Operating working capital. Working capital is a major issue for most corporations. It represents the short-term assets and liabilities which turn most quickly to cash. The accounts that deserve the most attention, however are the short-term assets and liabilities that are directly tied to the day-to-day operations. This is what is called operating working capital. In general, we define it as current assets excluding cash less current liabilities, excluding debt. If operating working assets are greater than operating working liabilities then OWC is set to be positive and that amount, since it is a net asset balance, requires funding. If operating working liabilities are greater than operating working assets, then there is negative operating working capital and this is a source of funding. Whether a company has a positive or negative OWC often depends on the nature of the business. It is not a sign in and of itself of mismanagement. One thing we should look at closely, however, is the rate at which the major OWC accounts convert to cash. We can assess that by looking at the following ratios receivable days, which are the ending receivables divided by sales times the number of days of sales in the period. If it's a quarter, we use 90. If it's a year, we use 365. This tells us how many days on average it takes to collect on our accounts receivable. Inventory days is ending inventory divided by cost of goods sold times the number of days of cogs in that period, same as the previous ratio, either 90 for a quarter or 365 for a year. This tells us on average how many days it takes to turn our inventory. And lastly we have payable days, taking the ending accounts payable divided by cost of goods sold times the number of days of cogs in that period, again, 90 or 365. This tells us, on average how long it takes us to pay our suppliers. As a note, average balances of the balance sheet accounts can be used to calculate these ratios. This is very commonly seen within the credit world. To see an example of this, here are the day ratios for a company. Decreased number of receivable days means that less funds are required because the assets are shrinking and turning to cash. The inventory days, which are going up means that assets are going up in which case more funds are required. Payable days are decreasing. When liabilities decrease, that also means that more funds are required. The working capital cycle, to see these ratios practically applied, here are the days ratios for a manufacturer. The product goes into inventory on day zero. It takes seven and a half days to turn the inventory which means it is sold as an account receivable on day 7.5. 37 days later on day 44.5, the cash comes in as the customer pays the invoice. Eight and a half days later on day 53, the manufacturer pays the bill for the inventory which was purchased all the way back on day zero. This means that the company was eight and a half days with positive cash or cash funding. Just to see this from another industry's perspective here's a home improvement retailer. Inventory is purchased on day zero, and it takes on average 69 days to turn the inventory or to sell it. This is largely due to the massive amounts of inventory that these stores have. The receivable days are seven, which means seven days after selling the inventory the company can expect to receive its cash. That puts it out at day 76, 69 plus seven. Unfortunately, the payables on all that inventory were due to suppliers 16.8 days on average. That puts us all the way back at day 16.8. This means that this retailer has 59.2 days without cash therefore is in need of funding.
