Chapter 13 - Working capital

Question 1

What is working capital defined as?

Answer 1

The excess of current assets over current liabilities

Question 2

What are the two main objectives of Working Capital Management?

Answer 2

• Liquidity

- Profitability

Question 3

What is the conservative approach to Working Capital Management?

Answer 3

Maintaining high levels of working capital to avoid liquidity problems

Question 4

What is the aggressive approach to Working Capital Management?

Answer 4

Keeping working capital to a minimum in order to improve profitability

Question 5

What is the conservative approach to Working Capital Financing?

Answer 5

Finance all NCA, permanent CA and a proportion of fluctuating CA using long term financing methods. ie bank loan

Question 6

What is the aggressive approach to Working Capital Financing?

Answer 6

Finance a proportion of permanent CA and fluctuating CA with short term financing methods ie bank overdraft.

Question 7

What the advantage of the conservative approach to Working Capital Financing?

Answer 7

Good for liquidity.

Question 8

What the advantage of the aggressive approach to Working Capital Financing?

Answer 8

Good for profitability

Question 9

What the disadvantage of the conservative approach to Working Capital Financing?

Answer 9

Bad for profitability ie high bank loan interest

Question 10

What the disadvantage of the aggressive approach to Working Capital Financing?

Answer 10

High risk of running out of cash

Question 11

What are the two types of working capital ratios?

Answer 11

Liquidity

Efficiency

Question 12

What is the current ratio?

Answer 12

(Current assets) ÷ (Current liabilities)

Question 13

What is the quick ratio? (acid test)

Answer 13

(Current assets - inventory) ÷ (Current liabilities)

Question 14

Inventory days?

Answer 14

(Inventory) ÷ (Cost of sales) x 365

Question 15

What are the three elements that inventory days can be broken down to?

Answer 15

Raw materials days
WIP days
Finished goods days

Question 16

Raw materials days?

Answer 16

(Raw materials) ÷ (Purchases) x 365

Question 17

WIP days? (Average production time)

Answer 17

(WIP) ÷ (Cost of sales) x 365

Question 18

Finished goods days?

Answer 18

(Finished goods) ÷ (Cost of sales) x 365

Question 19

Trade receivables days?

Answer 19

(Trade receivables) ÷ (Sales) x 365

Question 20

Trade payables days?

Answer 20

(Trade payables) ÷ (Purchases) x 365

Question 21

For payables and receivable days, what should ideally be used?

Answer 21

Credit sales/purchases over total sales/purchases.

Question 22

What is the cash operating cycles description?

Answer 22

The length of time from purchasing inventory to receiving cash from the sale of the related finished goods.

Question 23

What is the cash operating cycles formula?

Answer 23

Trade receivables days        x
Raw materials days              x
WIP days                                x
Finished goods days            x
Less: Trade payables days   (x)

Cash operating cycle x

Question 24

If there is an over investment in current assets, what is this termed as?

Answer 24

Over-capitalization

Question 25

When a company grows too quickly and as a result runs out of finance and hence cash, what is this termed as?

Answer 25

Over trading

Question 26

What are four things to look for if asked if a company might be overtrading?

Answer 26

- Rapid increase in revenue - Increase in working capital days (especially receivables and payables) - Most of the increase in assets financed by credit - A dramatic drop in liquidity ratios

Question 27

When calculating gearing, if you are told to use book value you include...

Answer 27

Retained earnings

Question 28

When calculating gearing, if you are told to use market value you do not include...

Answer 28

Retained earnings

Question 29

Why do you not include retained earnings in gearing when using market values?

Answer 29

Because its already included in the value of the shares.

Question 30

The faster a firm can ‘push’ items around the cycle the lower its investment in ...

Answer 30

Working capital

Question 31

What are four factors that the length of the cash operating cycle depend on?

Answer 31

- Liquidity verses profitability decisions - Terms of trade - Management efficiency - Industry norms ie construction

Question 32

Working capital turnover formula

Answer 32

Sales revenue / net working capital