken

to acquire

raw materials

Avg. storage

time of raw

materials

Finished goods

storage period

Avg. collection

period of rec.

W.I.P.

R.M.

Cash

Rec F. G.

R.M. = Raw materials

W.I.P. = Work in progress

F.G. = Finished

Rec = Receivables

Conversion

++++time