Working capital forecasts.

Working capital forecasts are often an underappreciated value driver in your model analysts often get more excited about a company increasing its revenue growth or expanding margins, but ignore what's happening in working capital. It's worth remembering that changes to working capital efficiency will impact on cash flows in exactly the same way as revenue growth and profit margins. The usual way to forecast working capital is to use working capital days ratios that's receivable days inventory days and payable days alternatively we can forecast these items as a percentage of sales based on historic levels. The rationale for these assumptions is that if business activity increases, for example, a company makes more sales, we would expect receivables inventory and payables also to increase whether you calculate the working capital days ratios will depend on the line items in your model. For example, the formula for inventory days is shown here. But if you forecasted revenue and EBITDA in your model, you won't be able to use cost of goods sold as a driver for infantry days or payable days. However, you could use total operating costs. The important thing here is consistency. If you use total operating costs for forecasting working capital days. You will also need to use total operating costs when calculating the historic working capital days, which you build your forecasts on. Otherwise, you're not being consistent between your historic analysis and your forecasts. When we're building our assumptions. We usually start with the historic working capital ratios, and then adjust for the following items, firstly changes in business mix. Different businesses have different levels of working capital for example business to consumer that's B2C companies usually have low receivable days. But business to business companies, that's B2B companies usually have high receivable days as they offer credit terms to other companies. If a company is increasingly selling direct to consumer and less via wholesale channels. We can expect their receivable days to reduce over time. Next we look at supply chain dynamics. If we know there are constraints in the supply chain. This could impact on inventory levels or it could trigger a renegotiation of supplier payment terms thus increasing payable days. Finally growth and scale companies working capital demands change as a business grows and achieves scale, small companies typically have very little negotiating power with suppliers and customers. Whereas market leaders will have strong negotiating power. This is particularly evident in the food and beverages sectors where some of the dominant players have managed to achieve negative working capital as a result of negotiating advantageous customer and supplier payment terms. Whereas the smaller companies in these industries have positive working capital. Therefore if you're forecasting a company which is going through rapid growth or contraction. This is likely to impact on your working capital forecasts.