8.Working Capital Management Policy_L.ppt

Dr. Evarist Stoja Financial Decision Making Working Capital Management Policy Working Capital Management Policy Learning Outcomes:By the end of this session you should:- Know various working capital management policy strategies. Have an understanding of the cash conversion cycle and be able to compute it. Be able discuss causes, consequences and remedies of over-trading. Working capital management Net working capital (working capital): current assets less current liabilities. e.g. cash, marketable securities, debtors stock. Working Capital management: – refers to the financing, investment control of net current assets within policy guidelines. Liquidity management: – is the planned acquisition utilization of cash – or near cash - resources to ensure a company’s ability to meet obligations as they fall due. Working capital ratios: Liquidity: Current ratio (CA/CL) Quick or ‘acid test’ ratio [(CA-Stock)/CL] Activity: Debtor days [(Debtors/Credit sales) *365] Creditor days [(Creditors/CoS) *365] Stock turnover [(Stock/CoS) *365] Cash conversion cycle (CCC) Sales/net working capital The dual objectives of working capital management are: profitability liquidity. Companies may adopt: Aggressive; Moderate; or Conservative - working capital policies regarding the level and financing of working capital. How much of firm’s investment is to be financed by short-tem/long-term finance? This involves a trade off between risk return. Current assets can be classified into: Fluctuating Current Assets (FCA): Current assets affected by seasonal or cyclical variations. e.g. Christmas stock. Permanent Current Assets (PCA): meet firm’s long-term requirements. e.g. min. level of cash, stock, debtors will always be outstanding. The ‘matching approach’ to relative proportions of long- and short-term debt used to finance working capital. The ‘conservative approach’ to relative proportions of long- and short-term debt used to finance working capital. The ‘aggressive approach