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Working Capital(1)

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Chapter 19

Lecture Objectives 

 

the importance of working capital and short shor t term finance the management of stocks, cash and debtors capital structure and long term finance

What is working capital 





On a balance sheet it is usually called “net current assets” The component part are; current assets stocks trade debtors cash, bank balances, and liquid assets current liabilities trade creditors bank overdrafts other short term claims over assets 













The working capital cycle - 1 



 working capital varies in size between industries examples a manufacturing organisation will invest in large amounts of raw materials, work in progress, and finished goods, and will often sell product on credit, therefore incurring large debtor balances  a retail outlet will only hold one form of stock (finished goods) and will normally sell for cash  working capital represents a net investment in short term assets 





The working capital cycle - 2 Raw materials

Creditors

Work in progress

Cash

Finished goods

Cash sales Debtors

The Management of Stock   

 Just in time (JIT) Materials requirement planning system (MRP) Economic order quantity (EOQ)

Data required: Holding costs Ordering costs Demand for inventory item   

Management of stocks - 2

Stock level

etc..

Time

Economic order quantity

Asset and Liability Components in Practice 

Service business: 



Supermarket business: 



 very little inventory, principally receivables and cash. inventory and cash, and a high level of trade payables but very low trade receivables.

Pharmaceuticals business: 

high levels of receivables, cash and payables.

The balance of debt and equity capital -problem Company A

Company B

Share capital

£500,000

£100,000

Loans - 10%

£500,000

£900,000

Total Capital

£1,000,000

£1,000,000

Year 1

£160,000

£160,000

Year 2

£80,000

£80, 000

Operating profits

Capital balance - solution Company A

£000 Op. profit

Year 1

Company B

Year 2

Year 1

Year 2

160

80

160

80

50

50

90

90

 Net profit

110

30

70

(10)

Equity

500

500

100

100

Return on Equity

22%

6%

70%

Interest

(10%)

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