Managing Working Capital
MANAGING WORKING CAPITAL
Cash Budgets and Current Assets
Learning Objectives
Upon reading this chapter, students should: • Be able to compare and contrast working and fixed capital • Understand the impact of the operating cycle on the size of investment in accounts receivable and inventories • Know the differences between the three motives • Be able to differentiate between float, collection float, and disbursement float • Know how to appraise a firm’s credit worthiness • Be able to appraise the effectiveness of a firm’s inventory management policies
Chapter Summary
A firm can invest in both working capital and fixed capital. Working capital is a firm’s current assets and includes cash, marketable securities, inventory, and accounts receivable. Fixed capital is a firm’s fixed assets and includes plant, equipment and property. Firms that cannot obtain short-term financing become candidates for bankruptcy. Management of working capital is particularly important to the entrepreneurial or venture firm because there is such a pull on resources. Two important concepts in managing working capital are the operating cycle and the cash conversion cycle: • The operating cycle measures the time between receiving raw materials and collecting the cash from credit sales posted to accounts receivable • The cash conversion cycle measures the time it takes to collect money from the company’s customers and use those funds to pay its suppliers Calculating three ratios will reveal the average length of these cycles: 1. Inventory days = 365 / (Cost of goods sold / Inventories) 2. Accounts receivable period (average collection period) = Accounts receivable / (Net sales / 365) 3. Average payment period = Accounts payable / (Cost of goods sold / 365) The operating cycle is the inventory conversion period plus the average
Cash Budgets and Current Assets
Learning Objectives
Upon reading this chapter, students should: • Be able to compare and contrast working and fixed capital • Understand the impact of the operating cycle on the size of investment in accounts receivable and inventories • Know the differences between the three motives • Be able to differentiate between float, collection float, and disbursement float • Know how to appraise a firm’s credit worthiness • Be able to appraise the effectiveness of a firm’s inventory management policies
Chapter Summary
A firm can invest in both working capital and fixed capital. Working capital is a firm’s current assets and includes cash, marketable securities, inventory, and accounts receivable. Fixed capital is a firm’s fixed assets and includes plant, equipment and property. Firms that cannot obtain short-term financing become candidates for bankruptcy. Management of working capital is particularly important to the entrepreneurial or venture firm because there is such a pull on resources. Two important concepts in managing working capital are the operating cycle and the cash conversion cycle: • The operating cycle measures the time between receiving raw materials and collecting the cash from credit sales posted to accounts receivable • The cash conversion cycle measures the time it takes to collect money from the company’s customers and use those funds to pay its suppliers Calculating three ratios will reveal the average length of these cycles: 1. Inventory days = 365 / (Cost of goods sold / Inventories) 2. Accounts receivable period (average collection period) = Accounts receivable / (Net sales / 365) 3. Average payment period = Accounts payable / (Cost of goods sold / 365) The operating cycle is the inventory conversion period plus the average