CHAPTER 8Liabilities and Equitylearning objectivesThe nature of working capitalTypesofpermanentcapitalHow to account for liability and equityTypes of equity capitalWHUTAccountingdepartmentofmanagementschool
WHUT Accounting department of management school learning objectives The nature of working capital Types of permanent capital How to account for liability and equity Types of equity capital CHAPTER 8 Liabilities and Equity
1.working capitalWorking capital is the capital available forconducting the day-to-day operations of anorganization.normally refers to a firm's investment incurrent assets (cash, marketable securities.receivables, and inventory), less currentliabilities (payables)WHUTAccountingdepartmentofmanagementschool
WHUT Accounting department of management school 1. working capital Working capital is the capital available for conducting the day-to-day operations of an organization. normally refers to a firm’s investment in current assets (cash, marketable securities, receivables, and inventory), less current liabilities (payables)
ElementsofWorking CapitalCurrent assetsCurrent liabilitiesCashTrade payablePayrollMarketablesecuritiesinventory:Taxation payableraw materialDividend payablefinished goodsShort-termloansReceivablesLong-term loansNet Working capital = current assets-current liabilitiesWHUTAccountingdepartmentofmanagementschool
WHUT Accounting department of management school Elements of Working Capital Current assets Cash Marketable securities inventory: raw material finished goods Receivables Current liabilities Trade payable Payroll Taxation payable Dividend payable Short-term loans Long-term loans Net Working capital = current assets – current liabilities
Why manage working capitalAll companies need some working capital inorder to keep the business running.Current assets are a major balance sheetitem. In typical manufacturing firm, it accountfor over half of its total assets.Working capital decisions have effect on thefirm's risk, return, share price, and moreimportant, cash flows. Too few current assets may incur shortage anddifficulties in maintaining smooth operationsWHUTAccountingdepartmentof managementschool
WHUT Accounting department of management school Why manage working capital All companies need some working capital in order to keep the business running. Current assets are a major balance sheet item. In typical manufacturing firm, it account for over half of its total assets. Working capital decisions have effect on the firm’s risk, return, share price, and more important, cash flows. Too few current assets may incur shortage and difficulties in maintaining smooth operations
The Purpose of Working CapitalInvestment in working capitaltomaintainthe efficient operationof thebusinessShort-term financingto maintain the liquidity of the firmMinimizetherisk ofinsolvency whilemaximize the return on assets52014-6-27WHUTAccountingdepartmentofmanagementschool
WHUT Accounting department of management school The Purpose of Working Capital Investment in working capital to maintain the efficient operation of the business Short-term financing to maintain the liquidity of the firm 2014-6-27 5 Minimize the risk of insolvency while maximize the return on assets
EvaluatingLiquidityAn important indicator of a company ability tomeet its current obligations.Two commonly used measures:Working Capital =CurrentAssets-Current LiabilitiesCurrent Ratio =CurrentAssets?Current LiabilitiesWHUTAccountingdepartmentofmanagementschool
WHUT Accounting department of management school Evaluating Liquidity An important indicator of a company ability to meet its current obligations. Two commonly used measures: Current Ratio = Current Assets ?Current Liabilities Working Capital = Current Assets - Current Liabilities
2.SourcesofCapitalLiabilities Definedas debts orobligationsarisingfrompasttransactionsorevents.Maturity=1yearorlessMaturity>1yearCurrentNoncurrentLiabilitiesLiabilitiesWHUTAccountingdepartmentofmanagementschool
WHUT Accounting department of management school Liabilities Defined as debts or obligations arising from past transactions or events. Maturity = 1 year or less Maturity > 1 year Current Liabilities Noncurrent Liabilities 2. Sources of Capital
The acquisition of assets is financed from twosources:DEBTEQUITYFundsfromFundsfromcreditors,witha definite duedate, andownerssometimesbearinginterest.WHUTAccountingdepartmentofmanagementschool
WHUT Accounting department of management school The acquisition of assets is financed from two sources: Funds from creditors, with a definite due date, and sometimes bearing interest. Funds from owners DEBT EQUITY
LiabilitiesQuestionDevon Co. borrows $100,000 from FirstBank. The loan will be repaid in 10 yearsand has an annual interest rate of 8%Isthis a current liability oranoncurrentliability?WHUTAccountingdepartmentofmanagementschool
WHUT Accounting department of management school Liabilities Question Devon Co. borrows $100,000 from First Bank. The loan will be repaid in 10 years and has an annual interest rate of 8%. Is this a current liability or a noncurrent liability?
LiabilitiesQuestionDevon Co.has current liabilities of$230,000andcurrentassetsof$322,000Whatis Devon's currentratio?CurrentCurrentCurrentRatioAssetsLiabilities322,000230,000ST1.4WHUTAccountingdepartmentofmanagementschool
WHUT Accounting department of management school Liabilities Question Devon Co. has current liabilities of $230,000 and current assets of $322,000. What is Devon’s current ratio? Current Ratio = Current Assets Current Liabilities = $ 322,000 $ 230,000 = 1.4