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Could you help how to interpret correctly negative WC that has a positive meaning?
For example, a Retail business of FMCG:
Period 1: DIO 22; A/R days 0; A/P days – 40; WC days -18
Period 2: DIO 20; A/R days 0; A/P days – 40; WC days -20
the interpretation would be that WC has improved and the retailer has 2 additional days of inventory sponsored by suppliers. In fact suppliers cover 2 inventory cycles for the retailer.
Is it correct?Working capital has improved certainly, but it has improved because they are keeping lower inventory and it would therefore seem that they are managing inventory better.
(Provided of course that the reason for keeping lower inventory is indeed because they are managing it better, and is not simply because they cannot afford to have more inventory)
Thank you!
Still, is it acceptable to comment that suppliers cover 2 inventory t/o cycles? or such comment is not really true?
@johnmoffat said:
and is not simply because they cannot afford to have more inventoryhow can this be understood? Have you mentioned that as a general comment or it can be applied to the given example?
It is true that suppliers are covering two inventory cycles, but that does not really mean too much and is not in itself either a good or a bad sign.
Any business wants to delay paying payables (provided that they do not delay so long that the suppliers stops supplying).
Any business wants to keep inventories as low as possible without damaging the business.In your example, payables days have not changed and so there is no particular comment to make about that.
However inventory days have fallen (albeit not significantly) and this suggests that they are perhaps managing inventory better. The problem is that we never have enough information in exam questions so be certain – that is why I say that it suggests that they are managing it better (and that they are deliberately holding less inventory).
What would always be useful additional information is inventory days for similar businesses. The level of inventory needed depends very much on the type of business.
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