Why can using a firm\'s working capital to discuss cash flow without further qua

Question

Why can using a firm's working capital to discuss cash flow without further qualification be misleading?

"Cash flow methodology should distinguish between a new capital intensive business and a more mature operation." Discuss.

The number of companies acquired only two or three years from startup has increased dramatically in the last few years. What are the root causes of these early exits?

How much is a customer worth? How much does it cost to acquire an additional one? This is the focus of Peters' plan for a successful early exit when the business model is yet to show any profit. However, investors will also have to consider other factors. Which factors are not covered in Peters' analysis?

Explanation / Answer

A Firm's working capital is simply the measure of excess 'current assets' over 'current liabilities'. At first sight, a negative working capital indicates that the current liabilities are much high above the cash or receivables that the company holds. This is what the general sense of working capital study is.

However, if we go on to analyze the likes of companies such as McDonald's, where they have no credit sales, we will note that since their business model relies entirely on cash sales, they can have current liabilities of x times the current assets but still generate profits!

In such a scenario, the working capital alone will not provide a fair picture of the company, but other measures such as profitability and cash generation should also be considered!

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