Working capital ratios demonstrate the company’s efficiency at managing its resources, with particular reference to cash flow, and allows a good financial analyst to quickly and efficiently assess this aspect of the company’s performance in a financial modeling project.
Some typical working capital ratios that a financial analyst will come across include:
- Days inventory, this tells us how long on average each unit of stock is in the shop/warehouse etc. before being sold. Clearly, the shorter this length of time the better.
Days inventory = ( Average inventory / Cost of goods sold ) x 365 days
- Debtor days (Days sales in receivables, or debt collection period), this tells us how long on average each debtor takes to settle their debt to the business. Clearly, the shorter this length of time the better. A very large debtor collection period might indicate that the business may be unable to collect its debts.
Debtor days = ( Average accounts recievable / Sales ) x 365 days
- Creditor days (Days accounts payable or credit period), this tells us how long on average the business takes to pay its creditors. The longer this length of time the better. However, a very large credit period may indicate that the business does not have the cash to pay its debts.
Creditor days = ( Average accounts payable / Cost of sales ) x 365 days
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