Topic 4 - Working Capital Flashcards
What is working capital?
current assets less the value of current liabilities
What the objective trade-off of working capital?
profitability and liquidity
Inventory turnover period
average length inventory is held for
(average inverntory/ COS) x 365
Rate of inventory turnover
how many times inventory turns over
COS/ average inventory
Should be as high as possible
Receivables collection period
how long do customers take to pay?
(average receivables/ annual sales revenue) x 365
Keep as low as possible
Payables payment period
how long company waits before paying suppliers
(average payables/annual purchases) x 365
Should be as long as possible
Current ratio
current assets/ current liabilties
Quick liquidity ratio
current assets- inventories/ current liabilities
Raw materials holding period
(average inventory of raw materials/ annual purchases) x 365
average production period
(average inventory of work in progress/ annual COS) x 365
What is the cash operating cycle?
Receviable days + inventory days - payable days
the less days the better
What causes a longer cash cycle?
- slower inventory turnover (holding period extended)
- lengthing of the average credit period taken by customers
- paying suppliers sooner
What are solutions to liquidity problems?
- reducing the inventory-holding period
- reducing the production period
- reducing customers’ credit period and tightening up on cash collection
- extending the period of credit taken from suppliers
