Working Capital FCF

CFA Level II
#1

Hi,

In an item set the following information was given:

Increase in receivables 25

Increase in inventories 40

Decrease in payables 15

Net Capex 42

Increase in LT Debt 150

Calculate FCFE (Net income 75)

In the solution all the components of the working capital have been subtracted. So essentially, 75 + 35 (depreciation) -25 -40-15 (WC) - 42 (Capex)+ LT Debt (150)

=138. What I wanted to know is why all the components within WC were subtracted away when some of them increased and payables decreased

thanks

#2

Think about this way.

Assets side

You’re using money to buy more inventory, outflow of money

You aren’t collecting money from the customers. Out flow of money.

Liabilites section

Instead of increasing payables to retaining more money, in this example the company is paying off its debt. So money is outflowing.

So all this increases your working capital.

That’s how I usually think of it. Hope that helps.

#3

Higher A/R = cash bad. You are owed this money but customers haven’t paid you yet.

Higher A/P = cash good. You’re holding onto this cash instead of paying your suppliers’ invoices.

Net WCInv = (increase in WC assets) − (increase in WC liabilities)

Net WCInv = (+25+40) − (−15)

Net WCInv = 25+40+15

#4

Sorry guys can you expand, I am still confused.

@Biuku why have you added the components of NWC capital together. This totals 80 when the solution suggest WC is -30.

To clarify @Jlion:

In the example above, A/R increased by 25. You have suggested this is an outflow of money, then why is the 25 not negative? I thought cash had no impact on Working Capital.

Increase in inventories is deducted and the decrease inpayables (which means we are retaining more cash) is deducted too?

Sorry, still confused.

#5

Starting with the answer:

  • FCFE = NI + Dep/NCC + Net Borrowing - FCInv - WCInv
  • WCInv = NI + Dep/NCC + Net Borrowing - FCInv - FCFE
  • WCInv = 75 + 35 + 150 - 42 - 138
  • WCInv = 80
  • 80 = (25 + 40) - (-15)

Don’t think of FCF as a following rules. Think of it as archaelogy – you found a 65M year old tooth in Vietnam, and it fits a 67M year old jaw found in Japan. How tall is the dinosaur?

The financial statements are fighting against you, if you’re trying to determine how much actual wealth you can generate from the company. You’re using agility in financial statements to create something outside them that is useful to a person who might buy the company.