Working Capital

Question 1

How do you deal with cash shortages?

Answer 1

chase recevaibles

Reduce inventories
Sell surplus assets
Sale and leaseback

Question 2

What is the liquidity and profitablity problem?

Answer 2

Liquidity: minimises the risk of insolvency

Profitability: maximises the retun on assets

This is the conflict

Question 3

Policy Formation for receivables

Answer 3

Credit analysis: Assessment of creditworthiness

Credit Control: Aged receivable analysis.

Collecting amounts owing: Phone calls,
Early settlement discounts
Debt factoring

Last resort: legal action

Benefit should exceed the cost

Question 4

Reasons for holding cash

Answer 4

Speculation: Take advantage of speculative opportunities

Precaution: Emergency fund for a firm

Transaction: hold cash in order to satisy the cash inflow and outflow

Question 5

What are the signs of overtrading?

Answer 5

Rapid increase in turnover: Investment in working capital does not match

Deterioration in inventory days: stockpiling in anticipation of increase in turnover, —-> operating costs

Deterioration in receivable days: due to relaxing credit terms

Will rely on short term sources of finance: overdraft, trade payables, leasing.

Decrease in current and quick ratio.

Question 7

Factor adv and disadv

Answer 7

Question 8

How to manage Foreign receivables

Answer 8

Agree early payment with an importer

Use bills of exchange

Documentary letters of credit

Assess the creditworthiness

Insurance

Export factoring

Question 9

Limitations of the Baumol Model

Answer 9

Assumes a constant disbursement rate; in reality cash outflows occur at different times, different due dates etc.

Assumes no cash receipts during the projected period, obviously cash is coming in and out on a frequent basis

No safety stock of cash is allowed for, reason being it only takes a short amount of time to sell marketable securities

Question 10

What determines a company’s investment in current assets?

Answer 10

1) Length of working capital cycle
2) Terms of trade
3) Policy on level of investment in current assets
4) Industry in which organisation operates

Question 11

Profitability Ratios

Answer 11

ROCE: PBIT/Capital Employed (eqtuiy + LT) (NCA + Net Assets) (Total Assets - CL)

Margins: /sales

ROE: Profit after tax - preference dividedns/