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Working Capital Management

A) Dan plans to use the preceding ratios as the starting point for discussions with SKI's operating executives. He wants everyone to think about the pros and cons of changing each type of current asset and how changes would interact to affect profits and EVA. Based on the data in the table, does SKI seem to be following a relaxed, moderate, or restricted working capital policy?

b) How can one distinguish between a relaxed but rational working capital policy and a situation where a firm simply has a lot of current asset because it is inefficient? Does SKI's working capital policy seem appropriate?

c) Calculate SKI's cash conversion cycle, assuming all calculations use a 360-day year.

d) What might SKI do to reduce its cash and securities without harming operation?

Q 23-3 What are the advantages of matching the maturities of assets and liabilities? What are the disadvantages?

Q 23-4 From the standpoint of the borrower, is long-term or short-term credit riskier? Explain. Would it ever make sense to borrow on a short-term basis if short-term rates were above long-term rates?

Q 23-5 If long-term credit exposes a borrower to less risk, why would people or firms ever borrow on a short-term basis?

Q 23-9 The availability of bank credit is often more important to a small firm than to a large one. Why?

Mini Case !

a) B&B tries to match the maturity of its assets and liabilities. Describe how B&B could adopt either a more aggressive or more conservative financing policy.

b) What are the advantages and disadvantages of using short-term credit as a source of financing?

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a) Dan plans to use the preceding ratios as the starting point for discussions with SKI's operating executives. He wants everyone to think about the pros and cons of changing each type of current asset and how changes would interact to affect profits and EVA. Based on the data in the table, does SKI seem to be following a relaxed, moderate, or restricted working capital policy?
At the inception, SKI seems to be following a moderate working capital policy. Consider, the Current ratio, 1.75 is smaller than the industry norm of 2.25 and so the policy seems to be moderate even though SKI current ratio is worse than the industry ratio. The quick ration is also less that the industry average of 1.20 but 0.83 is not alarming. The first point of alarm is that the inventory turnover is 45 days for SKI and 32 for the industry. This indicates the company seems to be following a relaxed working capital policy. Further, the inventory turn over is only 4.82 whereas the industry turnover is 7.00. This indicates that the company is following a relaxed policy with respect to investor. Fixed assets turnover is acceptable at 11.35 but the total assets turnover is 2.08 in comparison to the industry 3.00. What does this mean? This means that the problem does not lie with the underutilization of fixed assets, but with the underutilization of current assets. In other words there is a need to tighten up the working capital policy. Naturally, since the current assets are underutilized, the profit margin on sales is lower than the industry norm. The underutilization of the current assets is also the reason why the return on equity is lower than the industry norm. The payables deferral period is less that the industry average by 3 days , this is also an indicator that a relaxed working capital policy is being followed.

b) How can one distinguish between a relaxed but rational working capital policy and a situation where a firm simply has a lot of current asset because it is inefficient? Does SKI's working capital policy seem appropriate?
SKI appears to have large amounts of working capital given its level of sales.
Working capital policy is reflected in current ratio, turnover of cash and securities, inventory turnover, and DSO.
These ratios indicate SKI has large amounts of working capital relative to its level of sales. SKI is either very ...

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