Chapter 15 - Working capital management

Question 1

What is the primary objective of working capital management?

Answer 1

Strike a balance between current liabilities and assets

Trade off between cash flows and profits

Question 2

What are the consequences of poor working capital management?

Answer 2

• Inability to meet due bills
• Demands on cash during periods of growth
• Over-stocking or stock-outs

Question 3

What are some examples of a transaction that has a trade off between cash flow and profit?

Answer 3

• Purchase of non-current assets for cash
• Sale of goods on credit
• Tax payments

Question 4

What are the main sources of liquidity?

Answer 4

• Cash in the bank
• Short-term investments
• Cash inflows
• Overdraft

Question 5

How can liquidity be sacrificed for better profitbaility?

Answer 5

• Bulk purchase discount
• Offering credit to customers

Question 6

What does the working capital cycle reflect?

Answer 6

Firm’s investment in working capital as it moves throughout production

Question 7

What factors affect the length of the working capital cycle?

Answer 7

• Liquidity vs profitability
• Management efficiency
• Industry norms

Question 8

What does an increase in sales mean for the amount of cash needed to fund the working capital cycle?

Answer 8

Amount of cash needed increases

Question 9

What does an increase in the length of the working capital cycle mean for cash?

Answer 9

More cash needed to fund cycle

Question 10

What factors affect the amount of working capital required?

Answer 10

• Industry firm operates in
• Type of products sold
• Whether products are manufactured or bought
• Level of sales
• Policies towards working capital management

Question 11

What factors affect the level of investment in working capital?

Answer 11

• Nature of business
• Uncertainty in supplier deliveries
• Overall activity level
• Credit policy
• Length of cycle
• Credit policy of suppliers

Question 12

What are the 3 policies used to manage working capital?

Answer 12

• Aggressive
• Conservative
• Moderate

Question 13

What is an aggressive policy?

Answer 13

Reduce costs by holding lowest levels of cash, inventory and receivables

Question 14

What are the benefits of an aggressive policy?

Answer 14

• Lower levels of current assets means lower financing costs
• Lower financing costs mean better profitability
• Quicker cash turnover means reinvestment
• Greatest returns

Question 15

What are the negatives of an aggressive policy?

Answer 15

The greatest risk of liquidity

Question 16

What is a conservative policy?

Answer 16

Reduces risk by holding high levels of cash, inventory and receivables

Question 17

What are the benefits of a conservative cycle?

Answer 17

• Lower liquidity risk
• Greater ability to meet demand surges
• More relaxed credit policy for receivables may improve sales

Question 18

What is the negative of a conservative policy?

Answer 18

High costs

Question 19

What is a moderate policy?

Answer 19

Middle ground between aggressive and conservative

Question 20

What degree will short term finance be used if an entity takes an aggressive approach?

Answer 20

All fluctuations and some permanent investment financed by short term finance

Question 21

What degree will short term finance be used if an entity takes a conservative approach?

Answer 21

All permanent and portion of fluctuation investment financed by long term finance

Short term financed only used for part of fluctuation

Question 22

What degree will short term finance be used if an entity takes a moderate approach?

Answer 22

Fluctuating investment financed by short-term finance and permanent investment financed by long-term

Question 23

What are the typical indicators of overtrading?

Answer 23

• Rapid increase in turnover
• Rapid increase in volume of current assets
• Most of the increase in assets being financed by credit
• Dramatic drop in liquidity ratios

Question 24

What are the solutions to overtrading?

Answer 24

• Raise more long-term capital
• Slow down growth
• Improve working capital management