Accounts receivable as it relates to working cap investment

CFA Level II Equities
#1

I’m having trouble wrapping my head around this-

working cap investment = (2010 accounts receivable + 2010 inventory - 2010 A/P) - (2009 A/R + 2009 Inventory - 2009 A/P)

A few questions: Why does this formula include account payable? I’m trying to make sense of it like this-

I definitely understand that if inventory goes up on the balance sheet year of year that indicates (some) cash was spent on working capital investment. And I get why we would decrease accounts payable because maybe we bought inventory but only paid part of it upfront. But then why add the change in account receivable? Doesn’t a positive change in accounts receivable just indicate we sold items & didn’t collect all the cash yet? I’m definitely missing something here.

thnx

#2

you sold goods and did not collect yet on the cash. So someone owes you money - and it is uncollected as yet.

If you understand accounts payable - you did not pay it fully yet then the accounts receivable part is the exact opposite - you did not collect fully yet.

#3

so let’s say during the year, the firm sold 100units of bikes for $10 a piece but only collected $500 cash. A/R=$500 at the end of the year. Why does this affect our working capital investment that year? I thought working capital investment was more about the firm’s investment in inventory (is there anything else other than inventory?). Why would the fact that one of my customers hasn’t paid me affect my working capital INVESTMENT? Aren’t those 2 things unrelated- investment and collections?

I can even sort of memorize this just by understanding the A/P role in the formula above (we didn’t quite pay for all the inventory we bought that year)- and sorry I know I’m wrong and missing something- but just trying to clarify the point about the role of A/P…

thnx!

#4

you sold 100 units - so your inventory went down 1000.

You collected 500 - so total Assets = - 1000 + 500 = -500

you received cash 500

so net assets = 0 …

but is that really the case?

you were down 500 on your a/r

===

if you had collected the entire 1000 as A/R - you would have a net cash of +500…

and that gets reflected in the first scenario - when you subtract -500 (uncollected A/R).

#5

i believe I should pose this as a different question… (and this would be something that comes up in Level II in a later reading on financial statement analyis techniques I believe.

you are an analyst. how do you compare two companies – one that sold 10 bikes @$100 each, collected only $500 and another that sold the same # of bikes but collected $1000 in A/R.

#6

***ahhhh- so if you have $500 in A/R at the end of a year & the inventory asset account is flat, that means we sold $500 worth of inventory but replaced in with $500 in new investment of inventory, therefore we add it when calculating 'working capital investment. (I think this wa the big piece I just couldn’t remember!! Thanks!)

to answer the question above- (I would say): the company that collected more cash probably has stricter collection policies or the product is just more of a cash product…but from an accounting perspective I’d say they are very similar.