Working Capital Management (2) Flashcards
Whatever level of current assets the business decides to hold?
They must be matched by liabilities
What must management decide for interest rates?
Whether to use short-term or long-term finance or, if a mix is used, in what proportions
What is generally true?
That the cost of short-term finance is below the cost of long-term finance
What are short-term sources of finance?
Overdraft
Short-term loans
Accounts payable
What is an overdraft?
Repayable on demand
Usually expensive, but flexible
What is a short-term loan?
Usually lower interest rate than long-term debt
Renegotiation risk
What is accounts payable?
Trade credit can disappear
Appears cheap, but refusing settlement discounts can be expensive
Taking excessive credit may lead to lost goodwill with supplier
What is long-term equity?
New share issues or, to avoid issue costs, retained profits.
No legal commitment to repay
What is long-term debt?
Loan note issues and/or long-term bank loans
If interest rates are fixed, provides protection against rising rates (until maturity)
Examples of current assets that are more permanent?
Holding of “buffer stock”
Holding a minimum “precautionary” balance of cash
A minimum level of trade receivables over the business cycle
An example of the matching policy for working capital?
The maturity of the funds matches the maturity of the assets
An aggressive financing strategy for current assets?
Use short-term finance not only for the fluctuating balance of current assets
A conservative financing strategy for current assets?
Use long-term finance not only for the permanent level of current assets
