Why does Warren Buffett rely heavily on Net Working Capital analysis Essay - 2

Why does Warren Buffett rely heavily on Net Working Capital analysis as his principal method of valuing businesses Do you agree - Essay Example When current assets are twice the size of current liabilities, net working capital is enough for most businesses to avoid its problems. If the value of current assets is less than one and a half size of current liabilities, then the business would be short of working capital that will result in the difficulty to meet its immediate debts. Businesses having difficulty in controlling their cash flow and working capital are said to have liquidity problems. Liquid assets are those assets that can be easily changed in to cash such as stock, debtors and short term investments. Buffett looks and analyses a business mainly with ‘owner earnings’ and ‘return on equity’ measures both in turn give an overall picture of cash flow available in a business and its operational efficiency. According to Buffet’s analysis method, it is very obvious that increased working capital can be viewed as cash out flow because money that are owed by debtors to the business or occupied in stocks cannot be utilized for meeting any other payments and hence no returns can be expected. Here, even though the working capital shows increases, the business can be viewed as inefficient as it failed to collect debtors on time. From assessing a business through mere working capital analysis, Buffett finds an advanced method of analyzing exact net working capital or cash flow available to the shareholders through ‘owner earning’ analysis. Capital expenditure, that is the money needed to spend on purchasing or upgrading plant or equipments, is deducted from net income and hence it forms as an Economic Value Added (EVA) analysis. By adding depreciation and amortization back also it gives an accurate cash flow available to shareholders. This analysis method looks at the ability of a firm to generate cash for its residual owners. Even though, the decisive