Working Capital Gap
Shaker Cherukuri, MBA, MSEE
alum: GE, CAT, CMI, Booz
http://ProcessISInc.com/
Ph: (408) 634 - 4754
e-mail: scherukuri@ProcessISInc.com
Copyright 2010, Process IS Inc.

● Assets (Current + LT) = Liabilities (Current + LT) +
Stockholders 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)
● Stockholders Equity (SE)
● Paid in Capital (PIC)
● Retained Earnings (RE)
● Revenues-Expenses
Basic Accounting Equation….
Copyright 2010, Process IS Inc.

● Working Capital =
● Current Assets (CA) – Current Liabilities (CL)
● If CA > CL, then positive Working Capital
● If CA < CL, then negative working capital
● So what do we want?
Working Capital
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● 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?
It Depends….
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● Ratio Analysis to Measure Efficiency
● Day’s 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.
How do you Quantify (Measure) it?
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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?
Then there is Dell and Amazon…
Copyright 2010, Process IS Inc.

● 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)
● Stockholders Equity (SE)
● Paid in Capital (PIC)
● Retained Earnings (RE)
● Revenues-Expenses
● Cash Conversion Cycle (CCC) = DR + DI – DP
● WC = CA - CL
Back to Basics Again…
Copyright 2010, Process IS Inc.

● 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!
So why does everyone not do it?
Copyright 2010, Process IS Inc.

● 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
Could you not do the same using
leverage?
Copyright 2010, Process IS Inc.

● Dell is going through a transformation
● Is losing PC market share
● Due to focus on margin
● Strategic Decision to reposition during a trough in the
economic cycle
● Taken Private by Mr. Michael Dell
● Objective being to move from products to services
● Services growth as envisioned
● Why?
● For profitable growth
● Higher valuation
More: http://ProcessISInc.com/
So what is going on with Dell?
Copyright 2010, Process IS Inc.