Chapter 14 Working Capital Management - PowerPoint PPT Presentation

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Chapter 14 Working Capital Management

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With no increase in profits, ROI drops ... Xerox, GM, Ford, etc as ratings deteriorated. S-T less costly than L-T and more flexible ... – PowerPoint PPT presentation

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Title: Chapter 14 Working Capital Management


1
Chapter 14Working Capital Management
  • Key Sections (pages 441 - 446)
  • Risk/return trade-offs in Working Capital
    Management
  • Hedging principle

2
Introduction
  • Net WC current assets less current liabilities
  • Liquidity management establish current asset
    and liability levels so firm can meet its
    obligations
  • Short-term under one year. How much and from
    what sources?
  • On average, 15 of sales in working capital

3
Current Liabilities
  • Advantages
  • Flexibility
  • Lower interest cost on short-term debt
  • Disadvantages
  • - Causes increase in risk of illiquidity
    especially
  • if financial condition deteriorates
  • - Uncertain interest costs year to year

4
Risk/Return Trade-offLiquidity versus
Profitability
  • Large current assets reduce risk of production
    stoppages, lost sales and inability to pay bills
  • But as WC ? , no increase in returns
  • With no increase in profits, ROI drops
  • Greater reliance on current liabilities, greater
    risk of illiquidity

5
Short-term, Long-term Trade-offs
  • Risk of illiquidity
  • What happens if cant obtain or roll over S-T
    debt?
  • Xerox, GM, Ford, etc as ratings deteriorated
  • S-T less costly than L-T and more flexible
  • Uncertainty of interest costs from year to year
  • Trade-off increased risk of illiquidity versus
    increased profitability

6
Sources of Financing
  • Assets temporary (seasonal) or permanent
  • Spontaneous sources arise in normal course of
    business
  • Trade credit accounts payable
  • Other payables and accruals
  • Discretionary sources from an explicit decision
    by management, both short and long-term
    borrowings

7
Hedging Principle
  • Maturity should follow cash flows of asset being
    financed
  • - S-T Financing should be self-liquidating
  • After spontaneous sources used, finance
  • - Temporary assets with current liabilities.
  • - Permanent assets with permanent
    financing, including permanent part of working
    capital

8
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9
Hedging Principle
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