Working capital analysis is used to determine the liquidity and sufficiency of current assets in comparison to current liabilities. This information is needed to determine whether an organization needs additional long-term funding for its operations, or whether it should plan to shift excess cash into longer-term investment vehicles.
The first part of working capital analysis is to examine the timelines within which current liabilities are due for payment. This can most easily be discerned by examining an aged accounts payable report, which divides payables into 30-day time buckets. By revising the format of this report to show smaller time buckets, it is possible to determine cash needs for much shorter time intervals. The timing of other obligations, such as accrued liabilities, can then be layered on top of this analysis to provide a detailed view of exactly when obligations must be paid.
Next, engage in the same analysis for accounts receivable, using the aged accounts receivable report, and also with short-term time buckets. The outcome of this analysis will need to be revised for those customers that have a history of paying late, so that the report reveals a more accurate assessment of probable incoming cash flows.
A further step is to examine any investments to see if there are any restrictions on how quickly they can be sold off and converted into cash. Finally, review the inventory asset in detail to estimate how long it will be before this asset can be converted into finished goods, sold, and cash received from customers. It is quite possible that the period required to convert inventory into cash will be so long that this asset is irrelevant from the perspective of being able to pay for current liabilities.
The next major activity is to net these analyses together into a modified short-term cash forecast, using very brief time periods, such as intervals of every three to five days. If there is a shortage in the amount of available cash in any time bucket, it will be necessary to either plan for a delayed payment to a supplier, or to obtain sufficient cash from new debt or equity to offset the shortfall.
A working capital analysis of this type should be conducted at ongoing, regular intervals.