Class Notes (835,727)
Canada (509,353)
Rotman Commerce (1,103)
RSM219H1 (86)

Working Capital - Class Notes

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Rotman Commerce
Dragan Stojanovic

WORKING CAPITAL DEFINITION - Working Capital = Current Assets – Current Liabilities o Provides a measure of operating liquidity and ability to meet short-term obligations o Measured in absolute $$$, so difficult to compare companies of different sizes o Looking for a positive amount; “working capital deficiency” is a serious red flag - Ratio #1: Current Ratio = Current Assets / Current Liabilities o Similar to above, but standardizes the measure as a ratio, allowing comparison across companies of different size o Looking for a ratio > 1 - Ratio #2: Quick Ratio = Highly liquid current assets (Cash + Marketable Securities + A/R) / Current liabilities o Measures the ability to meet short-term obligations with only the most liquid assets o NOTE: USE JUDGMENT in what is included in highly liquid assets (e.g. what if average days in A/R is 300 days? Is that still highly liquid?) RATIOS - When using ratios o Always keep in mind the purpose of your analysis (this will determine which ratios to use, and possibly how to adjust the standard ratios) - Ratio in isolation is not that useful  look for benchmarks o Look at trends over time o Look at comparable companies RECEIVABLES - Key focus: Accounts Receivables (AR) - Issues relating to AR are linked to Revenue Recognition, but are NOT the same* o Often, AR is recognized at same time as revenues  Dr. A/R (BS)  Cr. Revenues (IS) o Remember, there are other types of receivables  Interest receivable  Royalties receivable  Rent receivable  Tax refund/receivable  Insurance refund receivable * - Collectability is a necessary condition for revenue recognition. In other words, if collection is doubtful at sale time, then either revenues are not recognized, or are recognized only to the extent of expected collectability (this is the linked part). However, this is not the same as realizing LATER that you might not collect the money (this is the subsequent A/R valuation issue, not an issue of going back and changing revenue recognition). In this case, the adjustment is acknowledged as bad debt expense (again, relating to a subsequent change in estimate of A/R collectability, not related to revenue recognition). DEFINITION - Receivables are financial assets (contractual right to future cash flows) - Need to distinguish current from long-term RECOGNITION - When do we recognize AR? o Meets the definition of a receivable:  It is an Asset, which is  1) Usually short-term (current)  2) Financial (get cash!)  contractual obligation to receive cash MEASUREMENT - At initial recognition: record the receivable at exchange/transaction amount (fair value) - Subsequent (at period end): value at NRV (this is the key question for AR) o NRV  net realizable value  Amount expected to be COLLECTED  Net of an ESTIMATE for uncollectible amounts  also called “Allowance for Doubtful Accounts” (AFDA) o Example:  Sell a truck (cost = $65,000) for $100,000 with terms of payment  90 days  Dr. A/R (BS) $100,000 o Cr. Revenues (IS) $100,000  Dr. COGS (IS) $65,000 o Cr. Inventory (BS) $65,000  At the end of month 1, company needs to show A/R at NRV  Still expect to collect A/R in full  no adjustments!  At end of next month 2, company announces it is undergoing bankruptcy  Estimate to collect $70,000  Therefore, GOAL is to show A/R at NRV (i.e. $70,000)  Accounts Receivable $100,000 Dr.  Allowance for Doubtful Accounts (AFDA) $30,000 Cr. (CONTRA-ASSET ACCOUNT)
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