Calculating Free Cash Flows: The Case of Preferred Shares
In the previous few articles we understood how to calculate free cash flows which accrue to the firm as a whole as well as to equity shareholders. However, while conducting this analysis we made an implicit assumption. We assumed that there are only two classes of funds available to the firm, this is equity and […]
Golden Rules of Accounting – 3 Main Principles
While the system of debit and credit is the foundation for maintaining balance and accuracy, it can often feel overwhelming for beginners and even for clerical staff who handle day-to-day bookkeeping. The Golden Rules of Accounting are designed to simplify these concepts into actionable principles that anyone can use. These rules break down the most […]
Risks Involved in Derivative Contracts
Derivatives are considered to be extremely risky. The market is divided in two fronts when it comes to the opinion about risks involved in a derivative contract. Some people are of the opinion that since derivatives are not new securities by themselves, how can they introduce new risk in the market? The opposing camp agrees […]
Follow On Public Offer
The common perception is that companies need to cultivate relationships with investment bankers only if they are unlisted and need to go public. It is believed that once they have already gone public, the services of investment banks have limited utility for these firms. However, that is not true. There are many already listed companies […]
Asset-Backed Commercial Paper
In the previous articles, we have already read about commercial papers and why they are an important segment of the money market. In most cases discussed earlier, commercial papers were related to unsecured debt. However, this need not always be the case. It is possible for commercial paper to be backed by other securities or […]
Working Capital to Sales Ratio = Working Capital / Sales
Stating the working capital as an absolute figure makes little sense. Consider two companies, both having the same working capital of USD 100. While one company uses this working capital to generate sales of USD 500, the other uses the same amount as working capital to generate USD 1000 in sales. Which one do you think will be more profitable? Which one do you think is more efficient?
When companies use the same working capital to generate more sales, it means that they are using the same funds over and over again. This is why this ratio is also called “Working Capital Turnover Ratio” as it measures the number of times working capital has been turned over. The higher the sales, the more the profits and therefore the more appropriate use of working capital has been made.
The working capital to sales ratio uses the working capital and sales figures from the previous year’s financial statements. Hence, there is obviously an assumption that working capital and sales have been accurately stated. Companies may over stock or under stock because of expectations of shortage of raw materials. These influences are however short term. Thus while reading this number the analyst must compare it with the past numbers to see if this is usual state of affairs for the company or whether this is an exception.
These investors may be true because the stock market takes any news of cash shortage very seriously and the stock plummets in the market. But the price in the stock may be short term.
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