# Understanding Financial Statements and Terms

Guest post by Sandesh Trivedi of http://sandeshtrivedi2.blogspot.com/ This article is especially good for someone who is brand new to investing, but also useful to a more advanced investor who might need to brush up on some accounting 101!

Working capital analysis

Working capital Calculation

Current Assets minus Current Liabilities = Working Capital

It’s the best way to judge how much a company has in liquid assets to build its business, fund its growth, and produce shareholder value. If a company has a positive working capital then that means its in good financial health with plenty of cash and short term resources to pay off its short term liabilities. however some companies can generate cash so quickly they actually have a negative working capital. This happens because customers pay upfront and so rapidly, the business has no problems raising cash. In these companies, products are delivered and sold to the customer before the company ever pays for them.A negative working capital is a sign of managerial efficiency in a business with low inventory and accounts receivable (which means they operate on an almost strictly cash basis).

Accounts Receivable turnover in days

Measures the average number of days from the sale of goods to collection of resulting receivables. It is obtained by the following formula: ( Accounts Receivable / Sales X 365). Rising accounts receivable is a sign of trouble because it shows that a company is taking longer to collect its payments. It suggests that the company is not going to have enough cash to fund short-term obligations because the cash cycle is lengthening. If Accounts receivable is handled poorly, it means that the company is having difficulty collecting payment from customers. This is because accounts receivable is essentially a loan to the customer, so the company loses out whenever customers delay payment. The longer a company has to wait to be paid, the longer that money is unavailable for investment elsewhere

Inventory Turnover

Measures the length of time on average between acquisition and sale of merchandise. For a manufacturer it covers the amount of time between purchase of raw material and sale of the completed product. It is obtained by the following formula: (Inventory / COGS X 365).

A high inventory turnover is good for business and is an indication of good demand for the company’s products.

Analyzing a company’s working capital management provides one with good insights about the business and enables a investor to foresee any financial difficulties that may arise in the near future.

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