Working Capital Management

Question 1

What does a large balance sheet often imply?

Answer 1

Less personnel expenses

Question 2

What are some examples of financing sources for growth?

Answer 2

• Profit
• New capital
• Loan
• Increasing operating liabilities
• Decreasing current assets
• Decreasing non-current assets

Question 3

Should the firm consider internal or external financing sources first?

Answer 3

Internal, since they are about efficiency. It is likely that external investors want to see that internal efficiency has been maximised.

Question 4

What are two needs as a firm grows?

Answer 4

• Investment capital need (long-term)
• Working capital need (short-term)

Question 5

What is the formula for working capital?

Answer 5

WC = Current assets - operating liabilities (NIBL)

Question 6

What is the formula for inventory value?

Answer 6

Inventory = (COGS / 365) * Inventory days

Question 7

What is the formula for Accounts receivables?

Answer 7

Accounts receivable = (Sales / 365) * Customer credit days

Question 8

What is the formula for Accounts payables?

Answer 8

Accounts payable = (Purchases / 365) * Supplier credit days

Question 9

What is the formula for purchases?

Answer 9

Purchases = COGS + Inventory(close) - Inventory(open)

Question 10

Are retirement benefits interest bearing?

Answer 10

Yes

Question 11

What are Days Inventory Outstanding (DIO)?

Answer 11

The number of days materials/goods are stored (storage time)

Question 12

What are Days Sales Outstanding (DSO)?

Answer 12

Credit time provided to customers

Question 13

What are Days Payables Outstanding (DPO)?

Answer 13

Credit time received from suppliers

Question 14

What is the formula for the cash conversion cycle?

Answer 14

CCC = DIO + DSO - DPO

Question 15

Is it possible to have a negative cash conversion cycle?

Answer 15

Yes, it means that we get paid from customers before we have to pay suppliers

Question 16

What sales figure do we use when calculating CCC?

Answer 16

Net sales (don’t include other operating income)

Question 17

What are the formulas for DIO?

Answer 17

DIO(average days) = (Average inventory / COGS) *365

or

DIO(average days) = 365 / Inventory turnover

where

Inventory turnover = COGS / Average inventory

Question 18

What is inventory turnover (in words)?

Answer 18

How many times the inventory completely changes per year

Question 19

If we can choose, should we include both cash and credit sales when calculating DSO?

Answer 19

No, only credit sales (often difficult to separate from external perspective)

Question 20

What is the formula for DSO?

Answer 20

DSO = (Average accounts receivable / Sales) * 365

Question 21

What is the formula for DPO?

Answer 21

DPO = (Average accounts payable / Purchases) * 365

Question 22

Do we need to consider that Accounts receivables/payables include VAT?

Answer 22

No, we do not need to adjust for it in this course, since we don’t know the proportion of the different VAT rates

Question 23

What are tradeoffs between liquidity and working capital?

Answer 23

Good liquidity (preferable) < – > Large net working capital

Low liquidity < – > Small net working capital (preferable)

Question 24

What are the major elements of current assets and operating liabilities?

Answer 24

CA: Inventories, account receivable, cash & cash equivalents

OL: accounts payable

Question 25

What does working capital represent?

Answer 25

A net investment in short-term assets

Question 26

What are some changes that can affect the optimal level of working capital?

Answer 26

- changes in interest rates - changes in market demand for our output - changes in seasons - changes in the state of the economy - internal changes such as different production methods and risk level managers are prepared to take.

Question 27

When may firms want to hold more inventories?

Answer 27

When there is risk that future supplies may be interrupted or scarce, or that the cost will increase in the future.

Question 28

What are some costs associated with holding inventories?

Answer 28

- Storage and handling costs - cost of financing the inventories - cost of pilferage and obsolescence - opportunity costs of tying up funds in this asset

Question 29

What are some costs associated with too low levels of inventories?

Answer 29

- loss of sales - loss of customer goodwill, from being unable to satisfy customer demands - purchasing inventories at a higher price to replenish inventories quickly - lost production due to shortage of raw materials - inefficient production scheduling due to shortages of raw materials

Question 30

What are the five factors that should be considered when customers want to buy on credit?

Answer 30

- Capital (financially stable) - Capacity (to pay) - Collateral (security) - Conditions (sensitivity to changes) - Character (willingness to pay)

Question 31

What can distort the number of the DSO?

Answer 31

Specifically slow or fast paying large customers

Question 32

Are all days in the cash conversion cycle of equal value?

Answer 32

No. If both accounts payable and receivable increased by the same number of days, the CCC would remain at the same level, but the AMOUNT tied up in working capital would not be the same (it would be a net increase)

Question 33

What is the cash conversion cycle (in words)?

Answer 33

The number of days between when we pay out money (to suppliers) and when we receive money (from customers)

Question 34

What two types of classifications can we make of liabilities?

Answer 34

- Time perspective: non-current vs current - Character (financial focus): Interest-bearing vs NIBL (operating)

Question 35

What are typical interest-bearing liabilities?

Answer 35

- Credit - Borrowing - Loans - Liabilities to credit institutions - Financial liabilities - Lease liabilities - Post retirement benefits

Question 36

What are typical non-interest bearing liabilities (operating)?

Answer 36

- Accounts payable - Tax liabilities - Prepayments from customers - Provisions other than post retirement benefits