Chapter 8 Overview of Working Capital anagement 8-1
8-1 Chapter 8 Overview of Working Capital Management
Overview of Working Capital Management Working Capital Concepts Working Capital Issues Financing Current Assets Short-Term and Long-Term Mix Combining Liability Structure and current asset decisions 8-2
8-2 Overview of Working Capital Management Working Capital Concepts Working Capital Issues Financing Current Assets: Short-Term and Long-Term Mix Combining Liability Structure and Current Asset Decisions
Working Capital Concepts Net Working Capital Current Assets- Current Liabilities Gross Working Capital The firm's investment in current assets Working Capital Management The administration of the firm's current assets and the financing needed to support current assets. 8-3
8-3 Working Capital Concepts Net Working Capital Current Assets - Current Liabilities. Gross Working Capital The firm’s investment in current assets. Working Capital Management The administration of the firm’s current assets and the financing needed to support current assets
Significance of Working Capital Management In a typical manufacturing firm, current assets exceed one-half of total assets Excessive levels can result in a substandard Return on Investment(Rol) Current liabilities are the principal source of external financing for small firms Requires continuous, day-to-day managerial supervision Working capital management affects the company' s risk, return, and share price 8-4
8-4 Significance of Working Capital Management In a typical manufacturing firm, current assets exceed one-half of total assets. Excessive levels can result in a substandard Return on Investment (ROI). Current liabilities are the principal source of external financing for small firms. Requires continuous, day-to-day managerial supervision. Working capital management affects the company’s risk, return, and share price
orking Capital Issues Optimal Amount(Level)of Current Assets Assumptions 50,000 maximum Policy A units of production i Policy B Continuous Policy C production u00 Three different Current Assets policies for current asset levels are possible 25,000 50,000 OUTPUT(units) 8-5
8-5 Working Capital Issues Assumptions 50,000 maximum units of production Continuous production Three different policies for current asset levels are possible Optimal Amount (Level) of Current Assets 0 25,000 50,000 OUTPUT (units) ASSET LEVEL ($) Current Assets Policy C Policy A Policy B
Impact on Liquidity Optimal Amount(Level)of Current Assets Liquidity Analysis Policy Liquidity/2 Policy A Policy B ABc High Average Policy C LoW Current Assets Greater current asset levels generate more liquidity all other factors held constant 25,000 50,000 OUTPUT(units) 8-6
8-6 Impact on Liquidity Liquidity Analysis Policy Liquidity A High B Average C Low Greater current asset levels generate more liquidity all other factors held constant. Optimal Amount (Level) of Current Assets 0 25,000 50,000 OUTPUT (units) ASSET LEVEL ($) Current Assets Policy C Policy A Policy B
Impact on Expected Optimal Amount Level)of Current Assets Return on Investment s Net Profit Policy A Total Assets Policy B Let Current Assets s Policy C (Cash Rec +Inv) Return on Investment s Current Assets Net Profit Current Fixed Assets 25,000 50,000 OUTPUT(units) 8-7
8-7 Impact on Expected Profitability Return on Investment = Net Profit Total Assets Let Current Assets = (Cash + Rec. + Inv.) Return on Investment = Net Profit Current + Fixed Assets Optimal Amount (Level) of Current Assets 0 25,000 50,000 OUTPUT (units) ASSET LEVEL ($) Current Assets Policy C Policy A Policy B
Impact on Expected Optimal Amount Level)of Current Assets Profitability Analysis Policy Profitability Policy A u Policy B ABc LoW Average High --00 Policy C As current asset levels Current Assets decline, total assets willl decline and the roi will rIse 25,000 50,000 OUTPUT(units) 8-8
8-8 Impact on Expected Profitability Profitability Analysis Policy Profitability A Low B Average C High As current asset levels decline, total assets will decline and the ROI will rise. Optimal Amount (Level) of Current Assets 0 25,000 50,000 OUTPUT (units) ASSET LEVEL ($) Current Assets Policy C Policy A Policy B
Impact on Risk Optimal Amount(Level)of Current Assets Decreasing cash reduces the firm's ability 山品 Policy A to meet its financial obligations. More risk Policy B Stricter credit policies Policy C reduce receivables and possibly lose sales and customers. More risk! Current Assets Lower inventory levels increase stockouts and lost sales, More risk! 25,000 50,000 OUTPUT(units) 8-9
8-9 Impact on Risk Decreasing cash reduces the firm’s ability to meet its financial obligations. More risk! Stricter credit policies reduce receivables and possibly lose sales and customers. More risk! Lower inventory levels increase stockouts and lost sales. More risk! Optimal Amount (Level) of Current Assets 0 25,000 50,000 OUTPUT (units) ASSET LEVEL ($) Current Assets Policy C Policy A Policy B
Impact on Risk Optimal Amount(Level)of Current Assets Risk Analysis Policy Risk Policy A Policy B ABc LoW Average Policy C High Current Assets Risk increases as the level of current assets are reduced 25,000 50,000 OUTPUT(units) 8-10
8-10 Impact on Risk Risk Analysis Policy Risk A Low B Average C High Risk increases as the level of current assets are reduced. Optimal Amount (Level) of Current Assets 0 25,000 50,000 OUTPUT (units) ASSET LEVEL ($) Current Assets Policy C Policy A Policy B
