Chapter 5. Working Capital and Cash Flow Analysis


  • Determining Working Capital

  • Tracking Changes in Working Capital

  • Tracking Cash Flow

We all like cash. Cash is liquid — you can spend it. As distinct from, say, a barrel of oil or a bushel of wheat, you know pretty closely how much it will be worth next week or next month. Stashed into the right money market instrument, it can even earn some interest, enough to slow, even if just slightly, the erosion of inflation.

But cash isn't really working for you. It just sits there, ready to meet upcoming obligations, perhaps newly converted from accounts receivable or deposited from an investor's capital infusion or a creditor's loan. Cash isn't really pulling its weight.

But it is a current asset and obviously it has value. Other current assets have value, and they are invested in creating income. Inventory, if you're regularly turning it over, contributes to your profits. Accounts receivable, if you're collecting them regularly, turn your older investments into cash you can use to make new investments. Prepaid expenses are viewed as unexpired assets: that is, assets that have not yet been used, such as the remaining coverage on a 12-month fire insurance policy.

Of course, you normally have liabilities that make claims on those assets. Accounts payable, salaries payable, and so on are typical current liabilities, those that are coming due within the next year. Because these liabilities already exist as claims on your assets, any accurate ...

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