Chapter 2.1 - Working Capital management & The Risk—Return Tradeoff Flashcards
What is working capital management?
The management of a company’s current assets and current liabilities to ensure sufficient liquidity for short-term obligations.
What is inventory management?
The process of determining how much inventory to carry to balance cash flow and sales needs.
What are the key components of working capital?
Current assets (cash, accounts receivable, inventory) and current liabilities (accounts payable, short-term debt)
What are the three key decisions in working capital management?
Inventory management, credit extension, and payment terms.
How to measure a firms liquidity ?
Current ratio and Net working capital
What is net working capital?
The difference between current assets and current liabilities.
What are the main strategies for effectively managing a firm’s liquidity?
Use just-in-time (JIT) inventory systems,
Implement strict credit policies and efficient collection processes,
Extend payment terms with suppliers,
Use short-term financing
What is the risk-return tradeoff?
Higher potential returns are associated with higher risks.
How does liquidity relate to profitability in working capital management?
High liquidity may reduce profitability, while investing in current assets can enhance profitability but increases risk
What is an example of the risk-return tradeoff in working capital management?
Reducing cash reserves to invest in inventory may lead to higher profits but increases the risk of cash flow issues if sales do not meet expectations.
