Lesson 4.5: Working Capital Management Flashcards
refers to company’s investment in short term asset such as cash,
inventory, short-term marketable securities, and account receivable.
working capital
refers to the difference between the firm’s current assets and
current liabilities.
net working capital
If the firm’s current assets exceed its current liabilities, the firm
has a
positive working capital
if current liabilities exceed
current assets, the firm has a
negative working capital
specifically refers to the efficient management of
the firm’s current assets (cash, receivables, and inventory) and current liabilities
(short-term payables).
working capital management
involves the maintenance of a cash and marketable
securities investment level, which will enable the company to meet its cash
requirements and at the same time optimize the income on idle funds.
cash management
Although cash has generally considered a non-earning asset, business firms must
hold cash for the following reasons:
transaction; precautionary; speculative; contractual MOTIVE
cash needed to facilitate the normal transactions of the
business, that is, to carry out its purchases and sales activities.
transaction motive
Cash may held beyond its normal operating requirement
level in order to provide for a buffer against contingencies such as unexpected
slow-down in accounts receivable collection, strike or increase in cash needs
beyond management’s original projections.
precautionary motive
cash held ready for profit making or investment
opportunities that may come up such as a block of raw materials inventory offered
at discounted prices or a merger proposal.
speculative motive
A company may be required by a bank to maintain a certain
compensating balance in its demand deposit account as a condition of a loan
extended to it
contractual motive
a metric that expresses the number of days it takes for a company to convert its inventory into cash flows from sales.
cash conversion cycle
The
operating cycle of a firm is mainly composed of two current asset categories which are
inventories and accounts receivable
It measures as the sum of the Average Age of
Inventory and Average Collection Period.
operating cycle
refers to the
time that lapsed when a good manufactured and eventually sold.
average age of inventory
refers to the time when the sale made and
collected.
average collection period
formula for operating cycle
operating cycle = average age of inventory + average collection period
average collection period and average age of inventory is measured in
days
reduces the number of days a
firm’s resource has tied up to its operating cycle.
accounts payable
cash conversion cycle formula
cash conversion cycle = operating cycle - average payment period
the time it takes for the firm to pay its accounts
payable expressed in number of days.
average payment period
The objective in managing inventory is to
convert it as quickly as possible to cash without losing sales due to stock outs
Therefore, the
financial manager plays a crucial role in overseeing that the firm maintains an
appropriate quantity of inventory
types of inventory in a manufacturing company
raw materials; work in process; finished goods
these are purchased materials not yet put into
production
raw materials
these are goods and labor put into production but
not finished.
work in process
these are goods put into production and finished.
These are ready to be sold.
finished goods
common technique in inventory management
ABC inventory system/ABC analysis
A in the ABC inventory system refers to
high value items that should be safeguarded the most
B in the ABC inventory system refers to
average-cost items that should be safeguarded more than C items
C in the ABC inventory system refers to
low-cost-items that are the least safeguarded
represents assets of the entity that expected
to be collected and thus converted to cash.
accounts receivable (management)
sound accounts receivable management practices
would form three parts
credit selection; credit terms; credit monitoring
A firm would generally want to collect
its receivables
as quickly as possible
The applicant’s record of meeting its past obligations has judged.
character
However, if the applicant does not have any credit history, he or she may be
required to have a
co-maker
another person who signs the loan and
assumes equal responsibility for repayment.
co-maker
This emphasizes the customer’s ability to repay its obligations in
reference to its current financial position or standing.
capacity
It determines whether the
customer has sufficient resources or sources of funds that it can use to settle
obligation
capacity
The applicant’s net worth which can be arrived at by deducting total
liabilities from total assets.
capital
how can capital in the 5C’s of credit be calculated
deducting total liabilities from total assets
The amount of assets the customer has that could serve as a security
in the event that the obligation is not paid.
collateral
This includes current economic and industry conditions that might
affect the customer’s ability to repay its obligations.
condition
allow the firm to carefully assess the
customer’s ability to repay its obligations along with the level of risk that the firm
will be subjected to once it decides to grant credit to the customer.
5C’s of credit
Another used in granting credit to customers is through
credit scoring
applies statistically derived weights to a credit applicant’s
scores on key financial and credit characteristics to predict whether he or she will
pay the requested credit on time.
credit scoring
the credit score is compared to a
pre-determined standard
This method is an
inexpensive way to obtain credit ratings for customers.
credit scoring
This approach aligns the duration of assets with their financing sources.
maturity-matching policies
in the maturity-matching policy, short-term assets are funded with
short-term liabilities
in the maturity-matching policy, long-term assets are funded by
long-term liabilities
In this strategy, a significant portion of both short-term and long-term assets is financed using short-term liabilities. This reduces financing costs but increases risk.
aggressive policy
focuses on minimizing risks by maintaining high levels of liquidity and low levels of debt.
conservative policy
