What Does Working Capital Mean? Wal-Mart vs. Amazon vs. Salesforce($ in Million Except Per Share Data)

Key Points of This Lesson:

They define it for you - Current Assets minus Current Liabilities - but they focus too much on

valuation and financial modeling purposes.

Like the difference between velocity and acceleration in physics…

Working Capital, by itself, does not tell you a terrible amount and could mean many different

metrics, AND the company's business model, that's when you start gaining insights.

2. So, What Does the "Change" in WC Mean?

"Official" definition of Working Capital is Current Assets minus Current Liabilities, so you could start from that… but that's not really the best way to think about this.

For one, cash and debt should be excluded altogether because those are NOT operationalline items.

For another, it's easier to think of this in terms of the individual items that comprise these"Operating" Assets and Liabilities.

Expenses.

payments you're waiting on (AR) - in other words, INCREASING any of these costs you cash!

Accrued Liabilities.

You either get the cash upfront (DR), or you effectively get more cash because you're payingfor something later (the last two).

So with the "Change" in Working Capital, you're seeing which group of items increasesby a higher amount - Current Assets Excl. Cash or Current Liabilities Excl. Debt.

1. Why Does This Matter? Can find lots of definitions online on Investopedia, Wikipedia, About.com, etc. but most of these places miss the point when it comes to "Working Capital"

the WHAT and not the WHY - why does it matter? How do you use it?

First thing to understand is that it's really the CHANGE in Working Capital that matters for

things… but when you also look at the CHANGE in WC, what it is as a % of revenue and other

Most Common Current, Operating Assets: Accounts Receivable, Inventory, and Prepaid

What do they all have in common? You've paid for them upfront in cash, or they represent

Most Common Current, Operating Liabilities: Deferred Revenue, Accounts Payable, and

for customer payments, might be paying suppliers very quickly…

or might just be delaying payments to suppliers.

Let's go to the examples to show you a few real world interpretations…

Wal-Mart - Working Capital Excerpt from Cash Flow Statement:

Changes In Certain Assets and Liabilities: Year 1 Year 2Accounts Receivable: $ (733) $ (796)Inventories: (3,205) (3,727)Accounts Payable: 2,676 2,687 Accrued Liabilities: (280) (935)Accrued Taxes: (153) 994

Net Change in (Operating) Working Capita (1,695) (1,777)

Annual Revenue: $ 421,849 $ 446,950 Annual Net Income: 16,993 16,387

Net Change as a % of Revenue: (0.4%) (0.4%)Net Change as a % of Net Income: (10.0%) (10.8%)

retailer, it MUST pay for Inventory in advance before selling it…

It does keep suppliers waiting a fair amount since its AP balance is also high and increasingeach year, but Inventory spending outweighs that.

This means that as Wal-Mart's business grows, it requires ADDITIONAL cash to keep funding it and keep growing it due to the Inventory that must be paid for in advance!

Now, as a % of revenue and net income, this is quite small, so it would never have to raiseequity/debt funding or anything like that, but it also doesn't get any type of "bonus cash"as its business grows.

reducing Wal-Mart's valuation in a DCF analysis.

Recap: So What Does Working Capital Mean?

If this Change is NEGATIVE, then Current Assets are increasing by MORE than Current Liabilities!

Interpretation: Company might be spending a lot on Inventory, might be waiting too long

If this Change is POSITIVE, then Current Liabilities are increasing by more than Current Assets!

Interpretation: Could be collecting a lot of cash upfront, might have no or minimal inventory,

Interpretation: Always negative due to huge Inventory expenditures - since WMT is a

Valuation: This will reduce Free Cash Flow (though not by a massive amount), thereby

expect… or it does it REQUIRE additional cash to grow?

Makes a big difference for a DCF analysis when you value a company based on itscash flows, but also makes a difference for how much funding the business needs to grow, and even what happens when that business gets acquired.

One final point to think about: we've focused on WC from the perspective of the company,but what about how it impacts the customers and suppliers of the business?

Are certain business models better or worse for them? Do company policies that benefit the company's stock price and investors hurt the average person?

Something to think about...

Well, by itself, not very much... the CHANGE in working capital, however, is huge!

Gets you closer to how much cash flow a company is really generating.

The key question it answers: As the business grows, does it generate MORE cash than you

They define it for you - Current Assets minus Current Liabilities - but they focus too much on

Working Capital, by itself, does not tell you a terrible amount and could mean many different

metrics, AND the company's business model, that's when you start gaining insights.

"Official" definition of Working Capital is Current Assets minus Current Liabilities, so you could start from that… but that's not really the best way to think about this.

For one, cash and debt should be excluded altogether because those are NOT operational

For another, it's easier to think of this in terms of the individual items that comprise these

payments you're waiting on (AR) - in other words, INCREASING any of these costs you cash!

You either get the cash upfront (DR), or you effectively get more cash because you're paying

So with the "Change" in Working Capital, you're seeing which group of items increasesby a higher amount - Current Assets Excl. Cash or Current Liabilities Excl. Debt.

Can find lots of definitions online on Investopedia, Wikipedia, when it comes to "Working Capital"

in Working Capital that matters for

in WC, what it is as a % of revenue and other

Accounts Receivable, Inventory, and Prepaid

You've paid for them upfront in cash, or they represent

Deferred Revenue, Accounts Payable, and

Let's go to the examples to show you a few real world interpretations…

Amazon - Working Capital Excerpt from Cash Flow Statement:

Year 3 Changes In Operating Assets and Liabilitie Year 1 $ (614) Accounts Receivable: $ (866) (2,759) Inventories: (1,777) 1,061 Accounts Payable: 2,997 271 Accrued Liabilities: 1,067 981 Deferred Revenue: 43 (1,060) Net Change in (Operating) Working Capita 1,464

$ 469,162 Annual Revenue: $ 48,077 17,756 Annual Net Income: 631

(0.2%) Net Change as a % of Revenue: 3.0%(6.0%) Net Change as a % of Net Income: 232.0%

the change is higher than Wal-Mart's each year… BUT it is also not paying suppliers as quicklyand is accruing a higher Accounts Payable balance each year.

It does keep suppliers waiting a fair amount since its AP balance is also high and increasingFor WMT, the increase in Inventory exceeds the increase in AP every year… for Amazon it'sthe opposite!

This means that as Wal-Mart's business grows, it requires ADDITIONAL cash to keep funding it and keep growing it due to the Inventory that must be paid for in advance! Lots of stories of Amazon delaying payments to suppliers for months and months… whereas

Wal-Mart aims to pay within 30-45 days.Now, as a % of revenue and net income, this is quite small, so it would never have to raiseequity/debt funding or anything like that, but it also doesn't get any type of "bonus cash" Plus, Amazon has that Deferred Revenue coming in - customers pay upfront for items that

will be delivered later. Amazon gets the cash NOW, further improving its cash flow.

WC far exceeds Net Income here - far more of an impact than for Wal-Mart.

, then Current Assets are increasing by MORE than Current Liabilities!

Company might be spending a lot on Inventory, might be waiting too long

, then Current Liabilities are increasing by more than Current Assets!

Could be collecting a lot of cash upfront, might have no or minimal inventory,

Always negative due to huge Inventory expenditures - since WMT is a Interpretation: Amazon is still spending a lot on inventory… and actually, as a % of revenue

This will reduce Free Cash Flow (though not by a massive amount), thereby Valuation: This will increase Amazon's FCF and boost its valuation in a DCF since the change in

Makes a big difference for a DCF analysis when you value a company based on itscash flows, but also makes a difference for how much funding the business needs to grow,

One final point to think about: we've focused on WC from the perspective of the company,

Are certain business models better or worse for them? Do company policies that benefit

in working capital, however, is huge!

As the business grows, does it generate MORE cash than you

Amazon - Working Capital Excerpt from Cash Flow Statement: Salesforce - Working Capital Excerpt from Cash Flow Statement:

Year 2 Year 3 Changes In Operating Assets and Liabilitie $ (861) $ (846) Accounts Receivable: (999) (1,410) Deferred Commissions: 2,070 1,888 Prepaid Expenses: 1,038 736 Accounts Payable: 275 399 Deferred Revenue: 1,523 767 Net Change in (Operating) Working Capita

$ 61,093 $ 74,452 Annual Revenue: (39) 274 Annual Net Income:

2.5% 1.0% Net Change as a % of Revenue:(3905.1%) 279.9% Net Change as a % of Net Income:

the change is higher than Wal-Mart's each year… BUT it is also not paying suppliers as quicklyBUT we still have AR (just like almost any company), and Deferred Commissions - must be paidupfront to sales reps in cash and then recognized over term of subscription (similar to Prepaid Expenses).

For WMT, the increase in Inventory exceeds the increase in AP every year… for Amazon it'sThe Net Change still ends up being positive, though, thanks to that huge increase in Deferred Revenue each year… subscriptions are often sold months or years in advance, cash is collected UPFRONT,

Lots of stories of Amazon delaying payments to suppliers for months and months… whereas and then revenue is recognized over time.

Great situation for company! Get all that cash right away, which boosts its cash flow.Plus, Amazon has that Deferred Revenue coming in - customers pay upfront for items thatwill be delivered later. Amazon gets the cash NOW, further improving its cash flow. So as Salesforce grows, if DR keeps increasing as it has been, company will get "bonus cash"

and will not need anything extra to fund its business.

WC far exceeds Net Income here - far more of an impact than for Wal-Mart.and therefore boost its valuation in a DCF.

Amazon is still spending a lot on inventory… and actually, as a % of revenue Interpretation: No inventory! It's a software/subscription company, so that helps a lot…

This will increase Amazon's FCF and boost its valuation in a DCF since the change in Valuation: This will increase Salesforce's FCF by a good amount, since its Net Income is negative,

Salesforce - Working Capital Excerpt from Cash Flow Statement:

Year 1 Year 2 Year 3 $ (245) $ (183) $ (425) (167) (233) (265) (8) (10) 105 80 193 (29) 445 479 612 105 247 (1)

$ 2,267 $ 3,050 $ 4,071 (12) (270) (232)

4.6% 8.1% (0.0%)(907.5%) (91.4%) 0.5%

BUT we still have AR (just like almost any company), and Deferred Commissions - must be paidupfront to sales reps in cash and then recognized over term of subscription (similar to Prepaid Expenses).

The Net Change still ends up being positive, though, thanks to that huge increase in Deferred Revenue each year… subscriptions are often sold months or years in advance, cash is collected UPFRONT,

Great situation for company! Get all that cash right away, which boosts its cash flow.

So as Salesforce grows, if DR keeps increasing as it has been, company will get "bonus cash"and will not need anything extra to fund its business.

No inventory! It's a software/subscription company, so that helps a lot…

This will increase Salesforce's FCF by a good amount, since its Net Income is negative,