Measures of Working Capital

Question 1

What is working capital?

Answer 1

The amount required for daily, normal operations

Question 2

Why is efficiency in working capital useful?

Answer 2

reduces the need for short-term financing

Question 3

How does good working capital reduce the need for short-term financing?

Answer 3

Working capital occupies cash. If a company manages its working capital
poorly → higher working capital needs → needs more cash → needs
short-term financing. This causes pressure on the company’s liquidity.
– Therefore, the less working capital the company needs, the less pressure on cash

Question 4

What are the three components to the working capital?

Answer 4

-Trade receivables (more trade receivables, less cash at hand)
– Inventories (more inventories, less cash at hand)
– Trade payables (more trade payables, more cash at hand)

Question 5

What are the two forms of working capital ratios?

Answer 5

-periods (number of days)
-in times

Question 6

What is the relationship between periods and times?

Answer 6

Inverse
eg
x2/year -> 365 days/2 -> 182 days

Question 7

What 4 measures of working capital are done in periods?

Answer 7

Settlement period for trade receivables
Payment period for trade payables
Inventory holding period
Operating cash cycle

Question 8

What 3 measures of working capital are done in times?

Answer 8

Trade receivable turnover
Trade payable turnover
Inventory turnover

Question 9

What does the Settlement period for trade receivables indicate?

Answer 9

the average length of time the company needs to wait before receiving cash payment from credit customers

Question 10

Credit sales can be substituted for _______ if unknown.

Answer 10

revenue

Question 11

If the settlement period for trade receivables is 10 days, what does that mean?

Answer 11

The company needs to wait on average around 10 days before it can receive
cash from credit customers.

Question 12

Are lower or higher settlement periods better?

Answer 12

lower as this means it’s collecting
cash from its customers faster.

Question 13

What does the payment period for trade payables indicate?

Answer 13

the average length of time it takes the company to pay
trade payables

Question 14

How to calculate closing inventory

Answer 14

Closing inventory = Opening inventory + Purchase – COGS

Question 15

If the payment period for trade payables is 60, what does that mean?

Answer 15

company spent on average around 60 days to pay cash to its suppliers, when making purchases on credit

Question 16

What does an inventory holding period indicate?

Answer 16

the average length of time that a company holds its inventory before selling

Question 17

What does it mean if Sainsburys had an inventory holding period of 23 days?

Answer 17

Sainsbury needs to hold inventory on average 23 days before the
inventory are sold.

Question 18

What is the operating cash cycle?

Answer 18

The time period between paying suppliers
and receiving payment from customers

Question 19

How to calculate operating cash cycle

Answer 19

inventory holding period + settlement period for receivables - payment period for payables

Question 20

What does it mean if Sainsburys has an operating cash cycle of -58 days

Answer 20

Sainsbury has a negative number of operating cash cycle, it means the cash for its working capital is not tied up for long,
and the liquidity is great

Question 21

What does trade receivables turnover measure?

Answer 21

Measures how many times a company collects its trade receivables during a year.

Question 22

The higher the turnover of receivables…

Answer 22

the shorter the time
between sales and cash collection

Question 23

How to convert settlement period to trade receivables

Answer 23

settlement period= 365/ trade receivables turnover

Question 24

What three things could a high trade receivables turnover indicate?

Answer 24

– Efficient collection of receivables
– Customers have a low bargaining power
– Sales are mostly in cash rather than on credit

Question 25

What three things could a low trade receivables turnover indicate?

Answer 25

– Inefficient collection of receivables – Customers have a high bargaining power – Company is extending favourable credit terms to attract more customers

Question 26

If Sainsburys trade receivables turnover is 35.75 times, what does this mean?

Answer 26

On average, Sainsbury collects its trade receivables 36 times a year.

Question 27

What does trade payables turnover measure?

Answer 27

Measures how many times a company pays off its trade payables over a year

Question 28

What could a high trade payables turnover indicate?

Answer 28

– Suppliers have more bargaining power and demand fast payment terms, or – The company may want to take advantage of early payment discounts

Question 29

What could a low trade payables turnover indicate?

Answer 29

– The company has more bargaining power than its suppliers so it can pay off the trade payables late, or – The company is in a bad financial condition as it is unable to pay off the payables quickly

Question 30

If Sainsburys has a trade payables turnover of 6.26 times, what does that mean?

Answer 30

Sainsbury pays off its trade payables to suppliers, on average, 6 times in a year

Question 31

What does inventory turnover measure?

Answer 31

Measures how many times a company can sell and replace inventory during a year

Question 32

What does high inventory turnover indicate?

Answer 32

strong sales or sufficient inventory

Question 33

What does low inventory turnover indicate?

Answer 33

weak sales or possible excess inventory

Question 34

If Sainsburys has an inventory turnover of 15.58 times, what does this mean?

Answer 34

On average, Sainsbury can sell and replace the inventory 16 times in a year