working capital management

Examples of working capital management in the following topics:

• Decision Criteria

  • The main considerations of working capital management decisions are (1) cash flow/ liquidity and (2) profitability/return on capital.
  • Working capital management decisions are, therefore, not made on the same basis as long-term decisions, and working capital management applies different criteria in decision making: the main considerations are (1) cash flow/liquidity and (2) profitability/ return on capital (of which cash flow is generally the most important).
  • Firm value is enhanced when, and if, the return on capital, which results from working-capital management, exceeds the cost of capital, which results from capital investment decisions as above.
  • Another factor affecting working capital management is credit policy of the firm.
  • Cash conversion cycle is a main criteria for working capital management.

• Short-Term Approach

  • Decisions relating to working capital are usually short-term, since it is the difference between current assets and current liabilities.
  • Working capital is the amount of capital that is readily available to an organization.
  • As a result, the decisions relating to working capital are almost always current, i.e., short term, decisions.
  • In other words, working capital management differs from capital investment decisions - specifically in terms of discounting and profitability.
  • Working capital management applies different criteria in decision making.

• Identifying Varying Conditions

  • Management uses policies and techniques for the management of working capital such as cash, inventory, debtors and short term financing.
  • Decisions relating to working capital and short-term financing are referred to as working capital management.
  • The goal of working capital management is to ensure that the firm is able to continue its operations and that it has sufficient cash flow to satisfy both maturing short-term debt and upcoming operational expenses.
  • Management will use a combination of policies and techniques for the management of working capital.
  • Identify the four main areas of variability of working capital management

• Evaluating Interest Rates

  • Management of working capital requires evaluating factors affecting cash flows -- including the evaluation of appropriate interest rates.
  • The management of working capital takes place in the realm of short-term decision-making.
  • Many criteria go into the management of cash flows and subsequently the management of working capital -- including the evaluation of appropriate interest rates.
  • The interest rate most commonly used in working capital management is the cost of capital.
  • Firm value is enhanced when, and if, the return on capital, which results from working-capital management, exceeds the cost of capital, which results from capital investment decisions.

• Working Capital

  • Along with fixed assets, such as plant and equipment, working capital is considered a part of operating capital.
  • If current assets are less than current liabilities, an entity has a working capital deficiency, also called a working capital deficit.
  • Decisions relating to working capital and short-term financing are referred to as working capital management.
  • The management of working capital involves managing inventories, accounts receivable and payable, and cash.
  • The management of working capital involves managing inventories, accounts receivable and payable, and cash.

• Choosing a Policy

  • A firm will use a combination of policies for managing working capital, focusing on cash flow, liquidity, profitability, and capital return.
  • Guided by criteria measuring cash flow, liquidity, profitability, and return on capital, the management of a firm will use a combination of policies and techniques for the management of working capital.
  • A final area management should be concerned with when deciding on a working capital policy is short-term financing.
  • One of the objectives within working capital management and general financing decisions is to match the maturity of liabilities with the life expectancy of assets.
  • This chart lays out sample working capital issues and some possible solutions.

• Understanding the Needs of the Business

  • Working capital is considered a part of operating capital along with fixed assets, such as plant and equipment.
  • However, too much working capital can carry with it a higher cost of capital.
  • The management of working capital involves managing inventories, accounts receivable and payable, and cash.
  • When calculating working capital, we think in terms of net working capital, which is calculated as current assets minus current liabilities.
  • If current assets are less than current liabilities, an entity has a working capital deficiency, also called a working capital deficit.

• Calculating Expected Value

  • Along with fixed assets such as plant and equipment, working capital is considered a part of operating capital.
  • If current assets are less than current liabilities, an entity has a working capital deficiency, also called a "working capital deficit. "
  • The management of working capital involves managing inventories, accounts receivable and payable, and cash.
  • We can find working capital by:
  • The common commercial definition of working capital for the purpose of a working capital adjustment in a mergers and acquisitions transaction (i.e., for a working capital adjustment mechanism in a sale and purchase agreement) is equal to:

• Constraint on Managers

  • Managers will have their actions influenced by their firm's capital structure and the resources that it allows them to use.
  • Managers who make decisions about the firm's corporate behavior will have their actions influenced by capital structure and the resources that it allows them to use.
  • When the capital structure draws heavily on debt, then this leaves less money to be distributed to managers in the form of compensation, as well as free cash to be used on behalf of the business.
  • When managers work with equity heave capital structure they have a little more leeway, and while shareholders may be upset or suffer because of fluctuations in the value of the firm, managers may find ways to make sure their compensation can have some immunity from the market value of the firm.
  • Therefore, firms that have debt-heavy capital structures have managers with goals that tend to be more aligned with those of the shareholder.

• Controlling the Components of Working Capital

  • Working capital (WC) can be controlled by changing the levels of current assets and/or current liabilities through a number of mechanisms.
  • Each company has different demands for how much Working Capital (WC) they need, but all companies prefer to have positive WC (recall that WC = current assets - current liabilities).
  • Thus, managing WC to an acceptable level is one of the most important jobs of management .
  • Debtors management: Identify the appropriate credit policy, such as credit terms, that will attract customers, such that any impact on cash flows and the cash conversion cycle will be offset by increased revenue and hence Return on Capital (or vice versa).
  • Financing management: Identify the appropriate source of financing.