Focused Compounding EP 277. Working Capital and the Cash Flow Statement: The Cash Conversion Cycle of a Business
Nov 5, 2020
Geoff Gannon, an investment analyst and writer known for his expertise in valuation and cash flow analysis, dives into the intricacies of working capital. He explains why cash flow is often a more reliable metric than earnings, discussing the implications of stock-based compensation and dilution. Listeners will learn about managing receivables during crises, the impact of inventory on cash flow, and signs of aggressive sales tactics. Gannon also shares insights on industry comparisons, using examples from Amazon and Micron to illustrate his points.
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Working Capital Defined
- Working capital is short-term assets and liabilities that convert to cash quickly, like cash, receivables, and inventory.
- It reflects the business's liquidity at a moment in time and differs from long-term assets like PP&E.
Why Cash Flow Uses Adjustments
- The indirect cash flow method reconciles net income to cash by adjusting for balance sheet changes.
- Increases in assets (like receivables) show as negative adjustments because they use cash, which confuses many readers.
Focus On Key Working Capital Items
- Focus on receivables, inventory, PP&E and key liabilities like accrued expenses and accounts payable when analyzing working capital.
- Compare those items to sales and peers to understand business-specific working capital needs.