The Daily Technical #140: When would an investor prefer fixed rates over floating rates (and vice versa)?

Good evening. Welcome to the 140th edition of The Daily Technical.

Now, you’re here for one reason, so let’s dive in.

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OVERVIEW OF YESTERDAY’S QUESTION
Why are cash and debt excluded in the calculation of net working capital (NWC)?

In practice, cash and other short-term investments (e.g., treasury bills, marketable securities, commercial paper) and any interest-bearing debt (e.g., loans, revolver, bonds) are excluded when calculating working capital because they're non-operational and don't directly generate revenue.

Net Working Capital (NWC) = Operating Current Assets − Operating Current Liabilities

Cash & cash equivalents are closer to investing activities since the company can earn a slight return (~0.25% to 1.5%) through interest income, whereas debt is classified as financing.

Neither is operations-related, and both are thereby excluded in the calculation of NWC.

Common Mistakes

1. Including cash and short-term investments as part of operational assets. Remember, these are closer to investing activities and not essential for daily business operations. Focus on distinguishing between operating and non-operating elements.

2. Forgetting the simplified formula for NWC. Always apply the formula: NWC = Operating Current Assets − Operating Current Liabilities, ensuring no non-operational items dilute the accuracy.

3. Incorrectly apply uniform interest rates across all cash and investments. It's necessary to factor in potential variations in interest rates and the capital implications to avoid misrepresenting their role in the calculation. Remember, precise distinctions prevent operational focus from becoming muddled.

TL;DR

• NWC focuses on operations: it excludes non-revenue generating cash, short-term investments, and interest-bearing debt.

• Cash and equivalents fall under investing activities, with limited returns from interest.

• Interest-bearing debt is related to financing, not daily business operations.

• NWC formula: Operating Current Assets − Operating Current Liabilities.

• Exclude cash and debt to reflect true operational needs and financial health

TODAY’S QUESTION
When would an investor prefer fixed rates over floating rates (and vice versa)?

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