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Financial Management > Working Capital Management > Flashcards

Working Capital Management Flashcards

1
Q

Working capital is usually expressed as…

A

current assets - current liabilities

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2
Q

What is working capital management?

A

Management of all aspects of current assets and current liabilities, to minimise the risk of insolvency while maximising the return on assets

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3
Q

The cost of working capital has a cost which is expressed either as:

A

* Cost of funding; or * Opportunity cost of lost investments opportunities because cash is tied up and unavailable

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4
Q

In terms of cash flows, when inventory is purchased….is paid to acquire it.

A

Cash

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5
Q

In terms of cash flows, what do receivables represent?

A

The cost of selling goods/services to customers including cost of materials and labour

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6
Q

In terms of cash flows the cash tied up in working capital is reduced to the extent that inventory is financed by —–

A

trade payables.

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7
Q

If suppliers give a firm credit period, the firms cashflows are________ and working capital is_______

A

Improved, reduced

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8
Q

What are the main objectives of working capital management?

A

To get the balance of current assets and liabilities right (liquidity and profitability)

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9
Q

Mismanagement of working capital is a common cause of business failure. eg.___

A
  1. Inability to meet bills as they fall due
  2. Overtrading (demands on cash during periods of growth being too great)
  3. Overstocking
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10
Q

What is the aggressive approach?

A

Lower levels of working capital (inc cash) than rivals

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11
Q

What is the conservative approach?

A

Higher levels of working capital (inc cash) than rivals

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12
Q

Which approach, conservative or aggressive, will result in higher woking capital funding costs but lower risk?

A

Conservative

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13
Q

Which approach, conservative or aggressive, will result in lower woking capital funding costs but higher risk?

A

Aggressive

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14
Q

What are the advantages of keeping inventory high?

A
  • Few stockouts -Bulk purchase discounts -Reduce ordering costs
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15
Q

What are the advantages of keeping Receivables high?

A
  • Customers like credit so more profitable as attracts more sales
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16
Q

What are the advantages of a high cash balance?

A
  • Able to pay bills on time
  • Take advantage of unexpected opportunities
  • Avoid high borrowing costs
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17
Q

What is the advantage of high trade payables?

A

Free finance and preserves own cash

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18
Q

What are the advantages of low inventory levels?

A
  • Less cash tied up - Lower storage costs - Flexibility - response to customers (JIT)
19
Q

What are the advantages of low receivables?

A

-Less cash tied up -Less chance of irrecoverable debt -Reduced credit control costs

20
Q

What are the advantages of low cash balances?

A
  • Can invest surplus to earn higher returns - Less vulnerable to takeover
21
Q

What are the advantages of low trade payables?

A
  • Take advantage of prompt payment discounts - Retain good credit status - More favourable supplier treatment
22
Q

If there are excessive inventories, accounts receivable and cash, and very few accounts payable, the company will have over invested in assets - this is known as what?

A

Over capitalisation

23
Q

Healthy trading growth typically produces:

A

* Increased profitability

* The need to increase investment in non current assets and working captial

24
Q

If a company does not have access to sufficient capital to fund an increase in investments, it is said to be what?

A

Overtradining?

25
Q

To diagnose over trading, what 4 things should you be looking for?

A
  1. Rapid increase in revenue
  2. Increase in values of woking capital days ( especially receivables and payables)
  3. Most of the increase in assets being financed by credit
  4. Dramatic drop in liquidity ratios
26
Q

What does the current ratio measure?

A

How much of the current assets are financed by current liabilities

eg 2:1 means current liabilities can be paid twice out of existing current assets

27
Q

What does the Acid Test measure?

A

How well current liabilities are covered by liquid assets

28
Q

What is the acid test particularly useful?

A

Where inventory is holding periods are long and thereofre distort the current ratio

29
Q

What would a measure of 1:1 mean in terms of the acid test?

A

A company is able to meet existing liabilities if they fall due at once

30
Q

In gerneral, is a high current and quick ratio good or bad?

A

Good

31
Q

Some companies use an overdrafts as part of their long term finance, in which case the current and quick ratio may appear worrying low. In this case what should you suggest the firm does to improve their liquidity ratios?

A

Replace the overdraft with a loan, which will also reduce the cost!!

32
Q

What is the cash operating cycle?

A

The length of time between the company’s outlay on raw materials, wages, and other expenditures and the inflow from sales of goods.

33
Q

The faster a firm can push items arounds the cycle, the________ it’s investment in working capital will be.

A

Lower

34
Q

For a manufacturing business how do calculate the cash operating cycle?

A

(Period)

Raw Materials X

WIP X

Finished Goods X

Receivable X

Less Payalbes (X)

35
Q

For whole sale or retail business, how do you calculate the operating cycle?

A

(In periods)

Inventory X

Receivable X

Payable (X)

36
Q

Give 4 factors which affect the length of the operating cycle?

A
  1. Liquidity vs profitability
  2. terms of trade
  3. Management efficiency
  4. Industry norms
37
Q

How would you calculate the turn over period?

A

Invert the working ratio and remove the multiple

38
Q

What are limitations of the Working capital ratios?

A
  • The SoFP is at a paritcular time and may not be typical
  • Balance used for a seasonal business may not represent an average
  • Ratios can be subject to window dressing/manipulation
  • Concern the past not the future
  • May be distorted by inflation and/or rapid growth
39
Q

What is the ratio for working capital turnover?

A

Sales revenue

Net working capital

40
Q

What does working capital turnover represent?

A

How efficiently management is utilising the working capital to generate sales

41
Q

What are the 4 aims of a JIT system?

A

* A smooth flow of work through manufacturing plant

* a flexible production process which is responsive customer requirements

* Reduction in capital tied up in inventory

* Elimination of waste

42
Q

In terms of JIT systems, how is waste defined?

A

‘Any activity performed which does not add value to a product

43
Q

Give some examples of waste

A

Inventory ( RM, WIP, FM)

Material handling

Quality issues

queues/delays

Long RM lead times

Long customer lead times

unnecessary clerical/accounting procedures

44
Q

What are the key factors which determine the level of investment in current assets?

A
  1. Policy and approach to risk
  2. Nature of the industry
  3. Terms of trade
  4. Length of operating cycle

Financial Management (18 decks)

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