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Working Capital Management

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Questions and Answers

What is a common reason why a company may have a cash outflow despite showing a profit on the income statement?

Poor accounting staff management

Increases in working capital requirements (correct)

Large asset purchases without senior management approval

Inefficient credit granting processes to existing customers

What is the primary role of a controller in evaluating working capital?

To manage accounting staff

To review and explain increases in working capital requirements (correct)

To grant credit to new customers

To approve large asset purchases

What is the result of a poor credit granting process to new customers?

A decrease in accounts receivable

An increase in company investment in accounts receivable (correct)

An increase in inventory

An increase in accounts payable

Which component of working capital represents a source of cash?

Accounts payable Signup and view all the answers

What are the three components of working capital?

Accounts receivable, inventory, and accounts payable Signup and view all the answers

Why may a company experience a cash outflow despite showing a profit on the income statement?

Due to an increase in working capital requirements Signup and view all the answers

What is the recommended frequency for reviewing a customer's ability to pay after being granted a credit limit?

Every year Signup and view all the answers

What is the consequence of not informing the shipping department about customers on credit hold?

Shipments to customers who are not paying on time, resulting in increased AR investment Signup and view all the answers

What is the role of the collections staff in managing AR?

To contact customers to resolve issues and ensure payment Signup and view all the answers

What is the consequence of not having an effective return authorization program?

Customers will return products without authorization Signup and view all the answers

What happens when a company's sales growth increases?

The company's investment in AR increases in proportion to sales growth Signup and view all the answers

What is the result of not being able to send error-free invoices to customers?

Customers will refuse to pay invoices until errors are corrected Signup and view all the answers

Study Notes

Working Capital Evaluation

A common issue for senior-level managers is to see a profit on the income statement but still face a cash shortage, often due to increased working capital requirements.

Components of Working Capital

There are three components of working capital: accounts receivable, inventory, and accounts payable.
Accounts receivable and inventory represent a net usage of cash, while accounts payable is a source of cash.

Accounts Receivable (AR) Issues

Credit granting problems: poor credit evaluation can lead to customers taking advantage of the company, resulting in increased AR investment.
Credit review problems: failure to regularly review customers' credit limits can lead to increased AR investment.
Credit hold problems: shipping to customers with poor credit ratings can increase AR investment.
Collection problems: ineffective collections can increase AR investment.
Billing problems: sending error-filled invoices can lead to delayed payments and increased AR investment.
Product return problems: inadequate return authorization programs can increase AR investment.
Sales growth: increased sales can lead to increased AR investment.

Inventory Issues

Production obsolescence problems: inventory that is no longer needed or used can increase working capital requirements.

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Description

Understand the reasons behind a cash outflow despite a profitable income statement. Learn how to identify and manage working capital effectively to ensure sufficient cash on hand to meet current requirements.