Working Capital Management

Financing Working Capital

Working Capital

• Total investment in current assets

• Current assets are

– Cash

– Accounts Receivable

– Inventory

• Net working capital is current assets minus current liabilities.

Working Capital Decisions

• The level of investment in current assets

– How much to hold

• The method of financing current assets

– Long or short term financing of current assets.

Working Capital Issues level of working capital

• Increasing production leads naturally to increased levels of current assets.

• A risky approach is to keep current assets at only the min level required to meet the new production.

– More chance for profit.

– But risky as less liquidity.

Level of working capital continued.

• A less risky approach is to keep a larger level of current assets for the production level

– More liquid less risk

• Cash will be there to pay bills

– Less chance of profit

• Profit likely to be less.

Nature of current assets

• Fluctuate

– More during months of greater sales and production

• Permanent current assets are required to meet a firm’s long term minimum needs.

• Temporary current assets fluctuate on a seasonal or cyclical basis.

Financing of Current Assets.

• Short time, self liquidating assets.

• Cycling

– Accounts Payable

• Buy the stock

– Merchandise inventory

• Hold the stock

– Accounts receivable

• Sell the stock

– Cash

• Collect the cash.

Financing the current Assets

• Arrange finance to pay the supplier.

• This allows for a higher level of current assets to keep this level high until collection is made.

Short term loans self liquidating

• Seasonal inventory purchases above current levels

Financing needs

• Fixed assets and non-seasonal current assets are financed with long-term debt and equity.

• Season needs are financed with short term loans.

Lower risk

• Finance more of those current assets with long term loans

• Risk vs. Return trade-off

• Paying more for the loan but have cushion of cash

Higher risk higher return

• Finance less of current assets with long term financing.

• Lower interest rates

• Borrow less

• Take a risk on future rates

• Accept greater profit and greater risk.

Homework execises

• Discussion Questions 6,7

• Problems 3,4,5,6,8