11: Working Capital and the Operating Cycle Flashcards
(20 cards)
working capital
capital available to fund day-to-day operations of an entity
difference between current assets and current liabilities
working capital cycle
period of time between when cash expects to be expended on production and when you collect cash from a purchaser
working capital cycle calculation
inventory days + receivable days - payable days
3 working capital ratios
inventory days
receivable days
payables days
inventory days
how long on average goods are held in inventory for
average inventory / cost of sales x 365
receivable days
how long on average consumers take to pay for goods bought on credit
average receivables / credit sales x 365
payables days
how long it takes to pay for goods bought on credit
average payables / credit purchases x 365
liquidity
measures an entity’s ability to meet debts as they fall due
liquidity ratios
current ratio
quick ratio
influencing ratios
current ratio
how many times an entity’s current assets cover current liabilities
current assets / current liabilities
quick ratio
more prudent measure of current ratio as it excludes inventory
(current assets - inventory ) / current liabilities
lower than current ratio
influencing ratios
comparing ratios to something else
prior periods, budgets, competitors, industry averages
2 risks of not monitoring working capital
overcapitalisation
overtrading
overcapitalisation
excess of working capital - too much tied up in inventories/receivables
overtrading
lack of capital
- might have a length operating/working capital cycle and you have to wait for cash
can cause a profitable business to go into liquidation
2 sections of current assets
permanent current assets
- core level of cash and inventory to keep the business going
fluctuating current assets
3 possible ways of financing working capital
conservative policy
aggressive policy
moderate policy
conservative policy
all permanent assets and some fluctuating assets financed by long-term funding
aggressive policy
all fluctuating and part of the permanent assets financed by short-term funding
moderate policy
somewhere in between where short-term funding finances fluctuating assets and permanent assets are financed by long-term funding
