F501
WEEK 2 – WORKING CAPITAL MANAGEMENT
Topic 2.1 Working-Capital Management Introduction
Learning Outcomes • List the determinants of a firm’s net working capital and explain their relationships • Utilize working capital in managing firm activities • Describe the hedging principle of short-term debt • Calculate the cash conversion cycle • Understand the risk/return trade-off in managing working capital
I. Background
The business manager must continually be alert to changes in working capital accounts, the cause of these changes and the implications of these changes for the financial health of the company. One convenient and effective method to highlight the key managerial requirements in this area is to view working capital in terms of its major components:
A. Cash and Equivalents
This most liquid form of current assets, cash and cash equivalents (usually marketable securities or short-term certificate of deposit) requires constant supervision. A well-planned and maintained cash budgeting system is essential to answer key questions such as: Is the cash level adequate to meet current expenses as they come due? What are the timing relationships between cash inflows and outflows? When will peak cash needs occur? What will be the magnitude of bank borrowing required to meet any cash shortfalls? When will this borrowing be necessary and when may repayment be expected?
B. Accounts Receivable
Almost all businesses are required to extend credit to their customers. Key issues in this area include: Is the amount of accounts receivable reasonable in relation to sales? On the average, how rapidly is accounts receivable being collected? Which customers are "slow payers?" What action should be taken to speed collections where needed?
C. Inventories
Inventories often make up 50 percent or more of a firm 's current assets and therefore, are deserving of close scrutiny. Key questions which must be considered in
Topic 2.1 Working-Capital Management Introduction
Learning Outcomes • List the determinants of a firm’s net working capital and explain their relationships • Utilize working capital in managing firm activities • Describe the hedging principle of short-term debt • Calculate the cash conversion cycle • Understand the risk/return trade-off in managing working capital
I. Background
The business manager must continually be alert to changes in working capital accounts, the cause of these changes and the implications of these changes for the financial health of the company. One convenient and effective method to highlight the key managerial requirements in this area is to view working capital in terms of its major components:
A. Cash and Equivalents
This most liquid form of current assets, cash and cash equivalents (usually marketable securities or short-term certificate of deposit) requires constant supervision. A well-planned and maintained cash budgeting system is essential to answer key questions such as: Is the cash level adequate to meet current expenses as they come due? What are the timing relationships between cash inflows and outflows? When will peak cash needs occur? What will be the magnitude of bank borrowing required to meet any cash shortfalls? When will this borrowing be necessary and when may repayment be expected?
B. Accounts Receivable
Almost all businesses are required to extend credit to their customers. Key issues in this area include: Is the amount of accounts receivable reasonable in relation to sales? On the average, how rapidly is accounts receivable being collected? Which customers are "slow payers?" What action should be taken to speed collections where needed?
C. Inventories
Inventories often make up 50 percent or more of a firm 's current assets and therefore, are deserving of close scrutiny. Key questions which must be considered in
References: Keown, Martin, Petty, & Scott (2005). Financial Management Principles and Applications (10th ed.). Retrieved July 21, 2005, from http://myphlip.pearsoncmg.com/faculty Groppelli, A.A., & Nikbakht, E. (2000). Finance (4th ed.). Hauppauge, New York: Barron’s Educational Series, Inc. Maness, T. S., & Zietlow, J. T. (2002). Short-term Financial Management (2nd ed.). United States: Southwestern Thomson Learning. Working Capital Management. Retrieved July 25, 2005, from http://www.treasury.govt.nz/publicsector/workingcapital/chap2.asp