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Working Capital

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Write a 2-page paper discussion working capital, net working capital and working capital policy. Include in your discussion the advantages and disadvantages of offering your customers credit.

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RESPONSE:

Working Capital Equation:

* Current Assets:
Debtors, Cash and Stock

(less)

Current Liabilities:
Creditors, Loans and Tax

=

Net Working Capital

Working capital (WC) refers to firm´s current assets. In other words, the current assets are those that the firm expects to convert into cash within a year. Current assets include cash, inventor, and accounts receivable. Current assets are considered liquid because they can be transformed into cash in a relatively short time.

Net working capital is the firm´s current assets minus current liabilities. In other words, the current liabilities are the business obligations (such as debt) that the firm plans to pay off or otherwise satisfy within a year. Net working capital is important to firms. It represents the amount of current assets remaining if they were liquidated to pay the company's short-term debt. (http://www.ctu.edu.vn/coursewares/kinhte/qttc/abstract/ch10.htm#2).

This measure serves as an indication of the amount of readily available funds that can be used in operation of the business. As such, working capital finances day-to-day business operation (called the CASH CONVERSION CYCLE), allowing bills to be paid while awaiting payment of cash for sales. Internal sources of working capital include RETAINED EARNINGS, allocation of POSITIVE CASH FLOW from sources such as DEPRECIATION or DEFERRED TAXES, and savings achieved through operating efficiencies. External sources of working capital include TRADE CREDIT, SHORT-TERM LOANS, TERM DEBT, EQUITY FINANCING not used for long-term assets (http://www.small-business-dictionary.org/default.asp?term=WORKING+CAPITAL). In other words, NET WORKING CAPITAL is a more precise wording for WORKING CAPITAL to differentiate from GROSS WORKING CAPITAL. ...

Solution Summary

This solution discuses three concepts: working capital, net working capital and working capital policy, as well as the advantages and disadvantages of offering your customers credit.

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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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