Working Capital Investment - do you ever remove cash from Current Assets?

I am working on a financial reporting question and for now I don’t see why the answer is the way that it is; i.e. I don’t see anything in the vignette that makes this question different.

Question: Calculate 2006 FCFF

Answer: FCFF = NI + NCC - WCInv - FCInv + Interest(1-tax)

Given: 2006 NI=800 2006 NCC = 341 2006 Interest = 411, tax rate is 34%, therefore interest expense = 411*(1-.34) = 271.3 2006 Capital Spending = FCInv = 241 2005 Working Capital = 350 MM

Here comes the question. It is given that Total Current Assets = 3,646 due to: cash 1,125 accounts receivable 1,081 inventories 1,253 prepaid expenses 187

It is given that Total Current Liabilities = 2,470 due to: notes payable 11 current portion of long term debt 425 accounts payable 1,065 accrued compensation 51 accrued liabilities 591 Income taxes payable 327

The answer given is: FCFF = 800 + 341 + 271.3 - 241 - (487 - 350)

The 487 - 350 is the WCInv, however I would have simply subtracted Current Liabilites from Current Assets to arrive at WC 2006, i.e.

WC 2006 = 3,646-2,470 = 1,176

However, the answer did the following to compute 2006 WC:

(1,081 + 1,253 + 187) - (1,065 + 51 + 591 + 327)

Why are they removing cash from current assets and why are they removing notes payable and current portion of long term debt from current liabilities?

If you have any pointers for finding an answer please let me know. Could the answer we wrong? Thanks in advance.

I know that many books like to describe working capital as current assets minus current liabilities but that’s not completely true. Here’s an example: If the only increase in NWC is attributeable to an increase in cash, how could that be a use of funds (-WCinv)?

Maybe it will help you to think of its as non-cash short-term investment into operations. Typically, this would be accounts receivable, inventory, and accounts payable.

Cash and “debt” are not working capital.

Karate is right. Think of it this way. you are removing WCinv. So the company invests in working capital when they convert cash to AR, inventory and pre paid expenses. Same logic holds on the liability side

I see your point although…

Can we all at least agree that Working Capital is defined as Current Assets - Current Liabilities?

Is ‘Total Current Assets’ different from ‘Current Assets’? I believe it may be.

Straight out of the CFA book: Current Assets, or liquid assets = Assets that are expected to be consumed or converted into cash in the near future, typically one year or less.

Given that definition I see that Cash should be removed from Total Current Assets.

The definition of Current Liabilities = Short-term obligations, such as accounts payable, wages payable, or accrued liabilities, that are expect to be setteld in the near future, typically one year or less.

I’ve, till this point, thought of ‘current portion of long term debt’ to be an accrued liability. Perhaps that is wrong. Not to be argumentative but ‘current portion of long term debt’ does sound to me like a short-term obligation. It would REALLY help for the definition to say, ‘this excludes debt,’ but it does not.

Does anyone have another resource that could be used to put this to rest? The issue is that in several questions I’ve seen WC = CA - CL and I’ve not seen cash or short term portion of long term debt removed. Perhaps those items weren’t even given in the question. Would the rule of thumb be, if you are given Total CA and Total CL look out to remove cash from CA and portions of long term debt from CL?


When you are calculating net working capital in terms of free cash flow, you exclude

  • changes in cash/cash equivalents
  • notes payable
  • current portion of long-term debt

These exclusions are considered financing activities and not operating items, that’s why they aren’t included in the working capital equation.

Tecnhically, working capital is defined as CA - CL. This is the way I think about it when going through this problem. But when you’re calculating free cash flow to the firm, these items are leverage components and shouldn’t be included

nailed by stunnerrunner

Thanks everyone.

One more thing guys. If you come across any examples regarding this topic that you think are worth sharing, please send them over (don’t know if the complexity ends there, i.e. for FCF examples exclude those items from WC or if there is more to add). Thanks.