Working capital

9 Key excerpts on "Working capital"

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  eBook - PDF

  Financial Accounting Theory and Analysis

  Text and Cases

  • Richard G. Schroeder, Myrtle W. Clark, Jack M. Cathey(Authors)
  • 2019(Publication Date)
  • Wiley

    (Publisher)

  279 8 Working capital A company’s Working capital is the net short-term investment needed to carry on day-to-day activities. The measurement and disclosure of Working capital on financial statements have been considered an appropriate accounting function for decades, and so the usefulness of this concept for financial analysis is accepted almost without question. This is not to say that the concept does not present some serious problems, namely (1) inconsistencies in the measurements of the var- ious components of Working capital, (2) differences of opinion over what should be included as the elements of Working capital, and (3) a lack of precision in the meaning of certain key terms involved in defining the elements of Working capital, such as liquidity and current. This chapter examines the foundation of the Working capital concept, reviews the concept and its components as currently understood, illustrates how the adequacy of a company’s Working capital position can be evaluated, and discusses how the concept might be modified to add to its usefulness. Development of the Working capital Concept The concept of Working capital originated with the distinction between fixed and circulating capital at the beginning of the twentieth century. As noted in Chapter 1, at that time accounting was in its adolescent stage and such concepts as asset, liability, income, and expense were not clearly under- stood. 1 The impetus for the definitions of fixed and circulating capital came from court decisions on the legality of dividends in Great Britain. As first defined, fixed capital was money expended that was sunk once and for all, and circulating capital was defined as items of stock in trade, which are parted with and replaced by similar items in the ordinary course of business. These definitions were not readily accepted by members of the accounting profession, some of whom feared that the general public would misinterpret the distinction.

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  Contemporary Financial Management

  • R. Charles Moyer, James McGuigan, Ramesh Rao, , R. Charles Moyer, James McGuigan, Ramesh Rao(Authors)
  • 2017(Publication Date)
  • Cengage Learning EMEA

    (Publisher)

  Working capital is used by firms to maintain liquidity, that is, the ability to meet their cash obligations as they come due. Otherwise, it may incur the costs associated with a deteriorating credit rating, a potential forced liquidation of assets, and possible bankruptcy. Working capital management is a continuing process that involves a number of day- to-day operations and decisions that determine the following: The firm’s level of current assets The proportions of short-term and long-term debt the firm will use to finance its assets The level of investment in each type of current asset The specific sources and mix of short-term credit (current liabilities) the firm should employ Working capital differs from fixed capital in terms of the time required to recover the investment in a given asset. In the case of fixed capital or long-term assets (such as land, buildings, and equipment), a company usually needs several years or more to recover the initial investment. In contrast, Working capital is turned over, or circulated, at a relatively rapid rate. Investments in inventories and accounts receivable are usually recovered dur- ing a firm’s normal operating cycle, when inventories are sold and receivables are collected. 16-2a Importance of Working capital It has already been noted that a firm must have Working capital to operate and survive. In many industries, Working capital (current assets) constitutes a relatively large percentage of total assets. In the manufacturing sector, for example, current assets comprise about 40 percent of the total assets of all U.S. manufacturing corporations. Table 16.1 shows the distribution of aggregate assets for several large companies. For the five companies shown, current assets as a percentage of total assets range from about 15 percent to over 42 percent. ExxonMobil, with its relatively high percentage of fixed assets, has a relatively low percentage of current assets.

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  eBook - PDF

  Financial Accounting Theory and Analysis

  Text and Cases

  • Richard G. Schroeder, Myrtle W. Clark, Jack M. Cathey(Authors)
  • 2020(Publication Date)
  • Wiley

    (Publisher)

  248 CHAPTER 8 A company’s Working capital is the net short‐term investment needed to carry on day‐to‐day activities. The measurement and disclosure of Working capital on financial statements has been considered an appropriate accounting function for decades, and so the usefulness of this con- cept for financial analysis is accepted almost without question. This is not to say that the concept does not present some serious problems, namely (1) inconsistencies in the measurements of the various components of Working capital, (2) differences of opinion over what should be included as the elements of Working capital, and (3) a lack of precision in the meaning of certain key terms involved in defining the elements of Working capital, such as liquidity and current. This chapter examines the foundation of the Working capital concept, reviews the concept and its components as currently understood, illustrates how the adequacy of a company’s Working capital position can be evaluated, and discusses how the concept might be modified to add to its usefulness. The concept of Working capital originated with the distinction between fixed and circulating capital at the beginning of the twentieth century. As noted in Chapter 1, at that time accounting was in its adolescent stage and such concepts as asset, liability, income, and expense were not clearly understood. 1 The impetus for the definitions of fixed and circulating capital came from court decisions on the legality of dividends in Great Britain. As first defined, fixed capital was money expended that was sunk once and for all, and circulating capital was defined as items of stock in trade, which are parted with and replaced by similar items in the ordinary course of business. These definitions were not readily accepted by members of the accounting profession, some of whom feared that the general public would misinterpret the distinction.

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  eBook - PDF

  Financial Accounting Theory and Analysis

  Text and Cases

  • Richard G. Schroeder, Myrtle W. Clark, Jack M. Cathey(Authors)
  • 2022(Publication Date)
  • Wiley

    (Publisher)

  293 8 A company’s Working capital is the net short-term investment needed to carry on day-to-day activities. The measurement and disclosure of Working capital on financial statements have been considered an appropriate accounting function for decades, and so the usefulness of this concept for financial analysis is accepted almost without question. This is not to say that the concept does not present some serious problems, namely (1) inconsistencies in the measurements of the var- ious components of Working capital, (2) differences of opinion over what should be included as the elements of Working capital, and (3) a lack of precision in the meaning of certain key terms involved in defining the elements of Working capital, such as liquidity and current. This chapter examines the foundation of the Working capital concept, reviews the concept and its components as currently understood, illustrates how the adequacy of a company’s Working capital position can be evaluated, and discusses how the concept might be modified to add to its usefulness. Development of the Working capital Concept The concept of Working capital originated with the distinction between fixed and circulating capital at the beginning of the twentieth century. As noted in Chapter 1, at that time accounting was in its adolescent stage and such concepts as asset, liability, income, and expense were not clearly understood. 1 The impetus for the definitions of fixed and circulating capital came from court decisions on the legality of dividends in Great Britain. As first defined, fixed capital was money expended that was sunk once and for all, and circulating capital was defined as items of stock in trade, which are parted with and replaced by similar items in the ordinary course of business. These definitions were not readily accepted by members of the accounting profession, some of whom feared that the general public would misinterpret the distinction.

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  Strategic Managerial Accounting

  Hospitality, Tourism & Events Applications

  • Tracy Jones, Helen Atkinson, Angela Lorenz, Peter Harris(Authors)
  • 2012(Publication Date)
  • Goodfellow Publishers

    (Publisher)

  12 Working capital Management 12.1 Introduction and objectives Capital is a scarce resource in any business and enormous attention is given to ensuring the right sources of finance are found and properly utilised with respect to the long-term non-current asset requirements of an organisation. However any business will require capital for short-term needs as well as long-term and this is known as Working capital. After studying this chapter you should be able to: „ Understand the importance of Working capital to the business „ Evaluate the different Working capital policies that can be adopted by a firm „ Understand what the key components of Working capital are „ Consider the Working capital requirements of a firm with respect to inventory, accounts receivable, cash and accounts payable „ Establish sound policies for the efficient management and control of the key component elements. 12.2 Understanding Working capital In the short term a business needs to ensure that it can pay its expenditure from its income, to generate income it must sell its products or services to custom-ers. In doing this the business will often buy inventory – goods to sell on as a retailer, or raw materials with which to make a finished product such as a meal in a restaurant. The inventory then has to be sold to a customer (at a profit) and when the customer pays, cash flows back in to the business (Figure 12.1). The organisation must ensure it has enough capital invested to ensure that it can buy the required inventory and still pay bills while it waits for the inventory to be sold and the customers to pay. This in essence is the Working capital requirement of the business. 194 Strategic Managerial Accounting Cash from customers Buy inventory Produce products/services Sell products/ services Customers owe money Figure 12.1: The trade cycle The Working capital of a business can be easily measured by looking at its statement of financial position.

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  Corporate Finance

  Economic Foundations and Financial Modeling

  • Michelle R. Clayman, Martin S. Fridson, George H. Troughton, Michelle R. Clayman, Martin S. Fridson, George H. Troughton(Authors)
  • 2022(Publication Date)
  • Wiley

    (Publisher)

  CHAPTER 3 Working capital & LIQUIDITY LEARNING OUTCOMES The candidate should be able to: • compare methods to finance Working capital • explain expected relations between Working capital, liquidity, and short-term funding needs (NEW) • describe sources of primary and secondary liquidity and factors affecting a company’s liquidity position • compare a company’s liquidity position with that of peers • evaluate short-term funding choices available to a company 1. INTRODUCTION Working capital (also called net Working capital) is defined simply as current assets minus current liabilities or (Net) Working capital ¼ Current assets – Current liabilities and includes both operating assets and liabilities, such as accounts receivable, accounts payable, and inventory, as well as financial assets and liabilities, such as short-term investments and short-term debt. Working capital management is the management of a firm’s short-term assets and liabilities and an important aspect of a firm’s operations. The goal of Working capital management is to ensure the company has adequate, ready access to funds necessary for day-to-day operations, while avoiding excess reserves that can be a costly drag on the business’ profitability and returns. Having excess levels of Working capital can have a harmful effect on shareholder returns. At the same time, insufficient levels of Working capital can harm a company if it cannot meet its short-term obligations, leading to product shortages, sales slowdowns, and, in the extreme, bankruptcy. An analyst should carefully evaluate the Working capital position of the firm to make an informed decision about the firm’s ability to meet its short-term needs as it works to implement its long-term plans. To assess whether a firm is operating at an optimal level of Working capital, financed at the lowest possible cost, an analyst should begin by asking two fundamental questions: 81

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  eBook - PDF

  HRM in Agri-Business

  • Thumar, V M(Authors)
  • 2018(Publication Date)
  • Daya Publishing House

    (Publisher)

  Unit 8: Working capital Management in Agri-business 8.1 Introduction Working capital is significant in financial management due to the fact that it plays an important role in keeping the wheels of a agri-business enterprise running. It may be regarded as lifeblood of a agri-business. It is concerned with short term financial decisions. Its effective provision can do much to ensure the success of a agri-business, while its inefficient management can lead not only to loss of profits but also to the ultimate downfall of promising concept. A study of Working capital is of major importance to internal and external analysis because of its close relationship with day-to-day operations of a agri-business. Working capital management includes management of various components of current assets as well as current liabilities. A firm invests a part of its permanent capital in fixed assets and keeps a part of it for Working capital i.e. for meeting the day to day requirements. The requirements of Working capital varies from firm to firm depending upon the nature of agri-business, production policy, market conditions, seasonality of operations, conditions of supply etc. Working capital management if carried out effectively, efficiently and consistently will assure the health of an organization. 8.2 Meaning and Definition In accounting, W. C. is the difference between the inflow and outflow of funds. It is the net cash inflow. This ebook is exclusively for this university only. Cannot be resold/distributed. W.C. is defined as the excess of current assets over its current liabilities and provision. Current assets are those assets which will be converted into cash with the current account period or within the next year as a result of the ordinary operations of the agri-business.

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  Corporate Finance

  Theory and Practice in Emerging Economies

  • Sunil Mahajan(Author)
  • 2020(Publication Date)
  • Cambridge University Press

    (Publisher)

  The company needed to ensure that its efforts to achieve higher sales were not stymied by inventory constraints and that its Working capital was supportive of its aggressive sales strategy. The company had to ensure that there was no let-up in production and that the stocks of the finished products were available to support sales and customer service. Like other aspects of financial policy, Working capital policy must be in consonance with the business strategy of a company. Different business environments and strategies demand different CHAPTER 12 284 | Corporate Finance Working capital support. It is important to understand the business strategy of the firm and how Working capital dovetails in and plays a part in the success of the strategy. Working capital management is a key determinant of a company’s performance. While profit and loss account receives maximum attention in judging how well a company is performing, balance sheet analysis is equally critical. The value of a company is derived from its free cash flows, and changes in the Working capital constitute a critical element of the free cash flows. Working capital management is a day-to-day activity, and finance managers spend considerable time and effort in managing it. Companies usually have more control over their Working capital than over longer-term aspects. A company invests in long-term and short-term assets to run its business. Long-term assets include buildings, plant and machinery, technology, patents, brands and other intangibles and involve cash flows that occur over many years. Short-term assets comprise investments in inventory, debtors (accounts receivables) and creditors (accounts payable). Usually in finance, the distinction between the long-term and the short-term period is taken as one year. Accounts receivables, payables and the inventory cycle generally last for less than one year and are, therefore, considered to be short-term investments.

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  Fundamentals of Corporate Finance

  • Robert Parrino, David S. Kidwell, Thomas Bates(Authors)
  • 2016(Publication Date)
  • Wiley

    (Publisher)

  When they finance seasonal Working capital requirements for inventories and receivables, most financial managers also prefer to match maturities of assets and liabilities by financing these investments with short-term debt. As a firm’s sales rise and fall seasonally, a financial manager can expand or contract Working capital by borrowing short-term when more assets are needed and, as cash becomes available, using it to pay off the short-term obligations as they mature. Permanent Working capital Many financial managers prefer to fund permanent Working capital with long-term funds, as shown in Figure A in Exhibit 14.7. They prefer to do this in order to limit the risks associated with a short-term financing strategy. To the extent that permanent Working capital is financed with long-term funds, the ability of the firm to finance this minimum level of Working capital is not subject to short-term credit market conditions. As illustrated in Figure C of Exhibit 14.7, other managers use short-term debt to finance at least some permanent Working capital requirements. These managers subject their firms to more risk in the hope that they will realise higher returns. Sources of Short-Term Financing Now that we have discussed Working capital financing strategies, we will turn our attention to the most important types of short-term financing instruments used in practice: accounts payable, bank loans and commercial paper. Accounts Payable (Trade Credit) Accounts payable (trade credit) deserves special attention because it comprises a large portion of the current liabilities of many businesses. For example, accounts payable constitute about 35 per cent of total current liabilities at publicly traded manufacturing firms. Accounts payable arise, of course, when managers do not pay for purchases with cash on delivery but instead carry the amount owed as an account payable.

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