Working Capital and Its Components Flashcards
Working capital
= Current assets - Current liabilities
A measure of solvency of a company
Current ratio
Current assets / Current liabilities
Quick ratio
(Cash + Net receivables + Marketable securities) / Current liabilities
Basically… (Current assets - Inventory) / Current liabilities
For working capital financial ratios, what does a higher ratio mean?
Lower risk
Current assets
Those resources that are reasonably expected to be realized in cash, sold, or consumed (prepaid items) during the normal operating cycle of a business or one year, whichever is longer
When would the cash surrender value of life insurance be a current asset?
If the policy owner intends to surrender the policy for its cash surrender value during normal operating cycle
Current liabilities
Obligations whose liquidation is reasonably expected to require the use of current assets or the creation of other current liabilities
Under US GAAP, when would ST obligations be excluded from current liabilities and included in noncurrent liabilities?
If the company INTENDS to refinance it on a LT basis and the intent is supported by the ABILITY to do so as evidenced either by:
- The actual refinancing prior to the issuance of the FS, or
- The existence of a noncancelable financing agreement from a lender having the financial resources to accomplish the refinancing
Under IFRS, what are ST obligations expected to be refinanced on a LT basis classified as?
Current liabilities (must wait until it actually happens to classify as noncurrent)
What are ST, highly liquid investments?
Investments that have an original maturity of 90 days that are readily convertible to cash
Present significant risk of changes in value
When are deposits held as compensating balances against borrowing arrangements with lending institutions considered a cash equivalent?
When it is NOT legally restricted
Restricted cash
Cash that has been set aside for a specific use or purpose
NET of restrictions should be disclosed in footnotes
Unrestricted cash
Used for all current operations
How do you classify the restricted cash?
- Associated with current asset/current liability => classify as current asset but separate from unrestricted cash
- Associated with noncurrent asset/noncurrent liability => classify as noncurrent asset but separate from Investments and Other assets
What are the two forms of bank reconciliations?
- Simple reconciliation
2. Reconciliation of cash receipts and disbursements
Simple reconciliation
Goal: Calculate “true balance”
Differences between the cash balance reported by the bank and the cash balance per the depositor’s records are explained
How are the following handled in a simple reconciliation: 1. Deposits in transit 2. Outstanding checks 3. Service charge 4. Bank collections 5. Errors 6. Non-sufficient funds (NSF) 7 Interest income
- Deposits in transit — Add to bank
- Outstanding checks — Subtract from bank
- Service charge — Subtract from books
- Bank collections — Add to books
- Errors — Correct appropriately
- Non-sufficient funds (NSF) — Subtract from books
7 Interest income — Add to books
What are the procedures for a simple bank reconciliation?
- Book balance is adjusted to reflect any corrections reported by the bank
- After adjustments are made => Adjusted Book Balance = True Balance
- Bank balance per bank statement is reconciled to the “true balance”
Reconciliation of cash receipts and disbursements
Four-column reconciliation (Proof of cash)
Serves as proof of the proper recording of cash transactions
Reconciles any differences between the amount the depositor has recorded as cash receipts and the amount the bank has recorded as deposits; and the differences between amounts the depositor has recorded as cash disbursements and amounts the bank has recorded as checks paid
Accounts receivable
Oral promises to pay debts and are generally classified as current assets
Classified as either trade receivables or non-trade receivables
What increases A/R and what decreases it?
Increase: Credit sales
Decrease: Write-offs, Convert to note, Cash collected
Blank analysis format
Tool that is merely an “add-subtract” form of a “T” account (BASE)
Net realizable value of accounts receivable
Balance of the accounts receivable account adjusted for allowances for receivables that may be uncollectible, sales discounts, and sales returns and allowances
Discounts (Speed)
Offer of a cash discount on payments made w/in a specified period
Encourages prompt payment
What are the two types of discounts?
- Sales/cash discounts
2. Trade discounts
How are sales/cash discounts accounted for?
Either net or gross
Sales/cash discount
Based on a percentage of the sales price (2/10, n/30)
Gross method for sales/cash discounts
Records sale w/out regard to available discount
J/E:
Sale:
Dr. A/R 100
Cr. Sales 100
Payment received w/in discount pd:
Dr. Cash 98
Dr. Sales discount taken 2
Cr. A/R 100
Net method for sales/cash discounts
Records sales and A/R net of available discounts
J/E:
Sale:
Dr. A/R 98
Cr. Sales 98
Payment not received w/in discount pd:
Dr. Cash 100
Cr. A/R 98
Cr. Sales discount not taken 2