Question

Rate the three most important concepts of Working Capital, Financial budgeting, and The Cash Budget in order of importance (one being the most important; three, the least). Provide a rationale for your ratings.

Answer 1

1. Working Capital:

Working capital, also known as net working capital (NWC), is the difference between a company’s current assets, such as cash, accounts receivable (customers’ unpaid bills) and inventories of raw materials and finished goods, and its current liabilities, such as accounts payable. Net operating working capital is a measure of a company's liquidity and refers to the difference between operating current assets and operating current liabilities. In many cases these calculations are the same and are derived from company cash plus accounts receivable plus inventories, less accounts payable and less accrued expenses.

Three important concepts of working capital are:

• A company has negative working capital If the ratio of current assets to liabilities is less than one.
• Positive working capital indicates that a company can fund its current operations and invest in future activities and growth.
• High working capital isn't always a good thing. It might indicate that the business has too much inventory or is not investing its excess cash.

2. Financial Budgeting:

A financial budget in budgeting means predicting the income and expenses of the business on a long-term and short-term basis. Accurate projections of cash flow help the business achieve its targets in the right way.

Financial budget preparation includes a detailed budget balance sheet, cash flow budget, the sources of incomes and expenses of the business, etc. The evaluation of incomes and expenses is done on a monthly, quarterly, half-yearly or annual basis, depending on the suitability of the organization. A financial budget is a very powerful tool to achieve the long-term goals of any business. Importantly, it also keeps the shareholders and other members of the organization updated about the functioning of the business.

Three important concept of financial budgeting are:

• The financial budget provides a blueprint for the business to move forward. It addresses not only the financial aspects of the business, but also checks the operational efficiency.
• The extra expenses are cut by emphasizing cost reduction and improving the market share. In terms of financial budgets, the organization is well prepared to meet the long-term and short-term expenses.
• A good financial budget helps in achieving the goals and objectives of the business in the shortest possible span of time.

Cash Budget:

A cash budget is an estimation of the cash flows for a business over a specific period of time. This budget is used to assess whether the entity has sufficient cash to operate.

Three important concept of cash budget are:

• Companies use sales and production forecasts to create a cash budget, along with assumptions about necessary spending and accounts receivable collections.
• A cash budget is necessary to assess whether a company will have enough cash to continue operations. If a company does not have enough liquidity to operate, it must raise more capital by issuing stock or taking on more debt.
• A cash roll forward computes the cash inflows and outflows for a month, and it uses the ending balance as the beginning balance for the following month. This process allows the company to forecast cash needs throughout the year, and changes to the roll forward adjust the cash balances for all future months.