9. Working Capital Management

Question 1

What is working capital?

Answer 1

The cash invested in current assets less current liabilities

Question 2

What are the 2 aims of working capital management?

Answer 2

1. To have enough cash to pay liabilities

2. To be as efficient as possible so that all capital is invested to earn the maximum profit

Question 3

What does the funding of working capital concern?

Answer 3

The extent to which the non current and net current assets are financed by short or long term sources of finance

Question 4

What are permanent current assets?

Answer 4

The certain base levels of inventory that are always carried and the cash balances that never fall below a certain level

Question 5

What are fluctuating current assets?

Answer 5

The proportion of current assets that are not fixed, for example due to seasonality

Question 6

What are the 3 approaches to funding working capital?

Answer 6

1. Conservative
2. Aggressive
3. Moderate/matching

Question 7

What is the conservative approach to funding working capital?

Answer 7

All non current and permanent current assets, and some of the fluctuating current assets, are financed out of long term funds (low return, low risk)

Question 8

What is the aggressive approach to funding working capital?

Answer 8

Only non current assets are funded by long term funds (high return, high risk)

Question 9

What is the moderate/matching approach to funding working capital?

Answer 9

Long term funds are used for long term and permanent current assets, and short term finance is used to fund fluctuating assets

Question 10

What are the consequences of over capitalisation? (Too much tied up)

Answer 10

Inventory could become obsolete, cash could be being used elsewhere to generate higher returns

Question 11

What is the consequence of overtrading (Too little working capital)

Answer 11

Lack of cash to pay debts

Question 12

What type of business is overtrading common in?

Answer 12

Expanding, young businesses

Question 13

What are the 2 typical indicators of overtrading?

Answer 13

Rapid increase in revenue and current assets (financed by credit), and a significant decrease in liquidity ratios

Question 14

What are 3 possible solutions to over trading?

Answer 14

1. Raising additional long term finance e.g. shares
2. Slowing down the growth of the business
3. Managing working capital better e.g. offering settlement discounts

Question 15

What is the working capital/cash operating cycle?

Answer 15

The cycle that shows the length of time between payment of cash for goods and eventual receipt of cash from their sale - the number of days for which finance is required

Question 16

What is the calculation for the working capital/cash operating cycle?

Answer 16

Receivables Days + Inventory Days - Payables Days

Question 17

What is the calculation for receivables days?

Answer 17

Receivables/Credit Sales x 365

Question 18

What is the calculation for finished goods days?

Answer 18

Average Finished Goods/ COS x 365

Question 19

What is the calculation for WIP days?

Answer 19

Average WIP/ COS x 365

Question 20

What is the calculation for raw materials days?

Answer 20

Average Raw Materials/ Raw Materials Purchases x 365

Question 21

What is the calculation for payables days?

Answer 21

Payables/Credit Purchases x 365

Can use COS if have no purchases

Question 22

What 4 actions could be taken to reduce the cash operating cycle? (and what are their potential issues?)

Answer 22

1. Delay payables (could be bad blood)
2. Reduce credit period allowed (may go elsewhere)
3. Speed up production time (incr costs)
4. Reduce inventory levels (could lead to stock out)

Question 23

What is the calculation for the current ratio?

Answer 23

Current Assets/Current Liabilities

Question 24

What is the calculation for the acid test/quick ratio?

Answer 24

Current Assets - Inventories /Current Liabilities