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Questions and Answers
What is the primary function of working capital in an organization?
What is the primary function of working capital in an organization?
What are the two views of working capital?
What are the two views of working capital?
What is the primary focus of Working Capital Management (WCM)?
What is the primary focus of Working Capital Management (WCM)?
What is included in current assets?
What is included in current assets?
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What are temporary current assets?
What are temporary current assets?
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Why is working capital considered the 'lifeblood' of a business?
Why is working capital considered the 'lifeblood' of a business?
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What is the goal of Working Capital Management (WCM) in terms of profitability?
What is the goal of Working Capital Management (WCM) in terms of profitability?
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What is the timeframe for current assets to be converted to cash?
What is the timeframe for current assets to be converted to cash?
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What is included in current liabilities?
What is included in current liabilities?
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What is the significance of working capital in business operations?
What is the significance of working capital in business operations?
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Study Notes
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
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Refers to the basic decisions regarding target levels for each category of current assets and how current assets will be financed.
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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.
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Description
Test your knowledge of Working Capital Management, including managing liquidity, current assets, and liabilities. Understand the risk-return tradeoff and setting working capital policy.
