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Chapter 14
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Chapter 14


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  • 1. Chapter 15 Working Capital Management
  • 2. Working Capital Management
    • What is working capital?
    • Working capital is defined as a firm’s total investment in current assets.
    • What is net working capital?
    • Net working capital is the difference between its current assets and current liabilities.
  • 3. Working Capital Management
    • What is the appropriate amount of current assets for the firm to carry?
    • How should the current assets be financed?
    Working capital management involves two basic questions:
  • 4.
    • Current Assets
    • Cash, marketable securities, inventory, accounts receivable
    • Long-Term Assets
    • Equipment, buildings, land
    Risk-Return Tradeoff
    • Which earn higher rates of return?
    • Which help avoid risk of illiquidity?
  • 5.
    • Current assets earn low returns, but help reduce the risk of illiquidity.
    Risk-Return Tradeoff
  • 6.
    • Current Liabilities
    • Short-term notes, accrued expenses, accounts payable
    • Long-Term Debt and Equity
    • Bonds, preferred stock, common stock
    Risk-Return Tradeoff
    • Which are more expensive?
    • Which help avoid risk of illiquidity?
  • 7.
    • Current liabilities are less expensive, but increase the risk of illiquidity.
    Risk-Return Tradeoff
  • 8.
    • A rule of thumb for guiding a firm’s working capital decision is the hedging principle.
    • It states that financing maturity should follow the cash flow-producing characteristics of the asset being financed.
    Hedging Principle
  • 9.
    • Should the total amount of a firm’s current assets equal to that of its current liabilities?
    • When applying the hedging principle, we should think in terms of the distinction between permanent and temporary assets, as opposed to the accounting fixed and current asset categories.
    Hedging Principle
  • 10.
    • Permanent assets are investments in assets that the firm expects to hold for a period longer than one year.
    • Permanent assets include the firm’s fixed assets as well as its minimum level of current assets.
    Permanent and Temporary Assets
  • 11.
    • Temporary assets are composed of current assets that will be liquidated and not replaced within the current year.
    Permanent and Temporary Assets
  • 12.
    • Spontaneous sources of financing include accounts payable, wages and salaries payable, accrued interest, and accrued taxes.
    • Asset needs of the firm not financed by spontaneous sources should be financed in accordance with the following rules:
    Hedging Principle
  • 13.
    • Permanent assets are financed with permanent sources such as long-term debt, preferred stock and common equity.
    • Temporary assets are financed with temporary sources, such as short-term bank loans and commercial papers.
    Hedging Principle
  • 14. Time Period Dollar Amount Fixed Assets Permanent Current Assets Current Assets Permanent plus spontaneous financing Temporary financing