How To Represent Working Capital

The last thing we are going to add is how an asset purchase can actually change the working capital. Earlier in the term we learned that working capital is defined as the difference between current assets and current liabilities, (i.e., working capital = current assets – current liabilities.) In this context here, working capital means the changes in the amount of inventory you have to keep on hand and the changes in the amount of accounts receivable that you have, and so we are dealing with these two parts, both of which are current assets. What we are working with here is that, due to the purchase of this asset, (or vehicle) for various reasons, we expect to see changes in inventory for the amount of accounts receivable.

The idea is that when we specified what was different from the initial case when we bought this asset, (vehicle) we said, look, in 2010, we are going to have this $1000 increase in sales and we said that this vehicle, for whatever reason, was also going to have some small operating expenses. Now, together this meant that it was more than likely, since I had an increase in sales, the size of the accounts receivable that was out there was going to be a little bit larger. For instance, instead of having only say $2000 worth of accounts receivable, you’d have something like $2150 worth of AR that are commonly floating around out there. So, what we are saying here is that because we purchased this vehicle, inventory requirements and accounts receivable are a little bit larger and so there is actually going to be a reduction the amount of cash that you have available, and this is what we are seeing here with this -$200, (in cell C17.)

Okay, so working capital ends up sucking up your cash because it is all bound up in that little increase in inventory that you have to have in order to make those additional sales. Thus, your cash is going to be tied up in accounts receivable, which is to say, it has been effectively lent out to other people.

Now the other thing we specified in this problem was that $1000 boost in sales was only going to happen in 2010. In 2011, that burst in sales was going to go down and well, look, that boost in sales was not a permanent increase in sales. So, while in the one year we needed to have more inventory hanging around and we were going to have more accounts receivable, in the next year this would not be the case and any money tied up in those two areas was going to be released back to us as cash. So, what we are seeing here, (in cell E17) for working capital in 2011, is this release of working capital. Now, it is important to see that in 2012, the amount of working capital we have, in the form of inventory and accounts receivable, is at the same level it would be at if the asset had not been purchased, so in 2012 the working capital is back at the regular level.

So, in summary, we see that in 2010, we have $200 more than we would have in the contrary case of purchasing this vehicle, tied up in inventory and accounts receivable. In 2011, we are doing is releasing that amount and having this extra cash available, and then in 2012, what we are seeing is that we are at that level we had before, that there is no additional change.

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