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Online Tutorial #4: How Do You Calculate A Company's Incremental Net Working
Capital Needs?

Incremental investment in net working capital is another important value driver in a

calculation of shareholder value. This session focuses on where to find the data, how
to calculate historical working capital trends and how to project future working
capital needs. As with previous sessions, we will use Domino's Pizza as of September,
2020, as a case study. Readers who want to calculate working capital while reading
this tutorial may wish to download the accompanying spreadsheet.

What Does Net Working Capital Mean?

To understand what we mean by net working capital, let's break this phrase down
into its component parts:

• Net. This means we look at cash tied up in short-term operating assets such as
accounts receivable and inventory, offset by non-interest bearing current
liabilities such as accounts payable.

• Working. This means that we want to focus on cash tied up in short-term

operating assets. Thus, working capital excludes long term capital required for,
say, investment in property, plant, and equipment (PP&E).

• Capital. This means that we want to calculate the amount of cash that a
company has to tie up in working capital to run its business.

More specifically, for industrial companies, net working capital equals cash tied up by
a company's short term operating assets, netted against short term operating
liabilities.

For any year, then, we add and subtract the following to calculate a company's net
working capital:

• Required cash. We usually assume that a company needs to have some cash on
hand to run its business. We can estimate that sum as a fixed amount of cash,
 or an amount as a percentage of sales. Thus, we add required cash to calculate
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• Accounts receivable (A/R). Accounts receivable equals money owed to a
company for goods or services purchased on credit. As A/R grow, then, a
company needs to tie up cash in its business as it effectively lends this money
out. Thus, we add accounts receivable to calculate working capital.

• Inventory. Any company selling a physical product will have to tie up cash in raw
materials, work-in-progress, and finished goods inventory. Thus, we add
inventory to calculate working capital.

• Other current assets. A company may have to tie up cash in other current
assets, such as insurance pre-payments. Thus, we add other current assets to
calculate working capital.

• Accounts payable. Accounts payable are bills from suppliers for goods or
services purchased on credit. A company benefits from accounts payable just
like consumers benefit from a charge card: you enjoy the merchandise now, and
pay later. Thus, we subtract accounts payable to calculate working capital.

• Other non-interest bearing current liabilities. Various companies may have

assorted non-interest bearing current liabilities such as accrued wages, accrued
expenses, accrued royalties, or other accrued liabilities. These non-interest
bearing current liabilities generate cash as they increase. Thus, we subtract
other non-interest bearing current liabilities to calculate working capital.

Case Study: Domino's Pizza as of September, 2020

To calculate Domino's net working capital, we first need to obtain the seven data
points described above from the company's historical SEC filings.

We have used these balance sheets to assemble a table that excerpts the current
assets and current liabilities portion of Domino's balance sheet (below). We highlight
those items that directly enter into a calculation of net working capital:
After entering this data The
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the Inputs worksheet
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spreadsheet, we Online
can calculate netand
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Other capital by adding the relevant current
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operating assets and subtracting the relevant current operating liabilities.

We do this in the table below:

The last step of the analysis calculates how much cash Domino's typically ties up in
working capital to generate a dollar of new revenue.

How Do You Project Future Incremental Working Capital (%)?

In the case of Domino's, the company's relatively modest working capital needs leads
us to anticipate that it won't be a major investment need. We project incremental
working capital as a percentage of incremental sales to be approximately 15.0%,
somewhat above the company's historical average.

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