ch14 - 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 compute a firm’s net working capital. Net working capital is the difference between current assets and current liabilities. Working capital management refers to the decisions made regarding the use of current assets and how they are financed. The goal of working capital management is to ensure that the firm can continue its day-to-day operations and pay its short-term debt obligations. The computation of net working capital for Dell Computer is illustrated in Section 14.1 2. Discuss the operating and cash cycles, explain how are they used, and be able to compute their values for a firm The operating cycle can be defined as the period starting with the receipt of raw materials and ending with the receipt of cash for finished goods made from those raw materials. It can be broken into two components: (1) days’ sales in inventory, which shows how long a firm keeps its inventory before selling it, and (2) days’ sales outstanding, which indicates how long it takes on average for the firm to collect its outstanding accounts receivable. Related to the operating cycle is the cash conversion cycle, which is the length of time between the cash outflow for materials and the cash inflow from sales. An additional measure, of days’ payables outstanding, is required to calculate the cash conversion cycle. Both cycles are
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simple tools to help the financial manager measure working capital efficiency and control liquidity. The computations are illustrated in Section 14.2. 3. Discuss the relative advantages and disadvantages of pursuing (1) flexible and (2) restrictive current asset investment strategies. A flexible strategy involves maintaining relatively high levels of cash, marketable securities, and inventory, while a restrictive strategy keeps the levels of current assets relatively low. In general, a flexible strategy is thought to be low risk and low return; its downsides include low returns on current assets, potentially high inventory carrying costs, and the cost of the money necessary to provide liberal credit terms. The restrictive strategy involves higher risk and return, with higher potential financial and operating shortage costs as its major drawbacks. 4. Explain how accounts receivable are created and managed, and be able to compute the cost of trade credit. Accounts receivable are promises of future payment from customers that buy goods or services on credit. The details are defined in the terms of sale, which include the due date, the interest rate charge, and any discounts for early payment. The terms of sale are affected by the practice in the industry and the creditworthiness of the customer. To manage accounts receivable, the financial manager should keep close track of both days’ sales outstanding and the aging schedule.
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5. Explain the trade-off between carry costs and reorder costs, and be able to compute the
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