Overview of Working Capital Management

Июль 25, 2022

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Overview of Working Capital Management

Содержание

2. After studying Chapter 8, you should be able to: Explain how the definition of "working capital"
3. Overview of Working Capital Management Working Capital Concepts Working Capital Issues Financing Current Assets: Short-Term and
4. Working Capital Concepts Net Working Capital Current Assets - Current Liabilities. Gross Working Capital The firm’s
5. Significance of Working Capital Management In a typical manufacturing firm, current assets exceed one-half of total
6. Working Capital Issues Assumptions 50,000 maximum units of production Continuous production Three different policies for current
7. Impact on Liquidity Liquidity Analysis Policy Liquidity A High B Average C Low Greater current asset
8. Impact on Expected Profitability Return on Investment = Net Profit Total Assets Let Current Assets =
9. Impact on Expected Profitability Profitability Analysis Policy Profitability A Low B Average C High As current
10. Impact on Risk Decreasing cash reduces the firm’s ability to meet its financial obligations. More risk!
11. Impact on Risk Risk Analysis Policy Risk A Low B Average C High Risk increases as
12. Summary of the Optimal Amount of Current Assets SUMMARY OF OPTIMAL CURRENT ASSET ANALYSIS Policy Liquidity
13. Classifications of Working Capital Time Permanent Temporary Components Cash, marketable securities, receivables, and inventory
14. Permanent Working Capital The amount of current assets required to meet a firm’s long-term minimum needs.
15. Temporary Working Capital The amount of current assets that varies with seasonal requirements. Permanent current assets
16. Financing Current Assets: Short-Term and Long-Term Mix Spontaneous Financing: Trade credit, and other payables and accruals,
17. Hedging (or Maturity Matching) Approach A method of financing where each asset would be offset with
18. Hedging (or Maturity Matching) Approach * Less amount financed spontaneously by payables and accruals. ** In
19. Financing Needs and the Hedging Approach Fixed assets and the non-seasonal portion of current assets are
20. Self-Liquidating Nature of Short-Term Loans Seasonal orders require the purchase of inventory beyond current levels. Increased
21. Risks vs. Costs Trade-Off (Conservative Approach) Long-Term Financing Benefits Less worry in refinancing short-term obligations Less
22. Risks vs. Costs Trade-Off (Conservative Approach) Firm can reduce risks associated with short-term borrowing by using
23. Comparison with an Aggressive Approach Short-Term Financing Benefits Financing long-term needs with a lower interest cost
24. Firm increases risks associated with short-term borrowing by using a larger proportion of short-term financing. TIME
25. Summary of Short- vs. Long-Term Financing Financing Maturity Asset Maturity SHORT-TERM LONG-TERM Low Risk-Profitability Moderate Risk-Profitability
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Слайд 2

After studying Chapter 8, you should be able to:
Explain how the

definition of "working capital" differs between financial analysts and accountants.
Understand the two fundamental decision issues in working capital management -- and the trade-offs involved in making these decisions.
Discuss how to determine the optimal level of current assets.
Describe the relationship between profitability, liquidity, and risk in the management of working capital.
Explain how to classify working capital according to its “components” and according to “time” (i.e., either permanent or temporary).
Describe the hedging (maturity matching) approach to financing and the advantages/disadvantages of short- versus long-term financing.
Explain how the financial manager combines the current asset decision with the liability structure decision.

Слайд 3

Overview of Working Capital Management
Working Capital Concepts
Working Capital Issues
Financing Current Assets:

Short-Term and Long-Term Mix
Combining Liability Structure and Current Asset Decisions

Слайд 4

Working Capital Concepts
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.

Слайд 5

Significance of Working Capital Management
In a typical manufacturing firm, current assets

exceed one-half of total assets.
Excessive levels can result in a substandard Return on Investment (ROI).
Current liabilities are the principal source of external financing for small firms.
Requires continuous, day-to-day managerial supervision.
Working capital management affects the company’s risk, return, and share price.

Слайд 6

Working Capital Issues
Assumptions
50,000 maximum units of production
Continuous production
Three different policies for

current asset levels are possible

Optimal Amount (Level) of Current Assets

0 25,000 50,000

OUTPUT (units)

ASSET LEVEL ($)

Current Assets

Policy C

Policy A

Policy B

Слайд 7

Impact on Liquidity
Liquidity Analysis
Policy Liquidity
A High
B Average
C Low
Greater current asset levels generate

more liquidity; all other factors held constant.

Optimal Amount (Level) of Current Assets

0 25,000 50,000

OUTPUT (units)

ASSET LEVEL ($)

Current Assets

Policy C

Policy A

Policy B

Слайд 8

Impact on Expected Profitability
Return on Investment =
Net Profit
Total Assets
Let Current Assets

= (Cash + Rec. + Inv.)
Return on Investment =
Net Profit
Current + Fixed Assets

Optimal Amount (Level) of Current Assets

0 25,000 50,000

OUTPUT (units)

ASSET LEVEL ($)

Current Assets

Policy C

Policy A

Policy B

Слайд 9

Impact on Expected Profitability
Profitability Analysis
Policy Profitability
A Low
B Average
C High
As current asset

levels decline, total assets will decline and the ROI will rise.

Optimal Amount (Level) of Current Assets

0 25,000 50,000

OUTPUT (units)

ASSET LEVEL ($)

Current Assets

Policy C

Policy A

Policy B

Слайд 10

Impact on Risk
Decreasing cash reduces the firm’s ability to meet its

financial obligations. More risk!
Stricter credit policies reduce receivables and possibly lose sales and customers. More risk!
Lower inventory levels increase stockouts and lost sales. More risk!

Optimal Amount (Level) of Current Assets

0 25,000 50,000

OUTPUT (units)

ASSET LEVEL ($)

Current Assets

Policy C

Policy A

Policy B

Слайд 11

Impact on Risk
Risk Analysis
Policy Risk
A Low
B Average
C High
Risk increases as the level

of current assets are reduced.

Optimal Amount (Level) of Current Assets

0 25,000 50,000

OUTPUT (units)

ASSET LEVEL ($)

Current Assets

Policy C

Policy A

Policy B

Слайд 12

Summary of the Optimal Amount of Current Assets
SUMMARY OF OPTIMAL CURRENT

ASSET ANALYSIS
Policy Liquidity Profitability Risk
A High Low Low
B Average Average Average
C Low High High

1. Profitability varies inversely with liquidity.
2. Profitability moves together with risk.
(risk and return go hand in hand!)

Слайд 13

Classifications of Working Capital
Time
Permanent
Temporary
Components
Cash, marketable securities, receivables, and inventory

Слайд 14

Permanent Working Capital
The amount of current assets required to meet a

firm’s long-term minimum needs.

Permanent current assets

TIME

DOLLAR AMOUNT

Слайд 15

Temporary Working Capital
The amount of current assets that varies with seasonal

requirements.

Permanent current assets

TIME

DOLLAR AMOUNT

Temporary current assets

Слайд 16

Financing Current Assets: Short-Term and Long-Term Mix
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.

Слайд 17

Hedging (or Maturity Matching) Approach
A method of financing where each asset

would be offset with a financing instrument of the same approximate maturity.

TIME

DOLLAR AMOUNT

Long-term financing

Fixed assets

Current assets*

Short-term financing**

Слайд 18

Hedging (or Maturity Matching) Approach
* Less amount financed spontaneously by payables

and accruals.
** In addition to spontaneous financing (payables and accruals).

TIME

DOLLAR AMOUNT

Long-term financing

Fixed assets

Current assets*

Short-term financing**

Слайд 19

Financing Needs and the Hedging Approach
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).

Слайд 20

Self-Liquidating Nature of Short-Term Loans
Seasonal orders require the purchase of inventory

beyond current levels.
Increased inventory is used to meet the increased demand for the final product.
Sales become receivables.
Receivables are collected and become cash.
The resulting cash funds can be used to pay off the seasonal short-term loan and cover associated long-term financing costs.

Слайд 21

Risks vs. Costs Trade-Off (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.

Слайд 22

Risks vs. Costs Trade-Off (Conservative Approach)
Firm can reduce risks associated with

short-term borrowing by using a larger proportion of long-term financing.

TIME

DOLLAR AMOUNT

Long-term financing

Fixed assets

Current assets

Short-term financing

Слайд 23

Comparison with an 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.

Слайд 24

Firm increases risks associated with short-term borrowing by using a larger

proportion of short-term financing.

TIME

DOLLAR AMOUNT

Long-term financing

Fixed assets

Current assets

Short-term financing

Risks vs. Costs Trade-Off (Aggressive Approach)

Слайд 25

Summary of Short- vs. Long-Term Financing
Financing
Maturity
Asset
Maturity
SHORT-TERM
LONG-TERM
Low
Risk-Profitability
Moderate
Risk-Profitability
Moderate
Risk-Profitability
High
Risk-Profitability
SHORT-TERM
(Temporary)
LONG-TERM
(Permanent)

Overview of Working Capital Management

Содержание

After studying Chapter 8, you should be able to:Explain how the

Overview of Working Capital ManagementWorking Capital ConceptsWorking Capital IssuesFinancing Current Assets:

Working Capital ConceptsNet Working CapitalCurrent Assets - Current Liabilities.Gross Working CapitalThe

Significance of Working Capital ManagementIn a typical manufacturing firm, current assets

Working Capital IssuesAssumptions50,000 maximum units of productionContinuous productionThree different policies for

Impact on LiquidityLiquidity AnalysisPolicy Liquidity A High B Average C LowGreater current asset levels generate

Impact on Expected ProfitabilityReturn on Investment =Net ProfitTotal AssetsLet Current Assets

Impact on Expected ProfitabilityProfitability AnalysisPolicy Profitability A Low B Average C HighAs current asset

Impact on RiskDecreasing cash reduces the firm’s ability to meet its

Impact on RiskRisk AnalysisPolicy Risk A Low B Average C HighRisk increases as the level

Summary of the Optimal Amount of Current AssetsSUMMARY OF OPTIMAL CURRENT

Classifications of Working CapitalTimePermanentTemporaryComponentsCash, marketable securities, receivables, and inventory

Permanent Working CapitalThe amount of current assets required to meet a

Temporary Working CapitalThe amount of current assets that varies with seasonal

Financing Current Assets: Short-Term and Long-Term MixSpontaneous Financing: Trade credit, and

Hedging (or Maturity Matching) ApproachA method of financing where each asset

Hedging (or Maturity Matching) Approach* Less amount financed spontaneously by payables

Financing Needs and the Hedging ApproachFixed assets and the non-seasonal portion

Self-Liquidating Nature of Short-Term LoansSeasonal orders require the purchase of inventory

Risks vs. Costs Trade-Off (Conservative Approach)Long-Term Financing BenefitsLess worry in refinancing

Risks vs. Costs Trade-Off (Conservative Approach)Firm can reduce risks associated with

Comparison with an Aggressive ApproachShort-Term Financing BenefitsFinancing long-term needs with a

Firm increases risks associated with short-term borrowing by using a larger

Summary of Short- vs. Long-Term FinancingFinancing MaturityAssetMaturitySHORT-TERMLONG-TERMLowRisk-ProfitabilityModerateRisk-ProfitabilityModerateRisk-ProfitabilityHighRisk-ProfitabilitySHORT-TERM(Temporary)LONG-TERM(Permanent)

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After studying Chapter 8, you should be able to:
Explain how the

Overview of Working Capital Management
Working Capital Concepts
Working Capital Issues
Financing Current Assets:

Working Capital Concepts
Net Working Capital
Current Assets - Current Liabilities.
Gross Working Capital
The

Significance of Working Capital Management
In a typical manufacturing firm, current assets

Working Capital Issues
Assumptions
50,000 maximum units of production
Continuous production
Three different policies for

Impact on Liquidity
Liquidity Analysis
Policy Liquidity
A High
B Average
C Low
Greater current asset levels generate

Impact on Expected Profitability
Return on Investment =
Net Profit
Total Assets
Let Current Assets

Impact on Expected Profitability
Profitability Analysis
Policy Profitability
A Low
B Average
C High
As current asset

Impact on Risk
Decreasing cash reduces the firm’s ability to meet its

Impact on Risk
Risk Analysis
Policy Risk
A Low
B Average
C High
Risk increases as the level

Summary of the Optimal Amount of Current Assets
SUMMARY OF OPTIMAL CURRENT

Classifications of Working Capital
Time
Permanent
Temporary
Components
Cash, marketable securities, receivables, and inventory

Permanent Working Capital
The amount of current assets required to meet a

Temporary Working Capital
The amount of current assets that varies with seasonal

Financing Current Assets: Short-Term and Long-Term Mix
Spontaneous Financing: Trade credit, and

Hedging (or Maturity Matching) Approach
A method of financing where each asset

Hedging (or Maturity Matching) Approach
* Less amount financed spontaneously by payables

Financing Needs and the Hedging Approach
Fixed assets and the non-seasonal portion

Self-Liquidating Nature of Short-Term Loans
Seasonal orders require the purchase of inventory

Risks vs. Costs Trade-Off (Conservative Approach)
Long-Term Financing Benefits
Less worry in refinancing

Risks vs. Costs Trade-Off (Conservative Approach)
Firm can reduce risks associated with

Comparison with an Aggressive Approach
Short-Term Financing Benefits
Financing long-term needs with a

Summary of Short- vs. Long-Term Financing
Financing
Maturity
Asset
Maturity
SHORT-TERM
LONG-TERM
Low
Risk-Profitability
Moderate
Risk-Profitability
Moderate
Risk-Profitability
High
Risk-Profitability
SHORT-TERM
(Temporary)
LONG-TERM
(Permanent)