Net-net working capital is calculated as: Cash and short-term investments + (75% of accounts receivable) + (50% of inventory) - All liabilities. This calculation is used in value investing to identify potentially undervalued companies based on their liquidation value.
Here's a breakdown of how to calculate net-net working capital, also known as Net Current Asset Value (NCAV):
Formula:
Net-Net Working Capital = Cash & Short-Term Investments + (0.75 Accounts Receivable) + (0.5 Inventory) - Total Liabilities
Explanation of Components:
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Cash & Short-Term Investments: This includes all liquid assets readily convertible to cash, such as checking accounts, savings accounts, money market funds, and short-term marketable securities. These are valued at 100%.
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Accounts Receivable: These are amounts owed to the company by its customers. The formula typically uses 75% of accounts receivable to account for potential bad debts (customers who may not pay).
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Inventory: This represents the value of the company's raw materials, work-in-progress, and finished goods. The formula uses 50% of inventory to account for potential obsolescence, damage, or difficulty in selling inventory quickly at full price during liquidation.
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Total Liabilities: This encompasses all of the company's obligations, including accounts payable, salaries payable, short-term debt, long-term debt, and deferred revenue.
Step-by-Step Calculation:
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Gather Financial Data: Obtain the necessary figures (Cash & Short-Term Investments, Accounts Receivable, Inventory, and Total Liabilities) from the company's balance sheet.
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Calculate Adjusted Accounts Receivable: Multiply the Accounts Receivable amount by 0.75.
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Calculate Adjusted Inventory: Multiply the Inventory amount by 0.50.
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Sum the Adjusted Assets: Add Cash & Short-Term Investments, Adjusted Accounts Receivable, and Adjusted Inventory.
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Subtract Total Liabilities: Subtract Total Liabilities from the sum calculated in the previous step.
Example:
Let's say a company has the following balance sheet information:
- Cash & Short-Term Investments: $1,000,000
- Accounts Receivable: $500,000
- Inventory: $800,000
- Total Liabilities: $1,500,000
Calculation:
- Adjusted Accounts Receivable: $500,000 * 0.75 = $375,000
- Adjusted Inventory: $800,000 * 0.50 = $400,000
- Sum of Adjusted Assets: $1,000,000 + $375,000 + $400,000 = $1,775,000
- Net-Net Working Capital: $1,775,000 - $1,500,000 = $275,000
In this example, the company's net-net working capital is $275,000.
Using Net-Net for Investment Analysis:
Value investors, particularly those following the principles of Benjamin Graham, use net-net working capital to identify potentially undervalued stocks. They look for companies whose market capitalization is less than their net-net working capital. This suggests that the market is undervaluing the company's assets, providing a potential investment opportunity. However, this is a very conservative approach, and it's essential to perform thorough due diligence before making any investment decisions. It's important to understand why the market is undervaluing the company, as there may be legitimate reasons (e.g., declining industry, poor management).
