Working Capital Management (WCM) Quiz

Working Capital Management (WCM)

• WCM involves managing a company's liquidity by managing current assets and liabilities.
• It covers both setting the working capital policy and carrying it out in daily operations.

Working Capital Policy

• Refers to the basic decisions regarding target levels for each category of current assets and how current assets will be financed.

• There are two kinds of working capital policies:

  Relaxed Current Investment Policy

  • Carries a relatively large amount of current assets.
  • Stimulates sales by liberated credit policy, resulting in a high level of receivables.
  • The firm carries a large amount of inventory.

  Restricted Current Investment Policy

  • Minimizes current assets.
  • Implements tight credit policy, which may result in losing sales.
  • Holds minimal safety stock of cash and inventory, and works out the highest current asset turnover.

Deciding the Appropriate Working Capital Policy

• Primary consideration is the trade-off between risk (liquidity) and return (profitability) associated with:
  • Asset mix decision (current and non-current assets)
  • Financing mix decision (short-term and long-term debts to finance current assets)

Minimizing Working Capital Requirements

• Efficiency in cash, receivable, and raw materials management.
• Reduction of time lag between completion and shipment of finished goods.
• Obtaining favourable credit terms from suppliers.

Management of Current Assets

• Cash management involves maintaining cash and marketable securities (MS) investment levels.
• Main objective: attain the optimum cash balance that balances liquidity and profitability.

Reasons for Holding Cash

• Transactional motive: to facilitate normal transactions of the business.
• Contractual motive: to meet bank (creditor) requirements contained in a financing agreement.

Working Capital

• Amount of current assets (financial management view) or current assets net of current liabilities (accounting view) used to finance the firm's short-term operations.
• Includes cash, marketable securities, receivables, inventories, and prepayments.
• Temporary current assets support fluctuations of the firm's level of activity.
• Permanent current assets maintain normal operations.
• Current liabilities: obligations to be paid within 1 year, through current assets or incurrence of another liability.