14-02-2013, 11:18 AM
INTRODUCTION TO WORKING CAPITAL MANAGEMENT
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WORKING CAPITAL MANAGEMENT
Goals of Working Capital Management:
Stimulate sales by offering customers credit (accounts receivable) and ready goods for sale (inventory) Increase Profits
Minimize costs by balancing production and sales levels through inventory Increase Profits
Secure low cost financing Increase Profits
Reach above 3 goals but never run out of cash by having enough cash and marketable securities on hand and/or by limiting use of short-term debt
MANAGEMENT OF CASH CONVERSION CYCLE
Cash Conversion Cycle = (Operating Cycle) - (Accounts Payable Deferral Period)
1. Operating Cycle = The time between ordering or raw materials and receiving cash from credit sales
2. Inventory conversion period = time required to order, produce and sell final products on credit
3. Average collection period = time required to collect cash from credit sales
4. Accounts payable deferral period = time firm is able to delay payment for raw materials, wages and other accounts
5. Cash conversion cycle = time between payments for raw materials and and labour (resources) and cash collection from sales
Working Capital Policies and the Current Ratio
Current Ratio is a measure of the extent to which current Assets are financed by current liabilities
Current Ratio = Current Assets / Current Liabilities
Doug’s Distributors has a current ratio of 70/50 or 1.4
A current ratio of 1.40 means that for every $1.40 of current assets there is one dollar of current liabilities
Working Capital PoliciesUnderstanding Liquidity
To understand how well a company can meet its ongoing cash obligations (its liquidity), you need to understand whether the firm is using or generating cash flow
To help you understand the nature of cash flows, you need to know how to develop and interpret a statement of cash flows
Before developing a statement of cash flows, let us review how the balance sheet and income statements are created