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module_6_-_working_capital_management

module_6_-_working_capital_management - FIN 220 MODULE 6...

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6-1 FIN 220 MODULE 6 WORKING CAPITAL MANAGEMENT
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6-2 Learning Objectives 1. Define working capital. 2. Describe how firms manage their working capital. 3. Describe the risk-return tradeoff involved in managing working capital. 4. Describe the determinants of net working capital. 5. Describe the hedging principle.
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6-3 MANAGING CURRENT ASSETS AND LIABILITIES ( Managing Liquidity )
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6-4 Working Capital Working capital - The firm’s total investment in current assets. Net working capital - The difference between the firm’s current assets (CA) and its current liabilities (CL). WC = CA - CL Finance refers to working capital as net working capital.
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6-5 Managing Net Working Capital 1. Investment in current assets 2. Use of short-term or current liabilities Managing net working capital is concerned with managing the firm’s liquidity. This requires managing two related aspects of the firm’s operations:
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6-6 Managing Net Working Capital : Explanation The firm’s investment in current assets (such as fixed assets) is determined by the marginal benefits derived from investing in them compared with their acquisition cost. The current versus fixed-asset mix of the firm’s investment in assets is an important determinant of the firm’s liquidity. That is, the greater the firm’s investment in current assets, other things remaining the same, the greater the firm’s liquidity. This is generally true, since current assets are usually more easily converted into cash. The firm can invest in marketable securities to increase its liquidity. However, such a policy involves committing the firm’s funds to a relatively low-yielding (in comparison to fixed assets) investment. The greater the firm’s use of current liabilities, other things being the same, the less will be the firm’s liquidity.
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6-7 Short-Term Sources of Financing Include current liabilities , i.e., all forms of financing that have maturities of 1 year or less . Two issues to consider when analyzing a firm’s use of short-term financing: How much short-term financing should the firm use?
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