Hey there,

I hope you are doing great.

This is the third part of our working capital analysis.

Trade working capital consists of inventories, trade receivables, and trade payables. Other items could also be classified as trade working capital. This is dependent on the company’s specific business model.

The main goal is to understand what drives trade working capital and how it developed over time.

There are several main analyses that you should conduct.

1. Monthly working capital analysis covering DIO, DSO and DPO
2. Inventories incl. ageing, write-offs and split
3. Receivables ageing and allowances
4. Payables ageing

Let's look into the receivables and payables analysis in more detail.

Trade receivables

The receivables’ analysis relates to receivables ageing and allowances.

Ageing

Ageing describes the average overdue age of the receivables. In a first step, you check if receivables are due or not yet due.

If they are due, by how many days? Based on this, the ability of the company to receive cash on its invoices can be explained. Also, it shows if are any major clients do not pay as agreed. The receivables ageing is calculated for different balance sheet days. This helps understand changes within these dates.

Allowances

Allowances comprise general and specific allowances. Mostly at year-end, a general allowance is calculated. This means that a receivable that was worth 100 is now only worth 98 if a 2% general allowance is applied. The allowance needs to be in line with the company’s experience of receiving invoices.

In a due diligence, it is paramount to understand if this is performed and how the allowance is calculated.

Specific allowances relate to individual cases. In these, the firm assumes that the specific receivable is not (fully) recoverable. Whether this is applied, you need to understand the rationale behind it. Also, if it is applied, is the company still able to receive cash from devaluated invoices or not?

Trade payables

Ageing

Sometimes, firms don’t pay outstanding invoices. They use this as a cheap way to finance their operations. Why? If an invoice is not paid today, the company can use the money for alternative means. The payables ageing analysis helps analyze this. It is comparable to the receivables ageing analysis. If a company applies the financing method, you should classify this portion as net debt. It is then considered a hidden source of financing.

Quick reminder

Maybe you remember that I introduced you to Wynter a couple of weeks ago. The company is looking for people to join its research panel. The great thing is, you get paid for your feedback whenever you participate. It's a super low key time commitment (10-15min per survey). Feel free to register here.

As always, feel free to reach out if you have any questions.

Cheers,

Jan