Something’s Gotta Give #63: Performance improvement – The NWC case

The Net Working Capital (“NWC”) is one of the most overlooked elements of a business. The reason for this, is that most business leaders typically focus on the Income Statement (“IS”) when trying to assess the performance of their business.

Cash flow management usually entails the reviewing of the projected short-term (up to a year) cash inflows, in conjunction with the cash requirements over the same period, to ensure that the company will be able to meet its obligations. Following that, the ability to return cash to the shareholder is examined (which is what most private entity shareholders focus on). As you can probably understand from this paragraph, cash flow management is usually done based on a direct method cash flow.

The Balance Sheet (“BS”) on the other hand, remains largely overlooked. Managers typically review their NWC management once every two years (minimum) or (more often) when a crisis looms, as is now the case with CoViD-19.

The above summarizes my experience in working with about 90% of my clients. I am also guessing that this is the reason why in 90% of the cases when I am asking for financial projections from clients, I tend to get a direct method cash flow and when clarifying that I would like to also receive WC projections, the typical reply that I receive is that “this is too complex to calculate.”

The truth however it that WC management (you can’t project it without knowing how you manage it) is something fairly simple, provided that it is done systematically and is shown the relevant commitment from the part of senior management.

Not only that, but it also forms an integral part of any (proper) valuation exercise. The management of WC therefore, contrary to popular belief among managers, does have a very visible impact on the valuation of the business, which is why it would make sense to track it, as proper valuations do tend to show the real potential of a business over the long term, which is what shareholders care about and by extension, what managers are evaluated on.