Hi,
Could someone help me understand how to calculate change in working capital investment. I understand, the formula is CA - CL in recent year and subtract last year’s CA - CL. I am getting confused with the addition and subtraction when Accounts Receivables increase or decrease and when Accounts Payable increase or decrease.
When A/R increases, working capital increases, and when A/R decreases, working capital decreases.
When A/P increases, working capital decreases, and when A/P decreases, working capital increases.
Thanks! So when the change in A/R, Inv and A/P is positive, we add A/R and Inv and subtract A/P. In other cases, even though change in A/R, Inv and A/P is negative, we add all these up. I don’t understand why we add them.
Then although this sum is negative, we still subtract this value from Net Income while calculating FCFF. Shouldn’t we be adding this as minus minus is positive?
Easiest way to calculate working capital requirement is to the following:
Ignore Negative sign in the formula and always use the positive sign provided that you follow the following 2 steps.
Changes in CA (A/R, Inv) should be calculated as (Assuming you are calculating for 2019): CA ( 2018 ) - CA (2019)
Changes in CL (A/P) should be calculated as (Assuming you are calculating for 2019): CL ( 2019 ) - CA (2018)
Thanks! What if the question only has the cash flow statement and A/R, Inv and A/P are negative in it?
Changes in CA and CL are always calculated in the cash flow statements based on the formulae I mentioned above. So you simply add changes in A/R, Inv and A/P irrespective of their signs in the cash flow statement to arrive at working capital changes.Since fixed capital investment is also cash outflow and appears as negative in the CF statement then you simply add all the components to arrive at FCFF (No need to remember any negative sign). Try Example 2 (Cane Distribution) from the Curriculum to get comfortable with the calculations i explained above.
Ok thank you so much!