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Unformatted text preview: Chapter 22 Working Capital Management 22-1 a. Working capital is a firms 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. b. 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 sales per day. The receivables collection period is the average length of time required to convert a firms receivables into cash. It is calculated by dividing accounts receivable by sales per day. 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. The payables deferral period is the average length of time between a firms 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). c. A relaxed NOWC 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. A restricted NOWC 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. A moderate NOWC policy matches asset and liability maturities. It is also referred to as the maturity matching, or self-liquidating approach. d. Transactions balance is the cash balance associated with payments and collections; the balance necessary for day-to-day operations. A compensating balance is a checking account balance that a firm must maintain with a bank to compensate the bank for services rendered or for granting a loan. A precautionary balance is a cash balance held in reserve for random, unforeseen fluctuations in cash inflows and outflows. Answers and Solutions: 22 - 1 ANSWERS TO END-OF-CHAPTER QUESTIONS e. A cash budget is a schedule showing cash flows (receipts, disbursements, and cash balances) for a firm over a specified period. The net cash gain or loss for the period is calculated as total collections for the period less total payments for the same period of time....
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This note was uploaded on 11/17/2010 for the course FI 515 FI 515 taught by Professor Senn during the Spring '10 term at Keller Graduate School of Management.
- Spring '10