MOS 2310 Chapter 14.docx

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Western University
Management and Organizational Studies
Management and Organizational Studies 2310A/B
Doug Hazlewood

141WORKING CAPITAL FUNDEMENTALSSHORTTERM FINANCIAL MANAGEMENTWORKING CAPITAL MANAGEMENTManaging current assets and current liabilitiesIs one of the financial managers most important jobsMust be decided on at daily basis whereas fixed assets or longerterm investments are often made only a few times a year and are likely to consume less timeGoal to manage each of the firms current assets and current liabilities to achieve balance between profitability and risk that contributes positively to the firms valueToo large an investment in current assets can reduce profitabilityToo little an investment in current assets increases liquidity riskToo little current liability financing can reduce profitabilityToo much current liability financing increases liquidity riskWhen an obligation is incurred the firm generally knows when the corresponding payment is so therefore outflows are predictable and current liabilities doesnt hold as much riskWhat are difficult to predict is cash inflowsthe conversion of the current assets to more liquid forms The more predictable its cash inflows the less net working capital a firm needsPROFITABILITYthe relationship between revenues and costs generated by using the firms assetsboth current and fixedin productive activitiesA firms profits can be increased by1 Increasing Revenues2 Decreasing CostsRISKprobability that a firm will be unable to pay its bills as they come dueTECHNICALLY INSOLVENTDescribes a firm that is unable to pay its bills as they come dueThe more NWC the more liquid the firm and therefore the lower its risk of becoming technically insolventChanges in Current AssetsPercentage of total assetscurrent assetstotal assetsRatioChange in RatioEffect on ProfitEffect on RiskCurrent AssetsINCREASEDECREASEDECREASETotal AssetsDECREASEINCREASEINCREASECurrent Liabilities INCREASEDECREASEINCREASETotal AssetsDECREASEDECREASEDECREASENote current liabilitiestotal assetsrepresents the percentage of total assets that have been financed with current liabilities Note Current Assetsinventory accounts receivable cash and marketable securitiesCurrent Liabilitiesaccounts payable accruals and short term loans142THE CASH CONVERSION CYCLEOPERATING CYCLE OCCThe time from the beginning of the production process to collection of cash from the sale of the finished product Encompasses two major shortterm asset categories1Inventory 2Accounts Receivable It is measured in elapsed time by summing the average age of inventory AAI and the average collection period ACP
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