What is Net Current Liabilities (Exclude Debt, Lease Liabilities and Deferred Revenue) in the Financial Analysis spreadsheet?

Hi Victor,
I have a similar question but not specific to Venture so thought to just ride on this thread to better understand the calculation of NWC.

I understand briefly that NWC is used to calculate Invested capital, which is the minimum capital that the cpy needs to grow in the next 12 mths. Hence we only look at "current" assets and liabilities when computing the "Invested Capital"

Invested capital = NWC + Net PPE 
which is also        = (Current assets - Cash & cash eq) - (Current Liabilities - Debt - Lease liabilities - Deferred revenue) + Net PPE

However I still have some further clarifications as to why we include/exclude some line items for NWC after watching your video multiple times:

On the current assets portion:
1) Why do we exclude cash and cash eq from the current assets? Are we already assuming that the cpy is intending to keep these as "spare cash" and does not need these amount to grow the biz?
2) The reason why we only exclude cash and cash eq from the current assets and include things like "prepaid expenses" or "other current assets" is because we assume that these are required assets that the company needs in the next 12 months to run its operations/grow?

On the current liabilities portion:
3) Why do we exclude lease liabilities? Thought that this is a sum that the company needs to pay for it to run its operations and so it should be included? (In your video you mentioned something about it being deducted under "Revenue" but I couldn't understand how it related to the balance sheet, appreciate if you could further elaborate on that pls, if possible)
4) Likewise, why do we exclude any current debt? I understand we exclude deferred revenue because it is not exactly a liability that the company needs to "pay back", but for current debt, isn't it what the company has to repay in the next 12 months? (or do we exclude it because we assume that this amount in current debt is not used for the next 12mth's operations, i.e. the amount that was borrowed was used to finance another period's operations?)
5) Why do we only exclude debt, lease liabilities and deferred revenue, but not other items like "income tax payable" or "accrued payroll and related benefits" and "other accrued liabilities"?
6) Finally, are these items to be included/excluded in the current assets & liabilities always the same for all the companies that the AQ team analyse? Kindly share the thought process and assumptions behind this, if any, e.g. is it because of the filters we have applied from the beginning e.g. FA/TA <60%? 

Thanks for taking the time to address my confusion here as I am trying to understand the significance of the line items in the financial statements, appreciate it!

I look forward to your reply!

Hi Terence,

On the current assets portion:
 

1. The reason for excluding the cash portion is to determine the company's true Return on Invested Capital (ROIC). For example, in a business with negative working capital, the company collects money upfront from customers and pays suppliers later. This gives the business a strong advantage as it doesn't need capital to operate, being financed by suppliers. If the balance sheet shows $100 million in cash, not all of this might be needed to run the business. Including it would lower the ROIC, not reflecting the company's true advantage.

2. Yes

On the current liabilities portion:

3.Due to a change in accounting standards, rent paid by businesses now must be recorded as lease liabilities. This mainly affects retail companies. Previously, rent was recorded as an expense on the income statement. Under the new standards, for example, a 2-year lease will show the first year's rent as a lease liability in the income statement, while the remaining 12 months' rent is recorded under current liabilities as lease liabilities. From a business perspective, rent is typically paid from revenue, and failure to pay would result in forfeiting the lease and covering it with a deposit fee. In most cases, lease liabilities are a small amount, except for retail businesses. If the amount is small, adding or removing it does not make a significant difference. I view this from a business perspective when analysing the balance sheet.

4.As mentioned above, we want to determine the real Return on Invested Capital (ROIC) of the business. For instance, an asset-heavy company will naturally have a lower ROIC, but including debt can boost the ROIC. Therefore, removing debt allows us to assess whether the business model inherently has a high ROIC. If it does, then introducing debt into the business can further enhance its ROIC. This approach helps to evaluate the true efficiency and profitability of the business operations.

5.The rest of the working capital is essential for keeping the business operational. For instance, payroll is a critical component—if the company fails to pay its employees, the business would come to a halt.

6. In most cases, this method should apply to the majority of companies, but it doesn't fit all. It's important to understand the business when using this ratio. When inputting figures, I analyse the business perspective to see if removing certain elements makes sense. So far, this method taught in AQ has worked well for me without any special adjustment. Generally, filtering companies with FA/TA <60% will get you good ROIC business. When you do further filtering using the ROIC method helps categorise these businesses from low to high ROIC.

Hope this helps.