Calculating change in Net Working Capital in Corporate Finance

CFA Level II
#1

I hope I’m not losing my mind and have been thinking this backwards all along, but here goes (this relates to the National Plastics case study)

If I’m attempting to calculate FCFF and I am given a Balance Sheet from 2011 and 2012, and within my 2011 Balance Sheet I have:

2011

Current Assets (excluding cash and equiv): $295

Current Liabilities: $670

2012

Current Assets (excluding cash and equiv): $315

Current Liabilities: $696

Here is the way I typically address these things when calculating any cash flow measure, and perhaps I’m wrong.

My change in assets from 2011 to 2012 was (315 - 295) = 20. I would consider this an outflow of cash since we are increasing our current assets, am I correct in assuming that?

My change in liabilities from 2011 to 2012 was (670 - 696) = 26, I would consider this an inflow of cash since I am putting off paying my suppliers.

All in all, I would suspect that this would actually increase my FCFF by $6, but the actual change according to the CFA answer is that it decreases FCFF by $6. Can someone explain what I’m missing here?

#2

Change in current assets:

  • increase lead to decrease in cash flows
  • decrease lead to increase in cash flows

Change in current liabilities:

  • increase lead to increase in cash flows
  • decrease lead to decrease in cash flows

Since change in current asset is +20 this lead to cash flow decreasing by 20.

Since change in current liabilities is +26, this lead to cash flow increasing by 26.

Hence, net increase in cash flow by 6.

#3

Ernest, I’m agreeing with you that I would consider it a cash inflow of $6. I went back and reviewed my problem and realized what I was doing wrong.

In the FCFF formula, I simply plugged in my positive number of 6, but still maintained my subtraction sign within the equation.

Something like

FCFF = NI + Int(1-T) + Dep - FCInv - WCInv

So I actually maintained the sign and subsequently ruined my formula.

Additionally, I do know the formula for Change in Net Working Capital, but I perfer to do it this way, most of the time.

Thanks for helping me work through this one

#4

It always helps to think of NWC as a use of cash, like an investment. It helps keep you grounded when dealing with all the +'s and -'s.