Week 1 - Working Capital Management Flashcards
What is working capital?
Current assets less current liabilities
Working capital represents a net investment in short-term assets essential for day-to-day operations.
What are the elements of current assets?
- Inventories
- Trade receivables (Accounts Receivables)
- Cash (in hand and at bank)
Current assets are crucial for maintaining liquidity.
What are the elements of current liabilities?
- Trade payables (Accounts Payables)
- Bank overdrafts
Current liabilities represent the obligations that a company must pay within a year.
What does a positive working capital indicate?
Current assets exceed current liabilities (CA > CL)
Positive working capital allows a firm to pay its short-term obligations.
What does a negative working capital indicate?
Current assets are less than current liabilities (CA < CL)
Negative working capital can signal potential liquidity issues.
Define liquidity in terms of working capital.
The margin by which current assets cover current liabilities
Higher liquidity indicates a better ability to meet short-term obligations.
What are the three components of the cash conversion cycle?
- Average age of inventory
- Average collection period
- Average payment period
Minimizing the cash conversion cycle is crucial for improving liquidity.
What is overtrading?
Growing sales faster than can be financed
Overtrading can lead to insolvency if a company cannot meet its financing costs.
What is the aim of managing accounts receivable?
Minimize credit without damaging customer relations
Effective management of receivables ensures cash flow stability.
What is debt factoring?
Giving your debt list to another organization to collect debt
It provides quicker cash flow but comes with costs.
What are the risks of having too much inventory?
- Storage and handling costs
- Obsolescence
- Opportunity cost
Excess inventory can tie up capital and increase costs.
What is the goal of working capital management?
To manage current assets and current liabilities positively contributing to the firm’s value
Balancing profitability and risk is essential in working capital management.
What is the current ratio?
Current assets/current liabilities
This ratio assesses a company’s ability to pay short-term obligations.
What is the acid test ratio?
Liquid assets/current liabilities
Liquid assets are current assets minus inventory, providing a stricter liquidity measure.
What are the consequences of poor working capital management?
- Increased liquidity risk
- Overtrading problem
Poor management can lead to insolvency and inability to meet obligations.
What is the cash-conversion cycle?
The time lapse between paying for goods and receiving cash from sales
A shorter cash-conversion cycle indicates better cash flow management.
Fill in the blank: The formula for working capital is _______.
Receivables + Cash + Inventory - Payables
What are the potential internal changes affecting working capital needs?
- Changes in interest rates
- Changes in market demand
- Changes in production methods
Internal changes can significantly impact working capital management strategies.
What does maximizing credit purchases aim to achieve?
Maximize benefits without damaging supplier relations
Effective management of accounts payable can enhance cash flow.
