PK14 - CHAPTER 14 Working Capital Management Learning...

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CHAPTER 14 Working Capital Management Learning Objectives 1. Define net working capital, discuss the importance of working capital management, and be able to compute a firm’s net working capital. 2. Define the operating and cash cycles, explain how they are used, and be able to compute their values for a firm. 3. Discuss the relative advantages and disadvantages of pursuing (1) flexible and (2) restrictive current asset investment strategies. 4. Explain how accounts receivable are created and managed, and be able to compute the cost of trade credit. 5. Explain the trade-off between carrying costs and reorder costs, and be able to compute the economic order quantity for a firm’s inventory orders. 6. Define cash collection time, discuss how a firm can minimize this time, and be able to compute the cash collection costs and benefits of a lockbox. 7. Identify three current asset financing strategies and discuss the main sources of short-term financing. I. Chapter Outline 14.1 Working Capital Basics Working capital management involves two key issues. 1
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What is the appropriate amount and mix of current assets for the firm to hold? How should these current assets be financed? Let us review some basic definitions related to working capital. Current assets are cash and other assets that the firm expects to convert into cash in a year or less. Current liabilities (or short-term liabilities) are obligations that the firm expects to pay off in a year or less. Working capital , also called gross working capital, is the funds invested in a company’s cash account, account receivables, inventory, and other current assets. Net working capital (NWC) refers to the difference between current assets and current liabilities. o NWC is important because it is a measure of liquidity and represents the net short-term investment the firm keeps in the business. Working capital management involves making decisions regarding the use and sources of current assets . Working capital efficiency refers to the length of time between when a working capital asset is acquired and when it is converted into cash. Liquidity is the ability of a company to convert assets—real or financial —into cash quickly without suffering a financial loss. 2
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A. Working Capital Accounts and Trade-Offs The various working capital accounts are: Cash: This account includes cash and marketable securities like Treasury securities. o The higher the cash balance, the better the ability of the firm to meet its short-term financial obligations. Receivables : These represent the amount owed by customers who have taken advantage of the firm’s trade credit policy. Inventory
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PK14 - CHAPTER 14 Working Capital Management Learning...

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