Why does Warren Buffett rely heavily on Net Working Capital analysis Essay

Why does Warren Buffett rely heavily on Net Working Capital analysis as his principal method of valuing businesses Do you agree - Essay Example What is meant by Net Working Capital? Net Working Capital (NWC) is Current Assets minus Current Liabilities. Current Assets include Cash and Cash Equivalents, Receivables, Inventory and other current Assets. Current Liabilities include all Short Term Borrowings. Net working Capital is also defined as that part of Current Assets that is financed by Long term Funds. This definition of the NWC is useful for the analysis of the trade-off between Profitability and risk. The Greater the amount of NWC, the greater is the liquidity of the business, lesser the risk. Thus, if the company’s goal is increasing profitability, it can be achieved by increasing risk, which again is measured by the lower level of Net Working Capital. The important elements of decision making during the process of purchase of a business are Profitability and Risk. Both these elements can be analyzed using Net Working Capital. Net Working Capital can be improved by infusing new funds in to the business in terms of Capital or long term finance. Similarly, NWC can be deteriorated by purchase of Long Term Assets. Any increase in Current Assets of the company which has a corresponding increase in current liabilities would not effect the NWC of the company. The value of the business is determined by its intrinsic value. Intrinsic value of a business can be determined by Long term Assets minus Long term Liabilities. The other way of measuring the intrinsic value of the business is Current Assets minus Current Liabilities, which is measured by Net Working Capital. 2In a net-net situation, an investor estimates a liquidation value for a company, then tries to pay a fraction of that value in the market. Ben Graham loved these types of situations, defining the net-net value as: Graham would invest in companies which are available at a price which is two-thirds of the NWC of the company, the one-third portion is the margin of safety which would protect the investor against