Question

Select a company from your country which is publicly traded in the U.S. Go to Yahoo Finance
(http://finance.yahoo.com/) and punch the company’s name or ticker symbol in the search box.
Use the “financials” tab to discuss the following (choose the annual statements):
- Calculate and interpret the Company’s net working capital
- Calculate and interpret the company’s cash conversion cycle
- Can you detect a positive or negative time trend? If so, what does that imply? 

Answer

For this assignment, I will be using 2019 financial statements of International Business Machines
Corporation and Subsidiary Companies, hereafter called as IBM. I have performed a financial
analysis of the same financial statement to accomplish my professional assignment.

Net Working Capital (NWC)

Net-working capital can be simply expressed as a difference between current assets and current
liabilities of the company which can be mathematically expressed as below:

NWC = Current Assets – Current Liabilities ….. (i) [ CITATION Ste15 \l 1033 ]

Here, From 2019 balance sheet of IBM ($ in millions)

At December 31: 2019 2018

Total Current Assets $ 38,420 $ 49,145
Total Current Liabilities $ 37,701 $ 38,227

NWC as of 2019 = $ (38,420 – 37,701) = $ 719

Thus, for the year 2019 IBM Net Working Capital was $ 719 million

NWC as of 2018 = $ (49,145 – 38,227) = $ 10,918 million

Net Change in Working Capital = $ (719-10,918) = - $ 10,199

Here, IBM has positive NWC in 2018 and 2019 which means that IBM had enough balance in its
operating account to cover all its financial obligations and can invest a surplus amount in other
income-generating activities. In 2018, NWC is higher than that of 2019 which signifies that
IBM’s liquidity capacity is comparatively lower in 2019 than that of 2018. This also means that
the change is the current assets of the company have increased more than the current liabilities.

It is often said that efficient working capital management creates positive value for investors.
According to Erasmus [CITATION Era10 \n \t \l 1033 ], company profitability could be improved
by decreasing the overall investment in the net-working capital. Hence, this also signifies that the
management of IBM has drastically decreased overall investment in networking capital of the
company to increase its profitability.

Cash Conversion Cycle (CCC)

Measures such as current ratio analysis, quick ratio, the ratio of net working capital to current
liabilities and other traditional measures are not found sufficient to interpret cash-flows of the
firm [ CITATION Jos96 \l 1033 ]. To overcome its limitations, the financial analyst uses the cash
conversion cycle. The Cash Conversion Cycle, also called the ongoing liquidity, is the time
measurement of several days it took for the conversion of investment in inventories and other
related items into cash from their sales [ CITATION Jos96 \l 1033 ].

Cash Conversion Cycle can be calculated using following formulae

CCC = DIO + DSO – DPO ……. (ii) [ CITATION Jos96 \l 1033 ]

Here,

DIO = Days Inventory Outstanding = (Average Inventory/Cost of Good Sales) X 365

DSO = Days Sales Outstanding = (Average Account receivable / Net Sales) X 365
DPO = Days Payable Outstanding = (Average Account Payable / Cost of Good Sales) X 365

From 2019 Financial Statement of IBM ($ in millions)

At December 31: 2019 2018 Average

Inventory 1,619 1,682 1,649
Account Receivable 7,870 7,432 7,651
Account Payable 4,896 6,558 5,727
Net Sales 77,147 79,591
Cost of Goods Sales 40,658 42,654

Now, For the Year 2019

DIO = (1,649/40,658) X 365 = 14.80 days

DSO = (7,651/77,147) X 365 = 36.20 days

DPO = (5,727/40,658) X 365 = 51.41 Days

From (ii)

CCC = -0.41 days

Positive or Negative Time Trend

From the above calculation, I can say that IBM has a negative time trend for the cash conversion
cycle. This implies that in the year 2019, IBM took less time to sell its inventory and other
related items to its customer and IBM does not pay its payable amount to its suppliers until after
it receives cash from its customers.

References
Erasmus, P. (2010). Working capital management and profitability : the relationship between the
net trade cycle and return on assets. Management Dynamics : Journal of the Southern
African Institute for Management Scientists, 19(1), 2-10.
Jose, M. L., Lancaster, C., & Stevens, J. L. (1996). Corporate Returns and Cash Cenoversion
Cycles. Journal of Economics and Finance, 20(1), 33-46.
Stephen, R. A., Randolph, W. W., & Bradford, J. D. (2013). Fundamentals of Corporate
Finance (10 ed.). New York: McGraw-Hill Education.