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Finance 1 week 7 summary
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Finance 1 week 7 summary including readings
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Week 7:Preparation: Chap 26: Working Capital
Management
Net Working Capital = Current Assets – Current Liabilities
It is the capital required in the short term to run business. Its management
involves short-term asset accounts such as cash, inventory, and accounts
receivable, AWA short-term liability such as accounts payable.
Most projects require the firm to invest in net working capital. The main
components are cash, inventory, receivables, and payables. Net working Capital
doesn’t include excess cash, which can be viewed as part of the firm’s capital
structure, offsetting firm debt.
The level of working capital reflects the length of time between when cash goes
out of a firm at the beginning of the production process and when it comes back
in.
A firm’s cash cycle is the legth of time between when the firm pays cash to
purchase its initial inventory and when it receives cash from the sale of the
output produced from that inventory.
Cash cicrcle is measured by calculating the cash conversion cycle (CCC)
CCC = Accounts Receivable Days + Inventory Days – Accounts Payable Days
With Accounts Receivable Days =
Accounts Receivable/ Average Daily
Sales
Inventory Days = Inventory/
Average Daily Cost of Goods Sold
Accounts Payable Days = Accounts
Payable/ Average Daily Cost of
Goods Sold
The firm’s operating cycle is the average length of time between when a firm
originally purchases its inventory and when it receives the cash back from selling
its product. If the inventory is paid cash, this period is identical to the firm’s cash
cycle.
When a firm allows a customer to pay for goods at some date later than the date
of purchase, it creates an account receivable for the firm and an account payable
for the customer.
The credit that the firm is extending to its customer is known as trade credit.
Even if preferred to be paid by cash directly, a “cash-only” policy may cause it to
lose its customers to competition.
Sometimes, firms offer discounts to their customers to push them to pay early.
In a perfectly competitive market, trade credit is just another form of financing.
Under the Modigliani-Miller assumptions of perfect capital markets, the amounts
of payables and receivables are therefore irrelevant.
Trade credit: a loan from the selling firm to its customer. The price discount is an
interest rate.
Trade credit can be an attractive source of funds.
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