Working Capital Flashcards
What is net working capital?
Current assets - current liabilities
Objectives of working capital management?
Increase profits of business
Ensure sufficient liquidity to meet short-term obligations
issue of profitability with low inventory?
Delivery lead times to customers are high, or business doesn’t have enough inventory. Affecting revenue
issue of profitability with low receivables?
Business’ credit terms are overly strict and long credit periods aren’t available to customers. Affecting revenue
Money tied up in short-term assets?
Causes liquidity issues
if a decision is made to invest in high invnetory or receivables to boost sales and profits?
Higher net working capital and reduces liquidity
If level of inventory and receivables is high because working capital is not managed well?
Improved in inventory management and credit control allows higher liquidity and profitability
What influences net working capital planning?
General factors
Company-specific factors
How can the nature of the industry affect working capital?
A supermarket will receive much of their sales in cash. However, not possible for a food wholesaler which relies on credit
What happens if sales are higher for company specific?
Inventory and receivables higher too
What is an aggressive strategy
Minimises net working capital
What is a conservative strategy
Maximises net working capital
Aggressive strategy characteristics
Inventory and receivables are low
Payables high
Prioritises liquidity but creates trading problems
Conservative strategy characteristics?
Inventories and receivables are high
Payables low
Reduces liquidity but could help with trading problems
Working capital ratios?
Inventory holding period
Accounts payable
Accounts receivable
What is the cash operating cycle?
Begins in production and ends in collection of cash
Cash operating cycle calculation?
Cash received - cash paid out
Cash received?
Inventory
Receivables
Cash paid?
Payables
How to measure a cash shortfall if sales rise too quickly?
Use net working capital ratio
Why is net working capital ratio important?
It considers the level of net current assets used to support revenue generation
Lower level of net current assets to support revenue generation?
Aggressive strategy
Higher level of net current assets to support revenue generation?
Conservative strategy
What is overtrading?
A situation where a business has inadequate cash to support its level of sales
Symptoms of overtrading?
Increase in sales revenue, receivables and inventory, trade payables
Worsening liquidity
Why is there a fall in profit margins for overtrading?
Discounts are used to chase higher sales
Mitigate overtrading?
Introduction of long-term capital
Improve working capital management
Reduce business activity
