Working Capital

Question 1

What is the definition of Working Capital?

Answer 1

It is the capital available to fund the day-to-day operations of an entity, normally the excess of current assets over current liabilities.

Question 2

What is the Working Capital Cycle?

Answer 2

Is the period of time which elapses between point at which cash begins to be expended on production of a product and the collection of cash from a purchaser.

Question 3

When deciding or credit terms to offer, what are 4 factors to take into consideration?

Answer 3

1.) Additional sales volume generated
2.) Profitability of extra sales
3.) Extra length of average receivables collection period
4.) Required rate of return on investment

Question 4

What is short-term finance when it comes to working capital?

Answer 4

consists of an overdraft, credit from trade suppliers and shortterm loans. These are relatively inexpensive sources of finance if used correctly.
However, there is a risk that they can be withdrawn at short notice, for example an
overdraft is repayable on demand.

Question 5

What is long-term finance when it comes to working capital?

Answer 5

Long-term finance consists of both long-term debt and equity and is more expensive
than short-term finance, for example the interbank lending rates are normally lower
on short-term loans compared to long-term unsecured loans.

Question 6

When looking at best finance for working capital, we must divide current assets into two types :fluctuating and permanent assets. Explain fluctuating assets and permanent assets:

Answer 6

-Permanent current assets are the core levels of cash and inventory that we will
always need to maintain in order to operate our production facility. For example, we
always need to maintain a buffer level of raw materials inventory such as whey
powder, peanuts, cashew and almond nut butters, protein powder flavouring and
Personal Best logo’d packaging materials (to protect us against any delays in
shipment).
-Fluctuating current assets vary from period to period, for example the inventory level
of protein powder flavouring will vary depending on sales (and therefore the required
production) of our protein powders.

Question 7

Explain the Conservative Working capital financing method?

Answer 7

With this method, we would finance all of the permanent assets (current and noncurrent) and some of the fluctuating current assets using long-term funding. This has
the benefit of ensuring that most of our financing needs are in place and that there is
little risk of a shortfall. However, it is likely to result in us paying higher rates of
interest and potentially paying interest on loans that are not always needed.

Question 8

Explain the Aggressive Working capital financing method?

Answer 8

If we choose to pursue an aggressive policy, we will hold minimal levels of cash and
inventories. We would be in the position that all of the fluctuating and part of the
permanent current assets are financed by short-term funding.
This reliance on short-term funding carries the highest risk of liquidity and insolvency
problems but also the highest level of financial return as cash is not tied up and can
be used to generate a return

Question 9

Explain the Moderate Working capital financing method?

Answer 9

A moderate policy will match the source of funding to the type of assets, therefore of
all the permanent assets (current and non-current) are financed by long-term funding
and the fluctuating current assets are financed by short-term funding. This in turn
balances the missed opportunities of the conservative policy with the risks
associated with the aggressive policy