003-WCManagement.docx - In Class Worksheet#3 Working...

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In Class Worksheet #3 Working Capital and Supply Chain Management Week #3 What are the basic definitions? 1. Working capital is a firm’s investment in short-term assets—cash, marketable securities, inventory, and accounts receivable. Net working capital is current assets minus current liabilities. Net operating working capital is operating current assets minus operating current liabilities. a. A relaxed WC policy refers to a policy under which relatively large amounts of cash, marketable securities, and inventories are carried and under which sales are stimulated by a liberal credit policy, resulting in a high level of receivables. b. A restricted policy refers to a policy under which holdings of cash, securities, inventories, and receivables are minimized; while a moderate current asset investment policy lies between the relaxed and restricted policies. 2. Permanent current operating assets are the current operating assets needed even at the low point of the business cycle. For a growing firm in a growing economy, permanent current assets tend to increase over time. Temporary current operating assets are the current operating assets required above the permanent level when the economy is strong and/or seasonal sales are high. 3. A moderate short-term financing policy matches asset and liability maturities. It is also referred to as the maturity matching, or "self-liquidating" approach. When a firm finances all of its fixed assets with long- term capital but part of its permanent current assets with short-term, nonspontaneous credit this is referred to as an aggressive short-term financing policy. With a conservative short-term financing policy permanent capital is used to finance all permanent asset requirements, as well as to meet some or all of the seasonal demands. 4. The cash conversion cycle is the length of time between the firm's actual cash expenditures on productive resources (materials and labor) and its own cash receipts from the sale of products (that is, the length of time between paying for labor and materials and collecting on receivables.) Thus, the cash conversion cycle equals the length of time the firm has funds tied up in current assets. a. The inventory conversion period is the average length of time it takes to convert materials into finished goods and then to sell them. It is calculated by dividing total inventory by daily cost of goods sold. b. The average collection period is the average length of time required to convert a firm’s receivables into cash. It is calculated by dividing accounts receivable by sales per day. c. The payables deferral period is the average length of time between a firm’s purchase of materials and labor and the payment of cash for them. It is calculated by dividing accounts payable by credit purchases per day (COGS/365).
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