9 Working Capital 1 - Cash & Receivables Flashcards
What is the calculation for working capital?
working capital = current assets - current liabilities
What are considered current assets?
- cash and equivalents
- marketable securities
- receivables
- inventories
- prepaid items
What are considered current liabilities?
- accounts payable
- notes payable
- current maturities of long-term debt
- unearned revenues
- taxes payable
- wages payable
- other accruals
What is permanent working capital?
Working capital is permanent when some liquid current assets must be maintained to meet the firm’s long-term minimum needs regardless of the firm’s level of activity or profitability.
What is trade credit?
When a firm is offered credit terms by its suppliers. Ex - a vendor has delivered goods and charged the firm $160,000 on terms of net 30. The firm effectively has received a 30-day interest-free $160,000 loan.
What is spontaneous financing?
Financing is spontaneous when current liabilities, such as trade payables and accruals, occur naturally in the ordinary course of business.
Why are accrued expenses, such as salaries, wages, interest, dividends, and taxes payable another source of (interest-free) spontaneous financing?
Because the company is receiving value it has not yet paid for.
What is maturity matching?
A firm ideally should offset each element of its temporary working capital with short-term liability with the same maturity. Ex - a short-term loan could be obtained before the winter season and repaid with the collections from holiday sales.
What is a conservative financing policy?
When a firm seeks to minimize liquidity risk by financing its temporary working capital mostly with long-term debt. This approach takes advantage of the certainty inherent in long-term debt.
What are the advantages of a conservative financing polity?
The locked-in interest rate mitigates interest rate risk (risk that rates will rise in the short run). The long-term maturity date mitigates liquidity risk (the inability to repay a current obligation when due).
What are the disadvantages of a conservative financing polity?
- Working capital is idle during periods when it is not needed - this inefficiency is mitigated in part by investing in short-term securities.
- Long-term debt is more expensive
What is an aggressive financing policy?
To increase profits, an aggressive financing policy reduces liquidity and accepts a higher risk of short-term cash flow shortages by financing part of its permanent working capital with short-term debt. This approach avoids the opportunity cost of idle funds incurred under the conservative policy. But it risks either unexpectedly high interest rates or the total unavailability of financing in the short run.
What does it mean when a transaction that causes equal changes in the numerator and denominator of a ratio, when the ratio is less than 1?
The transaction has a a proportionally greater effect on the numerator, resulting in a change in the ratio in the same direction. The effect is a decrease in the ratio, which means less liquidity.
What does it mean when a transaction that causes equal changes in the numerator and denominator of a ratio, when the ratio is greater than 1?
The transaction has a proportionally greater effect on the denominator, resulting in a change in the ratio in the opposite direction. The effect is an increase in the ratio, which means the firm is more liquid.
What is liquidity?
A firm’s ability to pay its current obligations as they come due and remain in business in the short run. Liquidity measures the ease with which assets can be converted to cash.
