The Daily Technical #69: Can companies amortize goodwill?

Good morning. Welcome to the 69th edition of The Daily Technical.

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OVERVIEW OF YESTERDAY’S QUESTION
What does change in net working capital tell you about a company's cash flows?

The change in net working capital gives you a sense of how much a company's cash flows will deviate from its accrual-based net income.

Change in Net Working Capital = NWC (Prior Period) − NWC (Current Period)

If a company's NWC has increased year-over-year, its operating assets have grown and/or its operating liabilities have shrunk from the prior year.

Since an increase in an operating asset is a cash outflow, it should be intuitive why an increase in NWC means less cash flow for a company (and vice versa).

Common Mistakes

1. Forgetting that an increase in net working capital indicates a reduction in cash flow, due to more cash tied in assets or fewer liabilities. Always remember that higher NWC is linked with reduced cash availability, impacting liquidity.

2. Forgetting that NWC changes reflect timing differences between income recognition and cash flow realization. Focus on whether current assets or liabilities have unexpected shifts, revealing much about the company’s operational behavior.

3. Skipping intuitive analysis and solely relying on formulas. Develop the habit of logically linking NWC changes with cash flow implications beyond calculations for a comprehensive understanding.

TL;DR

• Change in NWC indicates how a company’s cash flows deviate from accrual-based net income.

• Formula: Change in NWC = NWC (Prior Period) − NWC (Current Period).

• Increase in NWC: Operating assets grew and/or operating liabilities shrank → Cash Outflow → Less cash flow.

• Decrease in NWC: Operating assets shrank and/or operating liabilities grew → Cash Inflow → More cash flow.

TODAY’S QUESTION
Can companies amortize goodwill?

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THAT’S A WRAP
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