return on working capital handbook

Return On Working Capital Handbook

© 2011 Intuition Consulting Pte Ltd. All rights reserved.2

Structure of Handbook

• This handbook has been created to help users to construct a ROWC model• It starts by explaining the importance of ROWC as a business measure

together with the quick calculation• We then move on to the ROWC model with its 5 drivers

- Gross margin- Cost structure- Inventory days- Days sales outstanding- Days purchases outstanding

• There are explanations for each driver on the subsequent pages


Return on Working Capital

Operating Profit

Working Capital

Return on working capital (“ROWC”)

ROWC is one of the most important measures for a business. It reflects for any business the:

• Total business opportunity of the market focus• Strength of the value proposition• Quality of asset and resource management• Ability to negotiate with customers for value not price• Ability to be rewarded for value by suppliers• Barriers to entry in a given industry• Competitive advantages• Threat of being substituted


+

Working Capital Turn

Working Capital Days

Inventory Days Days Sales OutstandingGross Margin Cost Structure

Operating Margin

-

x


-Days Purchases

Outstanding

ROWC modelTogether with an example

ROWC is a multiplication of Operating Margin (determined by the profit model) and Working Capital Turn (determined by the working capital model)

Operating Margin is the difference between Gross margin and Cost structure

Working Capital Turn measures how many times per year working capital turns

Working Capital Days measures the time it takes between paying a supplier and receiving cash from the customer

+29.243.836.55% 4%

1%

51.1

7.14

7.14%


Financial Statements to ROWC

Two financial statements, the income statement and the balance sheet can be simplified into the following formats

Example Income Statement PeriodCurrency

Net sales and other income 100$

Cost of sales (97)$ Performance Rebates 2$

Gross profit/ margin 5$

Selling, General and Administrative costs (4)

Operating profit/ margin 1$

Example Balance Sheet PeriodCurrency

Investment in non working capital $11

Stock/ Inventory 10$ Receivables 12$ Creditors/ Accounts Payable (8)$

Investment in working capital $14

Net Assets $25

Shareholders funds/ equity 20 Borrowings 5

Invested Capital $25

From these financial statements, the ROWC model can be constructed.


Gross Margin

Gross Margin

Gross Profit

Sales

Example Income StatementCurrency %

Net sales and other income 100$ 100%

Cost of sales (97)$ -97%Performance Rebates 2$ 2%

Gross profit/ margin 5$ 5%

Period

= 5%

Key definitions1. Net sales represent invoices to resellers net of

any returns2. Cost of sales includes the direct costs of the

product and/ or service that has been invoiced to resellers. For a distributor this is typically the vendor costs of the product net of any rebates that are directly passed through to the reseller

3. Performance rebates are those incentives paid by vendors that should be protected by the distributor and form part of their profitability

MeasureGross margin measures the value delivered to the customer that the customer is willing to pay for


Cost structureExample Income Statement

Currency %Net sales and other income 100$ 100%



Selling, General and Administrative costs (4) -4%

Period

= 4%

Key definitions1. Sales, General and Administrative (“SG&A”) costs

include the following costs of a distributor:• Sales• Marketing• Logistics• Occupancy, including warehousing• Technology• Corporate, finance and administration

2. SG&A does not include interest, tax and extraordinary items costs

3. SG&A does not include those costs that have been included in cost of sales

MeasureCost structure measures the productivity of the various processes in the distributor, the key process being sales

Cost Structure

SG & A Costs

Sales


Operating MarginExample Income Statement

Currency %Net sales and other income 100$ 100%



Selling, General and Administrative costs (4) -4%

Operating profit/ margin 1$ 1%

Period

Key definitionsThe difference between gross margin and cost structure

MeasureThe return on sales or the difference between value and productivity

Gross Margin Cost Structure

Operating Margin

-5% 4%

1%


Inventory Days

Inventory x 365

Sales

Inventory daysExample Balance Sheet

CurrencyInvestment in non working capital $11

DaysStock/ Inventory 10$ 36.50Receivables 12$ 43.80Creditors/ Accounts Payable (8)$ -29.20

Investment in working capital $14 51.10

Net Assets $25



Period

Key definitionsIncluded in inventory are:• Goods held for resale• Goods In Transit• Work in Progress• Spares

MeasureNumber of days of working capital tied up in inventory

= 36.5 days


Days Sales Outstanding (“DSO”)Example Balance Sheet




Net Assets $25



Period

Key definitionsThe time it takes between the date of the invoice to customer and receiving the cash

MeasureThe number of days credit provided to customers usually dictated by Terms and Conditions

= 43.8 daysDSO

Receivables x 365

Sales


Days Purchases Outstanding (“DPO”)Example Balance Sheet




Net Assets $25



Period

Key definitions• The time it takes between the date of

the invoice from the supplier and paying the invoice

• Netted off Accounts Payable can be the amounts owed by the supplier to the business (rebates etc)

MeasureThe number of days credit provided by suppliers usually dictated by Terms and Conditions

= 29.2 daysDPO

Payables x 365

Sales


-+

Working Capital Turns


Inventory Days DSO DPO

Working Capital Turns and Days

29.243.836.5

51.1

7.14

Key definitions• Working Capital Turn measures how

many times per year working capital turns

• Working Capital Days measures the time it takes between paying a supplier and receiving cash from the customer

Measure• The faster you turn working

capital the better from both a cost and ROWC aspect

• The lower the working capital days the better as long as you do not compromise the value proposition


ConclusionROWC – The Business Model

+

Working Capital Turn


Inventory Days Days Sales Outstanding

Gross Margin Cost Structure

Operating Margin

-

x


-Days Purchases

Outstanding

29.243.836.55% 4%

1%

51.1

7.14

7.14%

• Every company is different• Easy visual to understand the model• Can be benchmarked• Best practices can improve performance

return on working capital handbook

Documents

working capital rowcrowc

capital turn measures

capital turns

intuition consulting

sales cost structuresg

following costs

returnscost of sales

key definitionsnet sales