Working Capital Flashcards
What is working capital?
Working capital is the difference between a company’s current assets and current liabilities. It represents the funds available for day-to-day operations. Working capital can be permanent or fluctuating.
What is permanent working capital?
Permanent working capital is the minimum level of working capital required at all times to maintain operational efficiency. It includes minimum levels of inventories, trade receivables, and trade payables.
What is fluctuating working capital?
Fluctuating working capital is the additional working capital needed at certain times due to fluctuations in the business cycle. Examples include bulk purchasing of raw materials or seasonal demand increases.
What are the differences between long-term and short-term finance?
Long-Term Finance: Includes equity and long-term debt. It is expensive but low risk. Short-Term Finance: Includes trade credit and bank overdrafts. It is less expensive but carries higher risk of withdrawal.
What is a conservative funding policy?
A conservative funding policy finances all permanent assets and part of fluctuating current assets with long-term funding. Short-term financing is used only for part of the fluctuating current assets. This policy is low-risk but yields the lowest expected return.
What is an aggressive funding policy?
An aggressive funding policy uses short-term finance to fund all fluctuating current assets and some permanent current assets. This approach has high risk due to potential illiquidity but offers higher returns due to lower costs of short-term debt.
What is a moderate (or maturity matching) funding policy?
A moderate funding policy matches short-term finance to fluctuating current assets and long-term finance to permanent current assets plus non-current assets. It provides a balanced approach between risk and return.
What are the benefits of using short-term finance?
Benefits of short-term finance include lower cost (e.g., trade credit incurs no immediate cost) and flexibility (e.g., bank overdrafts vary in size and are used as needed).
What are the risks associated with short-term finance?
Risks of short-term finance include renewal risk (e.g., trade credit needs frequent renegotiation) and immediate repayment risk (e.g., bank overdrafts can be demanded for immediate repayment).
