Question

In: Finance

First Paragraph - What is working capital? List one objective of working capital management. Second Paragraph...

First Paragraph - What is working capital? List one objective of working capital management.

Second Paragraph - Explain how rapidly expanding sales can drain the cash resources of a company.

Third Paragraph - What are the sources of short-term asset management / financing strategies?

Solutions

Expert Solution

Working Capital = Current Assets - Current Liabilities. Current Assets include assets which during the course of business has the potential to be converted into cash in less than a year without reduction in value and without causing any disturbance in the operations of the firm. Examples include cash, accounts receivable, marketable securities, inventories. Current Liabilities are the liabilities which are expected to be paid in less than a year during the course of business. Examples include accounts payable, bank overdrafts and current portion of long term liabilities and other outstanding expenses. The primary objective of working capital management is to maintain an optimal level of working capital for smooth operations of the firm. This means that the company must always maintain sufficient amount of cash flow to meet the short-term operating costs and short-term debt obligations..i.e, the operating cycle ( cycle starting from the buying raw material to its conversion to final cash should be without disruptions)

A rapidly expanding sales requires a piling up of the assets (specially current assets) so as to build up the inventories (both Work in Progress and finished goods) and increasing sales at a credit and increasing the credit period for the sales. .i.e more build up of accounts receivable. Thus, cash will be tied up in inventories, Accounts receivable which will have a drag on the cash resources of the company.

Sources of short term asset management -

One can have a revolving credit facility so as to finance any shortfall in cash requirements during the ordinary course of business.This is similar to the overdraft facility with a bank.

One can also have an arrangement to borrow a % of accounts receivables from a bank. This can be with recourse or without recourse. This concept is called factoring by which the company can finance a certain portion of the shortfall in cash by submitting the accounts receivables as a collateral or permananently selling the Accounts Receivable at a discount.

Another possible short term financing strategies is to take customer advances on future large orders so that the customer can have enough cash to fulfill those orders in time and without disruptions.


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