Working Capital Components and Calculations

Working Capital Components

• Current assets include cash, accounts receivable, inventories, and prepaid expenses.
• Current liabilities include bank indebtedness, accounts payable, accrued liabilities, current portions of finance lease obligations and long-term debt.
• Net working capital is the difference between current assets and current liabilities.
• The operating cycle is the time from raw materials purchase to cash collection from finished goods sales. It's the sum of the inventory period and the accounts receivable period.
• The cash conversion cycle is the time between paying for materials and collecting from sales. It's the operating cycle minus the accounts payable period.

Calculating Cycle Lengths

• Inventory period = (Annual cost of sales / 365)
• Accounts receivable period = (Annual sales / 365)
• Accounts payable period = (Annual cost of goods sold / 365)

Brick Brewing Example

• Brick Brewing's 2018 data: Revenue: $50,084,490; Cost of sales: $37,108,956; Inventory: $10,316,767; Accounts receivable: $4,851,774; Accounts payable: $7,303,233.
• Brick Brewing's inventory period was 101.47 days.
• Brick Brewing's accounts receivable period was 35.36 days.
• Brick Brewing's accounts payable period was 71.33 days.
• Brick Brewing's operating cycle was 136.83 days (101.47 + 35.36).
• Brick Brewing's cash conversion cycle was 65 days (136.83 - 71.33).

Working Capital Trade-off

• Maintaining current assets involves carrying costs, including the opportunity cost of capital.

Dynamic Mattress Example: Short-Term Financial Planning

• Dynamic Mattress's 2017 sales forecast (in millions): Q1 - $560; Q2 - $502; Q3 - $742; Q4 - $836.
• 70% of sales are collected in the current quarter; 30% in the next.
• Dynamic Mattress uses bank loans (up to $100 million at 10% interest) and stretching payables (up to $100 million per quarter) for short-term financing.

Short-Term Financing Options

• Bank loans: Lines of credit (with commitment fees), term loans, and syndicated loans.
• Secured loans: Loans backed by assets like accounts receivable and inventory. Factoring involves selling receivables at a discount.
• Commercial paper: Short-term unsecured notes issued by large corporations.
• Banker's acceptances: Time drafts accepted by a bank, sold to investors.

Interest Calculations

• Simple interest: (Loan amount × annual interest rate) / (Number of periods per year)
• Effective annual rate considers compounding: (1 + (quoted annual interest rate / m))^m - 1, where 'm' is compounding periods per year.
• Discount interest: Interest deducted upfront; effectively increases the interest rate.

Long-Term vs. Short-Term Financing

• Long-term assets are typically financed with equity and long-term debt.
• Short-term financial planning focuses on managing current assets and liabilities.
• Short-term financial plans are developed iteratively through trial and error.