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Working Capital

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How do we "manage" the levels of working capital required in a business?

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Please see response attached for the best formatting, which is also presented below.

RESPONSE:

1. How do we "manage" the levels of working capital required in a business?

We manage the levels of working capital through managing the cash flow cycle, as illustrated in the following diagram.

SEE DIAGRAM IN ATTACHED RESPONSE

As illustrated in the diagram above, cash flows in a cycle into, around and out of a business. It is the business's lifeblood. Therefore, it is the manager's primary task to help keep it flowing and to use the cash flow to generate profits. If a business is operating profitably, then it should, in theory, generate cash surpluses. If it doesn't generate surpluses, the business will eventually run out of cash and expire. Click here (see hyper link in attached response) for more information about the vital distinction between profits and cash flow. The faster a business expands, the more cash it will need ...

Solution Summary

This solution discusses how we "manage" the levels of working capital required in a business. A diagram illustrating this process is also provided. References are provided.

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See Also This Related BrainMass Solution

1. Two companies, A and B, have the following balance sheet accounts:

BELOW ARE TWO PROBLEMS THAT I NEED SOLVED. I HAVE ALSO ATTACHED A WORD DOCUMENT WITH THE PROBLEMS IN FORMAT THAT IS EASIER TO UNDERSTAND. THEY ARE ALSO LOCATED IN PDF FORMAT ON PAGE 170 THANKS.

1. Two companies, A and B, have the following balance sheet accounts:
A B
Current assets $ 150 $ 800
Fixed assets 300 2200
Current liabilities 75 600
Long-term debt 75 1000
Equity 300 1400
a. Compute values for all of the ratios that measure working capital for firms A
and B.
b. Compare Firm A to B with regards to its need for working capital and how it
finances its working capital (short-term vs. long-term financing).

2. The Latigo Company has the following financial information:
Sales $ 200
Cost of goods sold 100
Administrative expense 44
Depreciation 40
Interest expense 2
Tax 7
Net profit $ 7
Cash $ 5
Accounts receivable 20
Inventory 25
Fixed assets 50
Accounts payable 5
Note payable 15
Long-term debt 20
Equity 70
a. The current assets to sales ratio for the industry is 0.20. State whether Latigo
make more or less use of working capital than the industry.
b. Compute the working capital turnover for Latigo and for the industry.
c. Compute the operating cycle and the cash conversion cycle for Latigo.
d. The industry average cash conversion cycle is 112 days. Compare the industry
to Latigo and identify any inferences that you can make.

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