Lesson 4: Working Capital Management Flashcards
refers to the current assets used in the operations of the business. This includes cash, accounts receivable, inventories, and prepaid expenses.
working capital
working capital includes
cash, accounts receivable, inventories, prepaid expenses
The amount of resources that a company sets aside to these working capital accounts can be reduced by current liabilities such as trade accounts payable and accrued expenses payable.
working capital management
the difference between these current assets and current liabilities used in the operations of the business
net working capital
net working capital formula
net working capital = total current assets - total current liabilities
he management of these accounts, both the current assets and the current liabilities, is important because these accounts deal with
day-to-day operations of the business
importance of working capital management
good management allows the company to pay maturing obligations on time; relieves managers of unnecessary stress and gives them more time to improve the business operations; improve the earnings of the company
Good management of working capital accounts allows the company to
pay maturing obligations on time
Good management of working capital accounts also relieves
managers of unnecessary stress an gives them more time to improve the business operations
*Efficient management of working capital accounts can improve
the earnings of the company
Working capital requirements change with
the volume of the business operations
As the sales increase,
working capital requirements also increase
working capital financing policies
maturity-matching; aggressive; conservative WORKING CAPITAL FINANCING POLICY
During the year, sales are not the same every month. This is why companies have
slack season and peak season
the net working capital requirements during the slack season are
lower than those during peak season
permanent working capital requirements should be financed by long-term sources while temporary working capital requirements should be financed by short-term sources of financing.
maturity-matching working capital financing policy
according to the maturity-matching policy, permanent working capital requirements should be financed by
long-term sources
according to the maturity-matching policy, temporary working capital requirements should be financed by
short-term sources
Long-term sources of financing include
long-term debt and equity (common and preferred stocks)
short-term sources of financing includes
short-term loans from a bank
short-term loans from banks are called
working capital loans
Are strategies that businesses use to maximize their liquidity and financial flexibility, often by pushing the boundaries of traditional financing approaches.
aggressive working capital financing policy
in terms of short-term borrowing, the aggressive policy means
relying on short-term loans or lines of credit to cover immediate operational needs even if it involves higher interest rates
some of the permanent working capital requirements are financed by short-term sources of financing
aggressive working capital financing policy
in terms of inventory financing, the aggressive policy means
using inventory as collateral to secure loans, which allows the company to free up cash while still maintaining its stock levels
in terms of accounts receivable management, the aggressive policy means
implementing aggressive credit policies to accelerate receivables, such as shortening the credit terms offered or using factoring services to receive cash more quickly
some of the temporary working capital requirements are financed by long-term sources
conservative working capital policy
the most liquid asset of a company
cash
why is cash considered the most vulnerable
it is vulnerable to theft
how to safeguard the cash asset
there must be proper internal controls
what are some proper internal controls to manage cash
separating cashiering function from recording/accounting function; issuing O/R for collections and making a collection report; depositing collections to safeguard cash; adopting the check voucher system for payments
a small amount of cash kept on hand to cover minor or incidental expenses, such as the small change and bills kept in the cash register or lockbox
petty cash fund
how to cross-check a check
the payee draws two-lines on the check
what are the working capital accounts
cash, accounts receivable, inventory
the balance of money due to a firm for goods or services delivered or used but not yet paid for by the customer
accounts receivable
proper internal control over accounts receivable
providing credit terms to customers; following the five C’s of credit
how to manage accounts receivable
use the 5cs of credit
what are the 5C’s of credit
character, capacity, capital, collateral, condition
This refers to the integrity and reputation of the customer. The educational background and experience in the business are also considered.
character
This refers to the capacity to pay. The operations of the business especially the operating cash flows are given emphasis in this criterion.
capacity
what are looked into in terms of capacity since they affect the ability of the company to generate positive operating cash flows
liquidity ratios and efficiency of the management in handling A/R
If your company cannot collect its accounts receivable
it will have to shut down
This looks at the customer’s history and reputation for paying bills on time. If they’ve been reliable in the past, they’re likely to be reliable now
character
This checks if the customer has the financial ability to pay back what they owe. It involves looking at their income, expenses, and overall financial health.
capacity
This considers what assets the customer has that could be used to pay the debt if needed. It’s like having a backup plan—if they can’t pay with cash, they might have valuable things they could sell to pay off the debt.
capital
This looks at the economic situation and how it might affect the customer’s ability to pay. For example, if the economy is bad, even a normally reliable customer might struggle to pay.
conditions
This refers to something valuable the customer offers as security in case they can’t pay. If they don’t pay, the business can take the collateral as payment.
collateral
description of maturity-matching
moderate
liquidity of maturity-matching
balance
profitability of maturity-matching
balanced
default risk of maturity-matching
balanced
investments of maturity-matching
balanced
description of conservative
relaxed
liquidity of conservative
high
profitability of conservative
low
default risk of conservative
low
investments of conservative
current assets
description of aggressive
restricted
liquidity of aggressive
low
profitability of aggressive
high
default risk of aggressive
high
investments of aggressive
non-current assets
the company is increasing the probability that it will not be able to meet maturing obligations.
default risk
internal controls for inventory
separating custodial functions from the recording functions; aging of inventories/ABC analysis
24 hour companies have
two collection reports and deposits every day
how is a check cross-checked
drawing two lines on the payee of the check
