Never take your eyes off the cash flow because it’s the life blood of business.
– Richard Branson
Understanding working capital is fundamental to keeping your eyes on cash flow. Many a time, business plans and investment theses are thrown off course because of unexpected working capital movements, even when other parts of the business are seemingly fine.
This is the first entry of the Working Capital Series. The purpose of the series is to deliver a congruent and clear outline of how working capital fits into a private equiteer’s analyses. I plan to make practicable and thoughtful points that (hopefully) don’t regurgitate finance textbooks. So, if deep down, working capital is still a little bit of a mystery to you, stay tuned.
The series will broadly adhere to the following structure:
- Overview: working capital fundamentals that will provide a foundation for more complex discussions
- Dealmaking: working capital analysis conducted for valuation and settlement purposes
- Investees: working capital issues for portfolio companies including improvements and monitoring
- Exiting: working capital considerations when exiting an portfolio company
Although the generic working capital formula is hardly rocket science, it can be quite difficult to understand its exact dynamics in relation to valuation methodologies and other private equity topics. In some instances, it is vitally important to consider working capital, whereas in others it doesn’t really matter (more on that later in the series). Lastly, more than working capital itself, it is critical to understand its drivers and their own influences on value and ongoing performance.
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