Shaker Cherukuri Managing Principal Process IS Inc. (317)258-3552 scherukuri@processisinc.com http://process-improvement-solutions.

com/

Copyright 2010, Process IS Inc.

1/26/2010

Assets (Current + LT) = Liabilities (Current + LT) + Stock Holders Equity (SE) Current Assets (CA)
Cash + Marketable Securities (notes etc) Inventory (Inv.) Accounts Receivables (A/R) Pre-Paid Accounts (PPA)

Current Liabilities (CL)

Short Term Debt (STD) Accounts Payables (A/P) Unearned Revenue (UR)

Stock Holders Equity (SE)

Paid in Capital (PIC) Retained Earnings (RE)
Revenues-Expenses
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Working Capital =
Current Assets (CA) Current Liabilities (CA)

If CA > CL, then positive Working Capital If CA < CL, then negative working capital So what do we want?

Conventional Wisdom
Positive Working Capital is the norm. Increase in WC yields negative cash flows

How do you fund it?

Cash flow from operations that is greater than the negative cash flow for working capital Cash flow from financing or investing Other?

Copyright 2010, Process IS Inc.

1/26/2010

Ratio Analysis to Measure Efficiency

Days Receivables (DR) = (Lower the better)
Average Accounts Receivable/Average Daily Sales Average number of days that elapse between sale and cash collection

Days Inventory (DI) = (Lower the better)

Average Inventory/Average Daily COGS

Average number of days of sales that can be made using only the supply of inventory on hand

Days Payables (DP) = (Higher the better)

Avg. Acc Payable/Average Daily Purchases

Inventory Turnover = (Higher the Better)

Cost of Goods Sold (COGS)/Average Inventory

Cash Conversion Cycle (CCC) = DR + DI - DP

Working Capital Gap (lower the better) Time between cash outflow and cash inflow

Higher working capital indicates liquidity However, excessive liquidity ties up capital and lowers overall return on assets.
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Use unconventional wisdom and business model To fund internal operations using negative working capital Cash Conversion cycle could be negative! And get rewarded for it.. How do they do that?

Copyright 2010, Process IS Inc.

1/26/2010

Current Assets (CA)

Cash + Marketable Securities (notes etc) Inventory (Inv.) Accounts Receivables (A/R) Pre-Paid Accounts (PPA)

Current Liabilities (CL)

Short Term Debt (STD) Accounts Payables (A/P) Unearned Revenue (UR)

Stock Holders Equity (SE)

Paid in Capital (PIC) Retained Earnings (RE)
Revenues-Expenses

Cash Conversion Cycle (CCC) = DR + DI DP WC = CA - CL

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Requires the right business model. Automakers do not get paid before they ship. In fact they have their capital tied in inventory for a long time which is why they have a huge working capital. Amazon and Dell to an extent (since Dell is not just online/direct anymore as they used to be) get paid before they ship. So extending payables allows them to create a small cash conversion cycle (could be negative). The Unearned revenue, which is a liability, turns the working capital negative (credit UR and debit cash) They pay the suppliers with cash they get from customers and have some left over all the time in essence getting an interest free loan from the customers!
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Yes, you could. However, that usually is a red flag for the credit rating agencies (i.e. funding operations with cash from investing or financing activities) Amazon does not have to worry about credit rating downgrade due to A/P increase. They are doing it to increase their working capital efficiency and not because of cash flow constraint. They did issue large amount of debt few years ago and was the reason for Amazon.bom Barron's article. Servicing that debt is not an issue anymore and they successfully used the capital raised to scale themselves and the rest as they say is history

Copyright 2010, Process IS Inc.

1/26/2010

Dell is going through a transformation

http://process-improvementsolutions.com/blog/2009/11/03/dells-transformation/ Is loosing PC market share Due to focus on margin

Strategic Decision to reposition during a trough in the economic cycle

http://process-improvementsolutions.com/blog/2009/04/20/repositioning-duringtroughs/

Objective being to move from products to services

http://process-improvementsolutions.com/blog/2009/03/03/from-products-toservices-how-do-they-do-that/

Why? For profitable growth A topic for another discussion Next: Case Scenarios with Numerical Examples

Copyright 2010, Process IS Inc.

1/26/2010

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