23.2: An Integrated Approach to Net Working Capital (NWC) Management Flashcards
Explain how managing receivables, inventory, and payables is related in an integrated approach to net working capital management.
Managing receivables, inventory, and payables together ensures that a firm has enough liquidity to pay its bills and invest in growth, balancing short-term and long-term financial health.
What is trade credit?
Trade credit is a form of credit in which a customer orders a product or service and the firm delivers it, along with an invoice indicating the terms of payment.
How did the change in ABC’s working capital affect its financial situation?
The change in working capital, including increased receivables and inventory without corresponding payables, led to a cash flow shortage, causing financial distress despite profitability.
What was the main problem faced by Mr. Jones of ABC Co. in the provided example?
Mr. Jones faced cash flow problems due to rapid growth, increased receivables, and inventory, highlighting the importance of managing working capital effectively.
Why is generating profit not sufficient for a company’s financial health?
Generating profit is essential, but without proper working capital management, a company can still face liquidity issues and financial distress.
How can rapid growth cause cash flow problems for a company?
Rapid growth can increase accounts receivable and inventory faster than payables, leading to a cash flow shortage despite increased sales and profits.
What lessons can be learned from the example of SNC-Lavalin Group Inc.?
Effective working capital management and strategic restructuring are crucial for turning around a struggling company, as seen with SNC-Lavalin’s efforts to become a more focused engineering services company.
What is the importance of the cash flow statement compared to the income statement and balance sheet?
The cash flow statement provides a clearer picture of a firm’s liquidity and cash-generating ability, while the income statement and balance sheet may not reflect actual cash flow.
How does managing working capital contribute to a company’s long-term health?
Proper working capital management ensures liquidity, allows for timely bill payments, and supports sustainable growth, preventing financial crises.
Why is it important to consider both profit and cash flow in financial management?
Profit indicates overall performance, but cash flow shows the actual liquidity available for operations and investments, essential for day-to-day management.
What role does inventory management play in working capital management?
Efficient inventory management reduces excess stock, frees up cash, and ensures timely order fulfillment, balancing investment and liquidity.
What is a cash budget?
A cash budget is a cash flow statement for each month, projecting a firm’s cash inflows and outflows over a forecast horizon.
Why is a cash budget important for firms?
A cash budget helps firms understand their cash inflows and outflows, plan for excess cash investments, and identify potential shortfalls to arrange necessary financing.
How did ABC’s cash budget reveal its cash flow problems?
ABC’s cash budget indicated a cash flow shortfall in months 5 and 6 due to increased sales and inventory without corresponding cash inflows, highlighting the need for better working capital management.
What role do banks play in a firm’s cash budget?
Banks require a cash budget to assess loan requirements and terms for short-term or permanent financing, ensuring the firm can cover any cash shortfalls.
