In this step, we compute net working capital, or NWC, which is the difference between non-cash current assets and non-debt current liabilities. The components of net working capital are often projected as percentages of sales or COGS, as we have projected them in our model. The accounts receivable days, accounts payable days, inventory days, and inventory turnover shown here are imputed. Alternatively, you could drive inventory projections from an assumed inventory days, and then impute the inventory/COGS ratio, for example. For simplicity, we assume that these ratios are flat over the projection period. In reality, these drivers could reflect seasonality, increasing leverage in the supply chain, etc.
While we have built in a selector switch to toggle the P&L item (sales or COGS) driving each of these working capital components, the selection is not arbitrary. You would always express accounts receivable as a percentage of sales, inventory as a percentage of COGS, and accounts payable as a percentage of COGS, for example. Components of net working capital can vary from one company to another and one industry to another; for each such item, decide whether it is more intuitive to express the item as a percentage of sales or COGS. For public companies, detailed analyst/broker reports may offer clues on how to project the components of net working capital.
Once we have built our working capital schedule, we link it to the balance sheet.