As i have invested i have learnt along the way. Some of my earlier investments were in cos which despite posting good numbers and good return ratios drifted down in terms of stock price and as a result i lost money. Some of such notable cos were Shankara, Tiger Logistics etc
Anyways, painful memories aside , i realized that one way to differentiate cos is look at how they manage working capital. More specifically, is the cash from operations (before working capital changes) enough to cover working capital needs?
While this may sound obvious , i think that any method that helps to separate cos that one should avoid deserves special attention
Money locked away in working capital needs to be funded and i have began to appreciate the impact this plays on the overall valuations of a business.
If you find yourself invested in such a co then there is only one way its going to end.
Looking at the working capital cycle and estimating working capital needs of a business is as fundamental as it gets. I have looked at the operating cycles of many businesses now and its quite revealing in terms of giving a sense of how difficult or easy the business is to run & operate.
So i am sharing a sheet that helps one to estimate working capital needs and relate it to the operating cash flow ( before WC changes ). Cos like Shankara , Tiger Logistics and countless others just cant generate enough. Ambika Cotton for e.g even in tough times has generated enough to be able to chug along while Indocount is not able to. Dmart and Future retail same story.
Vmart for long ( that is the co analyzed in the sheet attached ), was not able to generate enough.
However, it improved its cycle drastically and in 2017-2018 with an operating cycle of 55 days, it made enough cash to be able to cover its working capital and turned debt free.
OC.xlsx (13.5 KB)
The cells marked in blue you will have to copy paste data from screener or any other source.
Items I and J are the numbers to look at. I is the WC required and J is Operating Cash flow ( before WC changes). The actual WC capital required by a business cant be picked from the balance sheet as the receivables contain a profit component and for cos with significant gross margins, the WC is overstated if picked directly from the balance sheet. It has to be estimated
Do let me know your views on the same. Any inputs appreciated