Leading Entrepreneurship

If you have never heard of adjusted working capital, or do not use this number as a financial measure inside your firm, you are at a disadvantage when speaking with your financing sources.

Let’s take a look at the traditional vs. adjusted working capital calculations:

Traditional Working Capital = Current Assets – Current Liabilities

Adjusted Working Capital = (Current Assets – Cash) – (Current Liabilities – Notes Payable – Current Maturities of Long Term Debt)

As you can see, the adjustment is removing truly liquid (cash) or non-operational (notes payable, current maturities) from the operational picture.

What does the adjusted analysis tell us? Well, if the number is increasing versus previous year (as a percentage of current sales), it is indicating a loss of operational efficiency – such as overstocking inventory, accounts receivable growth or poor collections. The number doesn’t always have to be negative; your firm could have signed a firm contract or received a great deal on raw materials.

Why is it important? This analysis, along with net sales and gross profit margin, is an indicator your financing firms use to test how your stated strategy is working. If the analyses do not match your goals and tactics, there may be problems with your loan covenants or promises to the board or shareholders.

What are your thoughts regarding using the adjusted working capital analysis?