Chapter 2

Working Capital Ratios and

Other Metrics

CACF 450 – N. Kirsh, CPA, MBA, CBV

Adapted from Working Capital Management: Applications and Cases, James S. Sagner
(Copyright ©2014 by John Wiley & Sons, Inc. All rights reserved.)
Learning Objectives
 Determination of how ratio analysis is used in
understanding working capital
 Appreciation of the calculation of the liquidity,
activity and profitability utilization ratios
 Understanding of other metrics such as the
statement of cash flows and the cash conversion
cycle
 Consideration of the advantages and disadvantages
of benchmarking of working capital
 Clarification of the general issues in using ratios and
other metrics in managing working capital
Ratio Analysis - Concepts
 Ratio analysis helps us determine how
a company performed over
time (financial performance) and also how it is
doing at a specific point in time (financial state)​
 Financial performance is measured

through metrics using the income statement​

◦ Performance metrics​
 Financial state generally is measured
through ratios on the balance sheet​
◦ Efficiency and solvency metrics
Ratio Analysis - Concepts
 Ratios are generally broken down by:​
◦ Liquidity: current ratio; quick ratio​
◦ Utilization: AR/ AP/ inventory turnover (cash conversion)​
◦ Solvency/Leverage: debt/ assets; debt to equity​
◦ Profitability: ROA; ROE; any IS line as a % of sales
 Once we’ve calculated something, you have to use it!​
 You want to compare ratios over time, to a budget,
or to the industry​
 See if you’re getting better or worse​
 Determine if you’re hitting internal targets​
 Compare your performance to your competitors​
Ratio Analysis - Concepts
 Ratio analysis and other metrics are used for a
comparative basis for a company versus its industry
(cross-sectional analysis) and its experience in
previous years (longitudinal analysis)
 Finding truly comparable companies is difficult

because no two organizations are exactly alike

◦ They may have different geographic coverage, varying
product lines, significantly dissimilar economies of scale,
and other distinguishing characteristics
 We will begin with the accepted “significant financial
ratios”
 Ratio Analysis – Best Buy - Illustration
Current Ratio - Longitudinal Current Ratio - Cross Sectional
1.6
1.5 1.5 Bed Bath & Beyond Inc. 1.6
1.4 1.4
1.4
1.3
1.2 1.2 DICK'S Sporting Goods, Inc. 1.5
1.2 1.1

1.0 Williams-Sonoma, Inc. 1.3

0.8
The Home Depot, Inc. 1.2

0.6
Lowe's Companies, Inc. 1.2
0.4

Best Buy Co., Inc. 1.2

0.2

- Walmart Inc. 1.0

FY2014 FY2015 FY2016 FY2017 FY2018 FY2019 FY2020 FY2021
- 0.2 0.4 0.6 0.8 1.0 1.2 1.4 1.6 1.8

Source: Capital IQ Research Database

Ratio Analysis – Best Buy - Discussion
 General comments on trends?
 Any other indicators you would look at?
Exhibits 1.1 and 2.1
Ratio Analysis - Liquidity
 Refers to a company’s cash position and its ability
to pay its bills as they come due; examples that
follow are based on text Exhibits 1-1 and 2-1
◦ Current ratio: Current assets ÷ Current liabilities
 2.9:1 ($65,000,000 ÷ $22,500,000)
◦ Quick ratio: (Current assets – Inventory) ÷ Current
liabilities
 2.2:1 ([$65,000,000 - $15,000,000] ÷ $22,500,000)
 Preferred as eliminates inventory that could be stale, obsolete,
and unsaleable
Ratio Analysis – Activity Utilization
 How efficiently the business is using its assets
◦ Receivables turnover: Sales (On credit)  Receivables
 5.5 times ($150,000,000 ÷ $27,500,000)
◦ Average collection period (ACP): 360 days  A/R turnover
 65 days (360 ÷ 5.5 times)
 Quickly determines if the established credit period (i.e., net
30 days) is not being observed
◦ Inventory turnover: Cost of goods sold  Inventory
 6.7 times ($100,000,000 ÷ $15,000,000)
◦ Inventory turnover days: 360 days  Inventory turnover
 54 days (360 ÷ 6.7)
 Useful in understanding the number of days of inventory
held by the company
Ratio Analysis - Profitability
 Not an explicit component of working capital; it is
included here because any change directly impacts
profits
◦ Net profits (after taxes) to sales (ROS)
 9.1% ($13,650,000 ÷ $150,000,000)
◦ Return-on-equity (ROE) profits after taxes  Owners’
equity
 21.8% ($13,650,000 ÷ $62,500,000)
 Leverage: not included in working capital
◦ Total debt ratio: Total debt ÷ Total assets
◦ Times interest earned: Operating income before interest
and taxes (EBIT)  Interest expense
Ratio Analysis – Industry Comparisons
 The rule when using industry comparisons is that
any result within the interquartile range is
considered as normal; any result outside of that
range is unusual and worthy of further analysis
◦ Interquartile range: the area in an array of results from
the 25th to the 75th percentiles (or the 1st to the 3rd
quartiles)
◦ Array: a listing of the members of a group in either
ascending or descending order
◦ Median: the middle item in an array (the 50 th percentile),
while the mean is the arithmetic average of the total of
all items divided by the number of items
Ratio Analysis – Sources and Results
 Troy and RMA provide alternative ratios that are quite useful
◦ Cash (cash flow) ratios included; not in significant ratios but critical to
working capital management
 Exhibit 2-2 compares Rengas with the median result for
plastic manufacturing industry
◦ Shows slow receivables (66 vs. 49 days)
◦ Excess liquidity (quick ratio is 3.3 vs. 0.9 times)
◦ Opportunities for improved working capital management
Ratio Analysis – Sources and Results
Other Metrics - Statement of Cash Flows
(see Exhibit 2-3)

 Operating cash by restating accrual income as

adjusted for changes in the financial statements
during the year
 Sources of funds is an increase in cash
 Uses of funds is any decrease in cash
 Strategic decisions in a company involve capital
investing, permanent financing and the calculation of
the net cash position
 Obvious concern of working capital management is
the operating cash section
 While a negative net operating cash position in a particular year
can be offset by financing or investing decisions, a continuing
cash loss from ongoing operations
Other Metrics - Cash Conversion Cycle (CCC)
 The number of days between disbursing cash and
collecting cash in connection with undertaking a
discrete unit of operations
 Dell Computer very aggressive with CCC

◦ Inventory turnover (2009) was an astonishing 57.8

(industry: 6.3 times); ROE: 58% vs. (industry: 16%)
Inventory Receivables Payables
= conversion + conversion – conversion
period period period
Average
Average Average accounts
inventory
accounts payable
= cost of + –
receivable cost of goods
goods sold
revenue / 365 sold / 365
/ 365
Amazon: negative CCC?
 Dell is obviously not a modern case study

 https://alphabridge.co/featured/amazons-ca
sh-conversion-cycle/

 Read and discuss

Other Metrics – Benchmarking I
 Compares the processes of a business and
selected performance metrics to industry best
practices
◦ Select problem to study
◦ Find similar processes in other companies,
particularly industry “leaders”
◦ Determine appropriate metrics
◦ Implement improved practices
Other Metrics – Benchmarking II
 Selected working capital benchmarks
◦ Full-time equivalent (FTE) staff levels: measured
as FTEs per dollar of sales
◦ Cost: measured as cost per dollar of sales
◦ Throughput: measured as units processed per
FTE for standard activities (such as payment
transactions)
◦ Cycle times: measured as days required to
complete specific activities
 Text discusses problems in using
benchmarking especially emphasis on
quantity (vs. quality); focus on micro-analysis
Problems Using Ratios and Metrics
 Finding a comparable industry
 Loss of specificity with aggregated data
◦ In industry data
◦ In certain ratios (i.e., current ratio)
 Differences in fiscal year of financial reports
 Accrual accounting conventions
 “Window dressing” at the end of reporting
period
 Off-balance sheet obligations that are not
included in the analysis
 Large companies have significant market power