concept of working capital management evaluating techniques for working capital operating cycle...
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Working Capital
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Concept of working capital management Evaluating techniques for working capital Operating cycle and cash conversion cycle
Learning outcomes
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Introduction Working capital management is the management
of the short-term investment and financing of a company.
Definition: Basic metrics used to evaluate the company's
efficiency and its short-term financial health
Copyright © 2013 CFA Institute 3
Working capital
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FormulaWorking capital= current asset – current liabilities
WC = CA – CLGoals
◦ Adequate cash flow for operations◦ Most productive use of resources
Working capital
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Working capital
Current Assets
Cash Account receivable Prepaid expense Merchandise
Inventory Marketable securities
Current Liabilities
Accounts payable Accrued expenses
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FormulaCurrent Assets/Current Liabilities
Anything below 1 indicates negative W/C (working capital).
While anything over 2 means that the company is not investing excess assets.
Most believe that a ratio between 1.2 and 2.0 is sufficient
Working Capital Ratio
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Operating Cycle
Is used to measure the efficiency of working capital
The operating cycle is the length of time it takes a company’s investment in inventory to be collected in cash from customers.
Acquire Inventory for Cash
Sell Inventory for Credit
Collect on Accounts Receivabl
e
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Cash Conversion Cycle The net operating
cycle (or the cash conversion cycle) is the length of time it takes for a company’s investment in inventory to generate cash, considering that some or all of the inventory is purchased using credit.
Copyright © 2013 CFA Institute 8
Acquire Inventory for Credit
Sell Inventory for Credit
Collect on Accounts
Receivable
Pay Suppliers
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Formula
Cash Conversion Cycle
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1. Days Inventory outstanding (DIO): is the average number of days a company hold their inventory before sell
Formula: DIO= 365/ inventory turnover**inventory turnover= COGS/average
inventory** **Avg. inventory= (beg.+ ending inventory)/2
Cash Conversion Cycle
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2. Day sales outstanding (DSO): is the average number of days a company takes to collect revenue after sales has been made.
Formula: DSO= 365/ Account receivable turnover**A/R turnover= Sales/average A/R ** **Avg. A/R= (beg.+ ending A/R)/2
Cash Conversion Cycle
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3. Days payable outstanding (DPO): is the average number of days a company takes to pay its suppliers.
Formula: DPO= 365/ Account payable turnover**A/P turnover= COGS/average A/P ** **Avg. A/P= (beg.+ ending A/P)/2
Cash Conversion Cycle
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Case:
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Case:
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Case:
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Competitor’s ScenarioItem 1/31/2004 1/31/2003
Revenue 6000
COGS 7000
Inventory 1000 2000
A/R 500 400
A/P 800 900
Average inventory (1000+2000)/2 = 1500
Average A/R (400+500)/2= 450
Average A/P (800+900)/2 = 850
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DIO = $1,500 / ($7,000/ 365) = 78.2 days
DSO = $450 / ($6,000 / 365 days) =
27.3days
DPO = $850 / ($7,000/ 365) = 44.3 days
CCC = 78.2+27.3- 44.3= 61.26 days
Competitor’s Scenario
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Items Kohler’s company X company
DIO 85 days 78 daysDSO 38 days 27 daysDPO 31 days 44 daysCCC 92 days 61 days
Competitive Analysis