Working Capital Flashcards
what is working capital
current assets less current liabilities
examples of current assets
cash, receibables, inventory
examples of current liabilities
payables, bank overdraft, short term loans, long term loans maturing in less than a year
what are the two main objectives of working capital management
the business has enough liquid resources to continue in business (to pay day to day expenses)
the business increases in profitability
what are the investing costs of working cpital
the cost of funding it
the opportunity costs of lost investment opportunities
what happens when there is too little working capital
inability to meet bills as they fall due
demands on cash during periods of growth are too great
how do managers often mismanage too much working capital
overstock
funds could be used more productively elsewhere
what is overtrading
when a business tries to do too much too quickly with too little working capital
reasons for cash flow problems
making losses
inflation
growth
seasonal business
once off expenses
how can inflation cause cash flow problems
replacing assets can be expensive if high inflation
how does growth cause cash flow problems
when a business is growing it will need more fixed assets as well as higher stock levels
how does seasonal business cause cash flow problems
cash inflows come later than cashoutflows
example of a once off expense that can cause cash flow problems
large capital repayment at the end of a loan
what does ROIC stand for
return on invested capital
which should be used return on equity or return on invested capital
return on invested capital
as it strips out cash which is unproductive
current ratio
current assets / current liabilities
ideal current ratio
between 1 and 2
if the current ratio is greater than 2 why might it not be a good thing
inventory could be too high - security costs and storage costs
if receivables are too high there is risk
if cash is too high this is unproductive as it could be invested to earn interest
acid test ratio
(current assets - inventory) / current liabilities
why is inventory omitted in acid test ratio
most iliquid
impossible to turn into cash in a short period of time
ideal acid test ratio
1
what is the cash operating cycle
the length of time between the company’s outlay on raw materials, wages and other expendictures and the inflow of cash from the sale of goods
inventory holding period calculation
average inventory / cost of sales * 365
what is the inventory holding perido
the length of time inventory is held between purchase and sale
