[AMFINANCE] M2 | Overview of Working Capital Management

Net Working Capital

Current Assets - Current Liabilities.

Gross Working Capital

The firm’s investment in current assets

Working Capital Management

The administration of the firm’s current assets and the financing needed to support current assets. This affects the company’s risk, return, and share price.

Components

Cash, marketable securities, receivables, and inventory

Return on Investment (ROI)

In a typical manufacturing firm, current assets exceed one-half of total assets. Excessive levels can result in a substandard ____________.

Current liabilities

are the principal source of external financing for small firms.

Time

Permanent Current Assets. Temporary Short Time Investment or Marketable Securities  

Permanent Working Capital

The amount of current assets required to meet a firm’s long-term minimum needs.

Temporary Working Capital

The amount of current assets that varies with seasonal requirements.

Spontaneous Financing

Trade credit, and other payables and accruals, that arise spontaneously in the firm’s day-to-day operations. Based on policies regarding payment for purchases, labor, taxes, and other expenses. We are concerned with managing non-spontaneous financing of assets.

Hedging (or Maturity Matching) Approach

A method of financing where each asset would be offset with a financing instrument of the same approximate maturity.

Fixed assets and the non-seasonal portion of current assets

are financed with long-term debt and equity (long-term profitability of assets to cover the long-term financing costs of the firm).

Seasonal needs

are financed with short-term loans (under normal operations sufficient cash flow is expected to cover the short-term financing cost). This require the purchase of inventory beyond current levels.

Increased inventory

is used to meet the increased demand for the final product.

Receivables

Sales become __________. These are collected and become cash.

The resulting cash funds

The ______________ can be used to pay off the seasonal short-term loan and cover associated long-term financing costs.

Conservative Approach

Long-Term Financing Benefits

• Less worry in refinancing short-term obligations

• Less uncertainty regarding future interest costs

Long-Term Financing Risks

• Borrowing more than what is necessary

• Borrowing at a higher overall cost (usually)

Result: Manager accepts less expected profits in exchange for taking less risk.

Long-Term Financing Benefits + Long-Term Financing Risks

Conservative Approach, Aggressive Approach

• Firm can reduce risks associated with short-term borrowing by using a larger proportion of long-term financing.

• Firm increases risks associated with short-term borrowing by using a larger proportion of short-term financing.

Aggressive Approach

Short-Term Financing Benefits

• Financing long-term needs with a lower interest cost than short-term debt

• Borrowing only what is necessary

Short-Term Financing Risks

• Refinancing short-term obligations in the future

• Uncertain future interest costs

Result: Manager accepts greater expected profits in exchange for taking greater risk.

Short-Term Financing Benefits + Short-Term Financing Risks

interdependent

uhe level of current assets and the method of financing those assets are ____________.

conservative policy

_________ of “high” levels of current assets allows a more aggressivemethod of financing current assets.

conservative method

_________ of financing (all-equity) allows an aggressive policy   of “low” levels of current assets.