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Finance T3 & T4 (Topic 4: Working Capital Management (Ch18) (Working…
Finance T3 & T4
Topic 4: Working Capital Management (Ch18)
Working capital cycle (586)
Operating cycle
= Inventory conversion period + Average AR collection period
Shorter = more efficient use of working capital
Is the period between purchasing inventories to receiving cash for goods sold
Inventory conversion period = 365 / Inventory turnover ratio
Ave AR collection period = Ave AR / (Annual Credit Sale / 365)
Inventory turnover ration = Annual COGS / Ave inventory
Cash conversion cycle
= Operating cycle - Average AP period
Will therefore be shorter than Operating cycle by the Ave AP period
Factors in AP period
Ave AP period = 365 / (COGS / AP)
See table that illustrates these concepts on p.586
Managing current liabilities and calculating the cost of credit (592)
Working capital policy (583)
Working capital management should be a day-to-day activity
Short-term assets should be funded by short-term liabilities and long-term assets should be funded by long-term liabilities
Principle of self-liquidating debt, i.e. maturity matching
Assets
Temporary, CA except min level of AR/Inventory
Permanent, N-CA plus min level of AR/Inventory
Sources of financing
Spontaneous, i.e. AP / accrued expenses
Termporary, i.e. overdraft
Permanent, i.e. long-term loans
Managing current assets
Cash and marketable securities (594)
Managing AR (595)
Terms of sale (596)
Quality of customer (596)
Collection effort (598)
Managing inventories (599)
Net working capital (580)
= current assets - current liabilities
Risk return trade-offs to consider when managing working capital
Topic 3: Cost Management
Break-even analysis (425)
Cost-volume-profit equation (CVP)
Sales revenue - variable costs - fixed costs = Profit
(Selling price x units) - (variable costs x units) - fixed costs = profit
Contribution margin = selling price - variable costs per unit (428)
Break-even
Cash break-even (
excludes
depreciation) (430)
Accounting break-even (
includes
depreciation) (426)
Costs (426)
Fixed costs (indirect costs)
Variable costs (direct costs)
Semi-variable, semi-fixed costs or stepped fixed costs
Degree of operating leverage (DOL) (433)
Connects the relationship between the balance of fixed and variable costs, with the difference between % increase in rev compared with % increase in operating profit
DOL = % change in OP / % change in revenue
Therefore, DOL x % change in rev = % change in OP
Planning and Budgets (558/568) - see topic guide for pros and cons