Working Capital Flashcards
(24 cards)
What is a company’s operating cycle?
For a company that makes and sells physical goods, its operations include acquiring materials, producing inventory, selling products to customers, and collecting cash.
What are days payable outstanding (DPO)?
The average duration of the days payable.
What are days of inventory on hand (DOH)?
Average duration of outstanding inventory
What are days sales outstanding (DSO)?
Average duration of outstanding sales.
What is the cash conversion cycle?
The number of days it takes a company to convert an inventory investment into cash receipts from customers.
DOH + DSO - DPO
What happens for a company with a longer cash conversion cycle?
The longer the cash conversion cycle, the longer a company needs financing to pay its bills, because it has not yet received cash from customers.
Ideal scenario is a short or even negative cash conversion cycle!
How can corporate issuers reduce their days of inventory on hand?
Discontinuing products with low or niche demand.
By negotiating with suppliers to do more frequent deliveries.
By using data to improve customer demand forecasts.
How can corporate issuers reduce their days of sales outstanding?
Offering prompt-payment discounts to customers, imposing late fees, tightening credit standards, imposing upfront deposits or accelerating installment payments, or third-party collection agencies.
How can corporate issuers reduce their days payable outstanding?
Negotiating supplier contracts for longer terms.
What is total working capital?
Current assets - current liabilities
What is net working capital?
Current assets + cash + marketable securities - current liabilities + short-term debt
For what goal do we use cash conversion cycle and working capital?
To analyze the efficiency of business operations
What is working capital ratio?
The working capital as a percentage of annual sales
What is the difference between long-term and short-term assets?
Liquidity. Long-term assets are not expected to be converted into cash within 12 months.
What does liquidity for an issuer mean?
A corporation’s ability to meet its short-term liabilities.
What are primary liquidity sources?
- Cash and marketable securities on hand = cash available in bank accounts or held as liquid assets.
- Borrowings
- Cash flow from business
What is free cash flow?
Cash flow from operations - investments in long-term assets
What are secondary liquidity sources?
- Suspending or reducing dividends
- Delaying or reducing capital expenditures
- Issuing equity
- Renegotiating contract terms
- Selling assets
- Filing for bankruptcy
What is a drag on liquidity?
Occurs when cash inflows lag, creating a shortfall due to a decline in available funds.
What is a pull on liquidity?
Acceleration of cash outflows
What are examples of liquidity drags?
Uncollected receivables
Obsolete inventory
Borrowing constraints
What are examples of liquidity pulls?
Making payments early
Reduced credit limits
Limits on short-term lines of credit
Low liquidity positions
What are three most used liquidity ratios?
Current ratio = current assets / current liabilities
Quick ratio = (cash + short-term marketable instruments + receivables) / current liabilities
Cash ratio = cash + short-term marketable instruments / current liabilities
