Working Capital and Liquidity Management

Question 1

What defines Working Capital in Financial Management?

Answer 1

W/C is the difference between a company’s current assets and current liabilities, crucial for daily operations and liquidity management.

Question 2

Define liquidity:

Answer 2

The ability of a company to meet its short-term obligations. High liquidity involves holding more cash or liquid assets, which may yield lower returns.

Question 3

Define Profitability:

Answer 3

Using assets to generate returns. Maximising profitability might reduce liquidity, increasing financial risk due to potentially insufficient funds to cover short-term needs.

Question 4

What is the Baumol cash management model and its formula?

Answer 4

The Baumol model treats cash like inventory, suggesting minimising costs by optimising transfer amounts using the formula:
Q = Square root of: 2DCo/ Ch
D = Total cash requirement
Co = Transaction Cost
Ch = Handling cost

Question 5

What is the Cash Operating Cycle and what is its formula?

Answer 5

Measures the time between purchasing inventory and receiving cash from sales. It includes days sales outstanding (DSO), days inventory outstanding (DIO), and days payable outstanding (DPO).
Formula:
CCC = DSO + DIO - DPO
Where CCC = Cash Conversion Cycle

Question 6

How does the Miller-Orr model manage cash?

Answer 6

Sets flexible upper and lower limits, adjusting balances automatically to maintain optimal liquidity in unpredictable environments.

Question 7

Inventory Management methods?

Answer 7

• Just in Time (JIT)
• Economic Order Quantity (EOQ)

Question 8

What is receivables management?

Answer 8

Focuses on the policies for offering credit and collecting debts to ensure cash flows are timed correctly and bad debts are minimised.

Question 9

What is payables management?

Answer 9

Involves managing the timing and terms of payments to suppliers to optimise cash outflows without damaging relationships or creditworthiness.

Question 10

What does the Economic Order Quantity (EOQ) model entail and what is its formula?

Answer 10

EOQ aims to minimise the total costs of inventory by determining the optimal order quantity that balances the ordering costs with the holding costs.
Formula:
EOQ = Square root of: 2DS/ H
D = Demand
S = Ordering cost per order
H = Holding cost per unit per period