Measures of Working Capital Flashcards
What is working capital?
The amount required for daily, normal operations
Why is efficiency in working capital useful?
reduces the need for short-term financing
How does good working capital reduce the need for short-term financing?
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
What are the three components to the working capital?
-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)
What are the two forms of working capital ratios?
-periods (number of days)
-in times
What is the relationship between periods and times?
Inverse
eg
x2/year -> 365 days/2 -> 182 days
What 4 measures of working capital are done in periods?
Settlement period for trade receivables
Payment period for trade payables
Inventory holding period
Operating cash cycle
What 3 measures of working capital are done in times?
Trade receivable turnover
Trade payable turnover
Inventory turnover
What does the Settlement period for trade receivables indicate?
the average length of time the company needs to wait before receiving cash payment from credit customers
Credit sales can be substituted for _______ if unknown.
revenue
If the settlement period for trade receivables is 10 days, what does that mean?
The company needs to wait on average around 10 days before it can receive
cash from credit customers.
Are lower or higher settlement periods better?
lower as this means it’s collecting
cash from its customers faster.
What does the payment period for trade payables indicate?
the average length of time it takes the company to pay
trade payables
How to calculate closing inventory
Closing inventory = Opening inventory + Purchase – COGS
If the payment period for trade payables is 60, what does that mean?
company spent on average around 60 days to pay cash to its suppliers, when making purchases on credit
What does an inventory holding period indicate?
the average length of time that a company holds its inventory before selling
What does it mean if Sainsburys had an inventory holding period of 23 days?
Sainsbury needs to hold inventory on average 23 days before the
inventory are sold.
What is the operating cash cycle?
The time period between paying suppliers
and receiving payment from customers
How to calculate operating cash cycle
inventory holding period + settlement period for receivables - payment period for payables
What does it mean if Sainsburys has an operating cash cycle of -58 days
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
What does trade receivables turnover measure?
Measures how many times a company collects its trade receivables during a year.
The higher the turnover of receivables…
the shorter the time
between sales and cash collection
How to convert settlement period to trade receivables
settlement period= 365/ trade receivables turnover
What three things could a high trade receivables turnover indicate?
– Efficient collection of receivables
– Customers have a low bargaining power
– Sales are mostly in cash rather than on credit
What three things could a low trade receivables turnover indicate?
– Inefficient collection of receivables
– Customers have a high bargaining power
– Company is extending favourable credit terms to attract more
customers
If Sainsburys trade receivables turnover is 35.75 times, what does this mean?
On average, Sainsbury collects its trade receivables 36 times a year.
What does trade payables turnover measure?
Measures how many times a company pays off its trade payables over a year
What could a high trade payables turnover indicate?
– Suppliers have more bargaining power and demand fast payment
terms, or
– The company may want to take advantage of early payment discounts
What could a low trade payables turnover indicate?
– 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
If Sainsburys has a trade payables turnover of 6.26 times, what does that mean?
Sainsbury pays off its trade payables to suppliers, on average, 6 times in
a year
What does inventory turnover measure?
Measures how many times a company can sell and replace inventory during a year
What does high inventory turnover indicate?
strong sales or sufficient inventory
What does low inventory turnover indicate?
weak sales or possible excess inventory
If Sainsburys has an inventory turnover of 15.58 times, what does this mean?
On average, Sainsbury can sell and replace the inventory 16 times
in a year
