Topic 11: Working capital management Flashcards
What is working capital? and B&D
The excess of a company’s current assest over its current liabilities.
Postivies:
Can offer trade credit = More sales
Can keep more inventory = No lost sales
Negatives:
Cost of financing working capital
The opportunity cost - The funds could be going towards a positive NPV project.
Discuss liquidity vs Profitability
Liquidity is the company’s need to have a sufficent level of resources so that the company can pay their obligations and stay in operation.
Profitability is the need to be profitable as it is the ultimate factor for shareholder wealth.
Will the following be good/bad for liquidity and profitability:
1.) Selling on credit
2.) Offering an early settlement payment.
3.) Taking advantage of a bulk discount purchasing.
4.) Paying suppliers late
1.) Bad for Liquidity & Good for Profitability.
2.) Good for Liquidity & Bad for Profitability
3.) Bad for Liquidity & Good for Profitability
4.) Good for Liquidity & Bad for Profitability.
What are the different approaches to managing the level of investment in working capital?
1.) Conservative approach - Maintain high level of investment in working capital = high inventory, high level of cash. This is low risk but high financing cost.
2.) Aggressive approach - Maintain low level of investment in workign capital = Low inventory, Low level of cash. More risky but lower finance cost.
3.) Moderate approach - Where a company will balance off the risk associated with holding working capital with associated cost.
What are the different approaches to financing working capital? and explain
Aggressive
Matching
Conservative
What is the differences between fluctuating and permanent current assets?
Permanent current assets - It is the proportion of current assets that always exist as a minimum level e.g minimum level of inventory.
Fluctuating current assets - are the assets above the permanent level as this can change based on other factors e.g seasonly.
What are the differences between using long-term and short-term finances?
Short-term finance - Less than one year e.g bank overdraft, credit purchases.
Long-term finance - Over 1 year e.g bank loan, equity finance, bonds
What type of finance do the finance approaches use?
Aggressive approach consists of - Fluctuating current assets all financed on short term finance, Permanent current assets are a mixture of short term and long term finance. Non current assets are all long term finance.
Conservative approach consists of : Fluctuating current assets is a mixture of long term and short term finance. Permanent current assets and non current assets are both funded by long term finance options.
Matching - Is a middle ground between the aggressive and conservative approaches.
What is the cash operating cycle? And how to calculate?
The cash operating cycle is the amount of time between initial purchase of raw materials until cash is received from the customer, LESS any credit periods taken from suppliers.
Inventory days + Receivable days - Payable days = Cash operating cycle.
What factors affect the length of the cash operating cycle?
Approach:e.g Aggressive and conservative = Aggressive is low operating cash cycle becasue of low stock and opposite for conservative.
Nature of company/industry - Retailers don’t have receivables but manufacturers do, Short shelf lives, industry norms can cause credit agrrements.
Quality of managment - if a company goes for an aggressive approach the management has to be on top of their game to get orders at the right time.
What are the liquidity ratios - Calculate and explain
1.) Current Ratio = Current assets/Current Liabilities. - This shows how many times the current assets could pay for the current liabilities.
2.) Quick (Acid test) Ratio = (Current Assets - Inventory)/Current Liabilities - This ratio shows how many times the current liabilities could be paid out of the most liquid current assets.
What are the efficency ratios - Calculate and explain
1.) Raw materials days = (Raw materials inventory/Purchases)x 365
2.) Work in progress inventory days = (WIP Inventory/Cost of sales) x 365
3.) Finished Goods inventory days = (Finished goods inventory/ Cost of sales) x 365.
4.) Trade Receivables days = (Trade receivables/Credit sales) x 365
5.) Trade payable days = (Trade payables/credit purchases) x 365
6.) Working capital turnover = Sales revenue/net working capital. Net working capital = inventory + Receivables days - payable days.
7.) Inventory days = Raw materials days + WIP days + Finished goods days.
What is the other name for the cash operating cycle?
Net working capital
What are the possible reasons for the following factors?
Increase in inventory days
Decrease in inventory days
Increase in receivables days
Decrease in receivables days
1.) Poor management, Taking advantage of Bulk purchase discount - This could lead to obsolete inventory.
2.) Improved management, introduction of just in time inventory purchasing - This could lead to loss of sales by not having the stock.
3.) Worsening credit control procedures, extention of credit terms - This could lead to liquidity issues and risk of irrecoverable debt.
4.) Improved credit control, introducing prompt payment discount - This could lead to loss of profits.
What is Overcapitalisation?
There is an excessive amount of inventory, trade receivables and cash and few payables = Over investing = adverse affect on profitability.
