Aspects and Elements Related to Working Capital Management

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Aspects and elements related to
Working Capital Management


Prepared by: Ahmed O. Sultan

- An important responsibility of the financial manager is overseeing the firm's day to day financial activities. This area of finance known as Working capital management, is concerned with management of the firm's current accounts to achieve his goal which is the balance between profit and risk that maximizes the firm's value by managing each of the firm's current assets (Cash, Marketable securities, Accounts receivables and Inventories) and current liabilities represent the firm's short term financing.¹

- Net Working Capital: is defined as current assets minus current liabilities.

- Liquidity Ratios provide information about the firm's ability to meet its short term financial obligations 1. Working Capital Ratio (Current Ratio) is the ratio of current assets to current liabilities, but inventory may include many items that are difficult to liquidate quickly. 2. Quick Ratio (Acid Ratio) is the ratio of current assets excluding the inventory to current liabilities. 3. Cash Ratio is the most conservative liquidity ratio, it exclude all current assets except the most liquid: cash and cash equivalents such as marketable securities and time deposits over current liabilities. it is an indication of the firm's ability to pay off current liabilities if for some reason immediate payment were demanded.²

- Working Capital policy: refers to the firm's policies regarding 1. Target levels for each category of current assets. 2. How current assets will be financed.

- The Cash Conversion Cycle:-
It is used to analyze the effectiveness of the firm's working capital management. So it focuses on the length of time between when the company makes payments and when it receives cash inflows. Can be expressed by this equation:

CCC (in days) = Inventory conversion period + Receivables conversion period – Payables deferral period

– Inventory conversion period represents the average time required to convert materials into finished goods.

– Receivables conversion period (Day sales outstanding) represents the average length of time required to convert the firm's receivables into cash.

– Payables deferral period represents the average length of time between the purchase of materials and labor and the payment of cash for them.³ ------------------------------------------------------------------------------------------------------- ¹ Lawrence J. Gitman; 'Principals of the Managerial Finance'; Fifth edition; P.473-474 ² Internet Center for Management & Business Administration, Inc.; ³ Eugene F. Brigham; Joel F. Houston; ''Fundamentals of Financial Management''; Fourth edition; P.549-551 Managing the Cash Conversion Cycle

- As we can say that the sound of working capital policy is designed to minimize the time between cash expenditures on materials and the collection of cash on sales. This could be happened by: 1- Turn over inventory as quickly as possible, avoiding stock outs that might result in a loss of sales. 2- Collect accounts receivable as quickly as possible without losing future sales. 3- Pay accounts payable as late as possible without damaging the firm's credit rating.¹

Alternative Current Asset Investment Policies:-
- The Cash Conversion Cycle highlights the strengths and weakness of the firm's working capital policy, which depend on critically on current asset management and the financing of current assets. There are different policies for financing current assets.

1) Relaxed Current Asset Investment Policy
- A policy under which relatively large amounts of cash, marketable securities, and inventories are carried and under which sales are...
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