Financial Management: Summary and Definitions
Analysis of ch16:
Working capital management is a managerial accounting strategy focusing on maintaining efficient levels of both components of working capital, current assets and current liabilities, in respect to each other. Working capital management ensures a company has sufficient cash flow in order to meet its short-term debt obligations and operating expenses. Implementing an effective working capital management system is an excellent way for many companies to improve their earnings. This chapter discusses the management of current assets, particularly cash, marketable securities, inventory, and receivables. This chapter answers some Basic questions involving working capital management such as how much cash and inventory should be kept on hand? Will it be affect the liquidity of the firm to sell on credit or not? And how and from which sources the short term financing can be obtained? Therefore this chapter helps us in answering these questions by analyzing the various options available to a firm.
The first important concept mentioned is Cash Conversion Cycle. the net number of days from the outlay of cash for raw material to receiving payment from the customer. As a management tool, this metric makes explicit the inter-relatedness of decisions relating to inventories, accounts receivable and payable, and cash. This is very important because a firm needs to know about the time that it takes to convert its production into sales and into cash receipts and also the payment periods in order to have a check on its liquidity. Moreover, investment policies for current assets are also being highlighted for e.g. relaxed current asset investment policy, restricted current asset policy etc. these policies can be effected by changes in technology. Furthermore, current assets financing policies such as permanent current assets, temporary current assets etc are also discussed.
This chapter also discusses the importance of marketable securities to a corporation. Cash although for an individual may include currency and demand deposits, for a corporation marketable securities are also a very important source of cash, these securities are liquid as well as having an interest factor associated with them which leads to stability of the interest rates throughout the world. Apart from the management of the cash the corporations have to decide on its credit policy which affects the amount of cash available to a firm directly. Credit policies that a firm can use include credit periods, cash discounts, credit standards and collection policy. A tighter credit policy may discourage sales as some customers may choose to go elsewhere if they are pressured to pay their bills sooner. Short-term credit refers to debt scheduled for repayment within 1 year. Major sources of short-term credit include accounts payable (trade credit), bank loans, and commercial loans. The chapter also discusses the importance of inventory management. Purchases in bulk result in huge inventories which results in the firm incurring a number of costs such as storage, insurance, depreciation, obsolescence, handling costs and property taxes. These costs come under the category of carrying costs. In order to reduce these costs which can be substantial in nature, a firm needs to reduce the amount of inventories the firm has at hand at a particular point of time.
Finally the chapter talks about the short term financing techniques. A firm has a number of options from which to finance its short term operations, these includes promissory notes. Here the banks play a very important role as they decide the interest rate that they are going to charge based on the past record and credit worthiness of the firm. Apart from this, commercial papers are also used by firms which however are not secured. A very important option is short term bank loans. From the firm’s perspective, short term credit is riskier than long term debt...
Please join StudyMode to read the full document