Questions and Answers
What is a common reason why a company may have a cash outflow despite showing a profit on the income statement?
Increases in working capital requirements
What is the primary role of a controller in evaluating working capital?
To review and explain increases in working capital requirements
What is the result of a poor credit granting process to new customers?
An increase in company investment in accounts receivable
Which component of working capital represents a source of cash?
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What are the three components of working capital?
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Why may a company experience a cash outflow despite showing a profit on the income statement?
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What is the recommended frequency for reviewing a customer's ability to pay after being granted a credit limit?
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What is the consequence of not informing the shipping department about customers on credit hold?
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What is the role of the collections staff in managing AR?
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What is the consequence of not having an effective return authorization program?
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What happens when a company's sales growth increases?
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What is the result of not being able to send error-free invoices to customers?
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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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