Why recompute
Balance sheets most often fail to reflect the fair value of assets because of accounting concepts and conventions such as the historical cost concept and the money measurement concept. The standard categorisation of line items also may not suit every type of analysis. So analysts compute additional metrics, two of which the syllabus works through.
Total debt
Debt consists of obligations settled through cash that carry interest as compensation for the time value of money. That separates it from all other liabilities, and analysts need to identify its total value. Total debt is calculated by summing long-term debt, the current portion of long-term debt, short-term debt, finance lease obligations and accrued interest.
Secured loans including accrued interest 1,413 (16,865 a year earlier); unsecured term loans 1,75,551 (71,011); non-convertible bonds 2,53,741 (3,89,558); non-convertible debentures 32,322 (30,068); finance lease obligation 47,721 (48,831); deferred payment obligation 4,66,191 (4,55,602); short-term borrowings 3,10,097 (1,29,569). Total debt 12,87,036 against 11,41,504 on 31 March 2018. The syllabus text quotes this as Rs 12.87 billion in one place; the exhibit is in millions, so the figure is Rs 1,287 billion, and the exam tests the components rather than the unit.
Working capital
Working capital is the capital invested in the business to sustain one operating cycle, popularly called the cash-to-cash cycle. Many describe it as capital locked up for day-to-day requirements, which the syllabus calls a misnomer: a company does not keep safety stock or speculative stock, or extend credit to customers, for day-to-day requirements. The day-to-day logic only explains why it keeps cash. Through the lens of supply chain management, working capital exists because a manufacturer brings in raw materials, sells on credit and waits to realise cash: it spends first and collects later.
Net working capital = Current assets - Current liabilities
- The accountant's approach, resting on the convention that a company generates short-term funds (not necessarily only cash) to meet working capital needs, so only the net amount has to be provided by long-term capital.
- Bharti Airtel FY2019: current assets Rs 329.06 billion, current liabilities Rs 930.55 billion, working capital negative Rs 601.49 billion.
Core working capital = Inventory + Trade receivables - Trade payables
- Current assets often include short-term investments not meant for operations, and current liabilities include obligations that do not arise from day-to-day operations, such as current maturities of long-term debt, so the plain difference misleads.
- Core working capital counts only operating items. It helps assess the need to raise working capital finance from banks. Cash is not in the formula, but including a reasonable cash balance is a good idea because operations need it and cash-out situations happen.
- Bharti Airtel FY2019: inventory 884, debtors 43,006, payables 2,80,031 (Rs million), giving negative Rs 2,36,141 million, about negative Rs 2.36 billion. A year earlier: inventory 693, debtors 58,830, payables 2,68,536, core working capital negative 2,09,013.
Bharti's working capital is hugely negative under both measures. The liquidity topic later explains that companies with high bargaining power over customers and suppliers often prefer negative working capital because it is an interest-free obligation. The metric tells you the shape of the operating cycle, not by itself the health of the company.
- Balance sheets often fail to reflect fair value because of the historical cost and money measurement concepts, and the standard categories do not suit every analysis, so analysts compute additional metrics.
- Debt is settled in cash and carries interest as compensation for the time value of money, which separates it from other liabilities. Total debt sums long-term debt, the current portion of long-term debt, short-term debt, finance lease obligations and accrued interest; Bharti Airtel's consolidated total on 31 March 2019 was Rs 12,87,036 million, including a deferred payment obligation of Rs 4,66,191 million.
- Working capital is the capital invested to sustain one operating cycle, the cash-to-cash cycle: the company spends first and waits for customers to pay. Calling it capital for day-to-day requirements is a misnomer. The accountant's net working capital is current assets minus current liabilities, on the assumption that only the net amount must come from long-term capital.
- Core working capital strips out items unrelated to operations (short-term investments, current maturities of long-term debt): inventory plus trade receivables minus trade payables, ideally with a reasonable cash balance added. It helps assess the need for bank working capital finance.