Objectives

Section Learning Objectives

1.1

What is Working Capital?

📖 Key Definitions

Working Capital (WC) = Current Assets - Current Liabilities
Net Working Capital (NWC) = (A/R + Inventory) - A/P

Working capital represents the capital needed for day-to-day operations.

Why Working Capital Matters

  • Liquidity: Ability to meet short-term obligations
  • Operations: Funds tied up in daily business activities
  • Cash Flow: Changes in NWC directly impact cash flow
  • Valuation: Affects free cash flow and company value
1.2

The Operating Cycle

🔄 Cash Conversion Cycle Visualization

Purchase
Buy Inventory
→
Inventory
Hold Stock
→
Sale
Sell on Credit
→
Cash
Collect Payment
Cash Conversion Cycle (CCC) = DSO + DIO - DPO

Where:
• DSO = Days Sales Outstanding (time to collect from customers)
• DIO = Days Inventory Outstanding (time inventory sits)
• DPO = Days Payable Outstanding (time to pay suppliers)
💡 Key Insight

Negative CCC is a competitive advantage!
Companies like Amazon and Walmart have negative CCC because they collect cash from customers before paying suppliers. This means suppliers fund their operations!

1.3

Working Capital Components

📥 Accounts Receivable (A/R)

Money owed by customers for credit sales

DSO = (A/R ÷ Revenue) × 365

Days Sales Outstanding
How long to collect from customers

Interpretation:
• Lower DSO = Faster collection
• Higher DSO = More cash tied up

📦 Inventory

Raw materials, WIP, finished goods

DIO = (Inventory ÷ COGS) × 365

Days Inventory Outstanding
How long inventory sits before sale

Interpretation:
• Lower DIO = Efficient management
• Higher DIO = Risk of obsolescence

📤 Accounts Payable (A/P)

Money owed to suppliers

DPO = (A/P ÷ COGS) × 365

Days Payable Outstanding
How long to pay suppliers

Interpretation:
• Higher DPO = Better cash flow
• Too high = Supplier relationship risk
1.4

Industry Benchmarks

📊 Typical Working Capital Metrics by Industry

Industry DSO (Days) DIO (Days) DPO (Days) CCC (Days)
Retail 5-15 30-60 30-45 -15 to +30
Manufacturing 45-60 60-90 30-45 60-105
IT Services 60-90 N/A 30-45 15-45
Software/SaaS 0-30 N/A 30-60 -30 to +30
Construction 60-90 30-60 45-60 45-90
⚠️ Important Note

IT Companies have unique working capital profiles:
• High DSO (60-90 days) due to long payment terms with enterprise clients
• Low or no inventory (services business)
• Moderate DPO (30-45 days)
• Result: Positive CCC but manageable

Excel Lab

Hands-On: Calculate NWC Metrics

📥 Download Practice File

⬇ Download lecture-06-nwc-data.csv

🎯 Exercise: Calculate DSO, DIO, DPO for TCS

Given Data (TCS FY2025)

Revenue ₹289,456 crores
COGS ₹179,463 crores
Accounts Receivable ₹80,394 crores
Inventory ₹88,431 crores
Accounts Payable ₹28,630 crores

Step-by-Step Instructions

  1. Open Excel and import the CSV file
  2. Create columns for DSO, DIO, DPO, and CCC
  3. DSO Formula: =(Accounts_Receivable/Revenue)*365
  4. DIO Formula: =(Inventory/COGS)*365
  5. DPO Formula: =(Accounts_Payable/COGS)*365
  6. CCC Formula: =DSO+DIO-DPO
  7. Copy formulas for all companies and years

Expected Results (TCS FY2025)

DSO 101.5 days =(80,394/289,456)*365
DIO 179.7 days =(88,431/179,463)*365
DPO 58.2 days =(28,630/179,463)*365
CCC 223.0 days =101.5+179.7-58.2
Summary

Key Takeaways

  • Net Working Capital = (A/R + Inventory) - A/P
  • Cash Conversion Cycle = DSO + DIO - DPO
  • Negative CCC is a competitive advantage (Amazon, Walmart)
  • Industry benchmarks vary significantly - compare within sector
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