Net Operating Working Capital (copy)

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What is working capital management?

What is working capital management?

Includes both establishing working capital policy (the level of each current asset, how current assets are financed) and then the day-to-day control of cash, inventories, receivables, accruals, and accounts payable

What is the cash conversion cycle?

Indicates the length of time it takes for a firm to convert its inputs (such as inventory) into cash, accounting for both converting credit sales into cash and paying suppliers

CCC formula

(Accounts Recievables / (Sales / 365)) + (Inventory / (COGS / 365)) - (Accounts Payable / (COGS / 365))

If purchase are available then it would be Accounts Payable / (Purchases / 365) instead

What current assets and liabilities are primarily affected by the cash flows related to a firm’s operating activities?

CA: inventory, accounts receivables

CL: accounts payable

Why is inventory management important?

•Inventory affects a firm’s sales and hence its profitability

•If the firm doesn't have enough inventory, this is an opportunity cost

•Profitability affects the overall value of the firm, because investors are willing to pay more for a company that turns a healthy profit

•Goal is to find a balance between customers’ needs & wants with firm’s desire to maintain as little stock as possible

Why is accounts receivable management important?

• Providing trade credit allows a firm to remain competitive with other companies in the industry that are doing the same

• The cost of providing trade credit is that the firm is delayed in receiving money from its customers

• Aging of receivables---preparation for bad debts

Why is accounts payable management important?

• Relying on accounts payable is a source of short-term funding

• A potential cost is that the firm might be foregoing discounts for early repayment

Nominal Cost

(Discount % / (1-Discount %)) x (365 Days / (Days Taken - Discount Period))

Ex: 1/10 net 40

1/99 × 365 / (40-10)

Effective Annual Rate

(1+Nominal rate)^n - 1.0

What does a working capital gap depend on?

How much inventory a firm has

How rapidly receivables are collected

How long it takes pay suppliers

What are 3 ways to reduce a working capital gap

Decrease the age of inventory

Decrease the age of accounts receivable

Increase the age of accounts payable