Net Working Capital Peg Nuances
August 03, 2023
by a searcher from Indiana State University in Minneapolis, MN, USA
I'll admit that thinking about NWC pegs makes my head hurt. Situation is seller is an inventory based business that does quasi accrual accounting (cash based with YE adjustments).
Sales are retail credit card, so no A/R, just inventory as an asset.
A/P would be the only liability, but they are not tracking payables, just payments (again, cash based)
If we had A/P by month (and in transit inventory), calc would be pretty straightforward, but alas, here we are.
Anyone that has dealt with something similar, and can you share any sage advice on how best to navigate would be greatly appreciated.
from United States Naval Academy in Colleyville, TX 76034, USA
Assuming you start with your first "batch" of inventory with the purchase and you don't have crazy inventory requirements (like paying for inventory today and you don't get it for 6 months)...
Start with how long it takes you to convert the sale to cash. Since you're retail credit card, that's probably 3-5 days. Even though you don't have A/R, you sort of do because of your cash conversion timing. Call it 5 days of A/R, maybe one week to be safe.
Next, look at your payouts including inventory restock. Pick a safe timing so you can keep the lights on and the inventory stocked. Maybe sixty days, maybe 90, and plan on having that much cash available.
Add your 60/90 days cash and one week of A/R, there's a starting NWC without having to fret about building A/P as a "source" of cash.
If it's really an inventory-based business then your A/P is really only your inventory payment terms. The rest of your bills (payroll, utilities, insurance, fuel, shipping, whatever) are on such short cycles that trying to calculate an A/P for NWC planning is probably not worth the effort, just assume zero days and then any A/P timing you do get is cash flow positive.
Bottom line, keep it simple.
in United States
In terms of understanding AP, you might consider a “search for unrecorded liabilities.” That is, look at cash payments after some cutoff date (e.g., 7/31) and get the invoices for those payments. If you choose 5 payments and the invoices are all from 4 months ago, you probably have a lot of AP that you’ll be paying off (though you’ll probably have generous terms with your suppliers). If all the invoices are from yesterday, they probably pay AP quickly and you won’t have much.
As for inventory, you need to make sure you have enough to meet demand. If all your revenue comes from holiday sales, but the seller only buys enough to cover summer sales in Nov, you’ll dump a lot of cash buying inventory and probably wont meet your goals. Many businesses can deal with###-###-#### days of inventory (2-3 months of COGS), but not if there are long lead times. Just try to understand the cycle and come up with your best estimate so that you don’t have to invest a lot more immediately post close.