Lesson 14: Working Capital Management

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Watch this with a 10-15 minute audiotrack at http://vimeo.com/novusprogram/lesson14

Working Capital Management is a very important of managing a business. By properly managing your liquid assets, you can ensure that your business can pay off its obligations and take advantage of special opportunities. The lesson also introduces the common financial ratios used to evaluate working capital management: the current ratio, the quick ratio, and the cash ratio.

The Novus project is a combination of video tutorials designed to be used in conjunction with a free business simulation software program. The Novus Business and IT Program contains 36 business and IT training videos, covering basic finance, accounting, marketing, economics, business strategy, Word, Excel, and PowerPoint. Users will have an opportunity to apply the lessons in the Novus Business Simulator. Over six rounds, the user or teams will have to make decisions on capital purchases, financing, production, financing, and human resources for a microbrewery. This channel has arranged the 36 video lessons into the order in which they are meant to be used with the simulator. To watch this slideshow as a video, please go to our Vimeo page at: https://vimeo.com/novusprogram. To download our free business simulation software, please go to our SourceForge page at: http://sourceforge.net/projects/novus/.

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Lesson 14: Working Capital Management

  1. 1. Working Capital Management Objective: To understand how efficient use of working capital affects the profitability of businessesNovus Business and IT Training Program
  2. 2. Working Capital Working = Current Assets - Current Liabilities Capital Cash Short-term Debt Current portion of Long-term Short-term Investments Debt Inventory Accounts Payable Accounts ReceivableNovus Business and IT Training Program 1
  3. 3. Why Do Businesses Need Cash?• Transactions – To buy and sell things• Protection – To have some extra money in case something goes wrong• Speculation – To take advantage of opportunitiesNovus Business and IT Training Program 2
  4. 4. Types of Inventory• Raw Materials• Work in Progress• Finished ProductNovus Business and IT Training Program 3
  5. 5. Working Capital: Example Star Hat Store Balance Sheet Dec 31 2011 Dec 31 2010Assets Cash 20,000 65,000 20,000 Inventory 143,600 107,000 143,600 193,600 Accounts Receivable 30,000 0 30,000 Property, Plant & Equipment (gross) 60,000 60,000 Accumulated Depreciation -10,000 0 124,600 Net Property, Plant & Equipment 50,000 60,000 Total Assets 243,600 232,000Liabilities Accounts Payable 64,000 32,000 64,000 Current portion of long-term debt 5,000 0 69,000 5,000 Long-term Debt 60,000 90,000 Total Liabilities 129,000 122,000Shareholders Equity Paid-In Capital 110,000 110,000 Retained Earnings 4,600 0 Total Shareholders Equity 114,600 110,000Novus Business and IT Training Program 4
  6. 6. Liquidity – Current Ratio Star Hat Store Balance Sheet Dec 31 2011 Dec 31 2010Assets Cash 20,000 65,000 20,000 Inventory 143,600 107,000 143,600 193,600 Accounts Receivable 30,000 0 30,000 Property, Plant & Equipment (gross) 60,000 60,000 Accumulated Depreciation -10,000 0 Net Property, Plant & Equipment 50,000 60,000 = 2.8x Total Assets 243,600 232,000Liabilities Accounts Payable 64,000 32,000 64,000 Current portion of long-term debt 5,000 0 69,000 5,000 Long-term Debt 60,000 90,000 Total Liabilities 129,000 122,000Shareholders Equity Paid-In Capital 110,000 110,000 Retained Earnings 4,600 0 Total Shareholders Equity 114,600 110,000Novus Business and IT Training Program 5
  7. 7. Liquidity – Quick Ratio Star Hat Store Balance Sheet Dec 31 2011 Dec 31 2010Assets Cash 20,000 65,000 20,000 Inventory 143,600 107,000 50,000 Accounts Receivable 30,000 0 30,000 Property, Plant & Equipment (gross) 60,000 60,000 Accumulated Depreciation -10,000 0 Net Property, Plant & Equipment 50,000 60,000 = 20.7x Total Assets 243,600 232,000Liabilities Accounts Payable 64,000 32,000 64,000 Current portion of long-term debt 5,000 0 69,000 5,000 Long-term Debt 60,000 90,000 Total Liabilities 129,000 122,000Shareholders Equity Paid-In Capital 110,000 110,000 Retained Earnings 4,600 0 Total Shareholders Equity 114,600 110,000Novus Business and IT Training Program 6
  8. 8. Measuring Efficiency: Inventory Turnover Ratio Cost of Goods SoldInventory Turnover = Average Inventory Or, another way Cost of Goods SoldInventory Turnover = (Beginning Inventory + Ending Inventory) / 2Novus Business and IT Training Program 7
  9. 9. Measuring Efficiency: Inventory Turnover Star Hat Store Income Statement Star Hat Store Balance Sheet Year Ending Year Ending 31-Dec-11 31-Dec-10 31-Dec-2011 31-Dec-2010 Assets Cash 20,000 65,000Sales 100,000 80,000 Inventory 143,600 107,000 Cost of Goods Sold - 65,000 55,000 Accounts Receivable 30,000 20,000 Property, Plant & Equipment (gross) 60,000 60,000Gross Income = 35,000 25,000 Accumulated Depreciation -10,000 0 Selling General and - 15,000 15,000 Net Property, Plant & Equipment 50,000 60,000 Admin Expenses Total Assets 243,600 232,000 LiabilitiesOperating Income = 20,000 10,000 Accounts Payable 64,000 32,000 Other Income and Exp - 8,000 8,000 Current portion of long-term debt 5,000 0 Long-term Debt 60,000 90,000Pre-Tax Income = 12,000 2,000 Total Liabilities 129,000 122,000 Taxes - 2,400 400 Shareholders Equity Paid-In Capital 110,000 110,000Net Income = 9,600 1,600 Retained Earnings 4,600 0 Total Shareholders Equity 114,600 110,000 Inventory 65,000 = = 50% Turnover ( 143,600 + 107,000 ) / 2 Novus Business and IT Training Program 8
  10. 10. Measuring Efficiency: Inventory Turnover in Days Inventory 365 = Turnover (in days) Inventory Turnover RatioNovus Business and IT Training Program 9
  11. 11. Measuring Efficiency: Inventory Turnover Star Hat Store Income Statement Star Hat Store Balance Sheet Year Ending Year Ending 31-Dec-11 31-Dec-10 31-Dec-2011 31-Dec-2010 Assets Cash 20,000 65,000Sales 100,000 80,000 Inventory 143,600 107,000 Cost of Goods Sold - 65,000 55,000 Accounts Receivable 30,000 20,000 Property, Plant & Equipment (gross) 60,000 60,000Gross Income = 35,000 25,000 Accumulated Depreciation -10,000 0 Selling General and - 15,000 15,000 Net Property, Plant & Equipment 50,000 60,000 Admin Expenses Total Assets 243,600 232,000 LiabilitiesOperating Income = 20,000 10,000 Accounts Payable 64,000 32,000 Other Income and Exp - 8,000 8,000 Current portion of long-term debt 5,000 0 Long-term Debt 60,000 90,000Pre-Tax Income = 12,000 2,000 Total Liabilities 129,000 122,000 Taxes - 2,400 400 Shareholders Equity Paid-In Capital 110,000 110,000Net Income = 9,600 1,600 Retained Earnings 4,600 0 Total Shareholders Equity 114,600 110,000 Inventory 65,000 Inventory 365 = = 50% Turnover (in = = 730 days Turnover ( 143,600 + 107,000 ) / 2 0.5 days) Novus Business and IT Training Program 10
  12. 12. Measuring Efficiency:Accounts Receivable Turnover Ratio SalesAccounts Receivable Turnover = Average Accounts Receivable or SalesAccounts Receivable Turnover = (Beginning Receivables + Ending Receivables) / 2 Novus Business and IT Training Program 11
  13. 13. Measuring Efficiency: Accounts Receivable Turnover Ratio Star Hat Store Income Statement Star Hat Store Balance Sheet Year Ending Year Ending 31-Dec-11 31-Dec-10 31-Dec-2011 31-Dec-2010 Assets Cash 20,000 65,000Sales 100,000 80,000 Inventory 143,600 107,000 Cost of Goods Sold - 65,000 55,000 Accounts Receivable 30,000 20,000 Property, Plant & Equipment (gross) 60,000 60,000Gross Income = 35,000 25,000 Accumulated Depreciation -10,000 0 Selling General and - 15,000 15,000 Net Property, Plant & Equipment 50,000 60,000 Admin Expenses Total Assets 243,600 232,000 LiabilitiesOperating Income = 20,000 10,000 Accounts Payable 64,000 32,000 Other Income and Exp - 8,000 8,000 Current portion of long-term debt 5,000 0 Long-term Debt 60,000 90,000Pre-Tax Income = 12,000 2,000 Total Liabilities 129,000 122,000 Taxes - 2,400 400 Shareholders Equity Paid-In Capital 110,000 110,000Net Income = 9,600 1,600 Retained Earnings 4,600 0 Total Shareholders Equity 114,600 110,000 Accounts Receivable 100,000 = = 4.0x Turnover ( 30,000 + 20,000 ) / 2 Novus Business and IT Training Program 12
  14. 14. Measuring Efficiency: Collection Period Collection 365 = Period (in days) Accounts Receivable TurnoverNovus Business and IT Training Program 13
  15. 15. Measuring Efficiency: Collection Period Star Hat Store Income Statement Star Hat Store Balance Sheet Year Ending Year Ending 31-Dec-11 31-Dec-10 31-Dec-2011 31-Dec-2010 Assets Cash 20,000 65,000Sales 100,000 80,000 Inventory 143,600 107,000 Cost of Goods Sold - 65,000 55,000 Accounts Receivable 30,000 20,000 Property, Plant & Equipment (gross) 60,000 60,000Gross Income = 35,000 25,000 Accumulated Depreciation -10,000 0 Selling General and - 15,000 15,000 Net Property, Plant & Equipment 50,000 60,000 Admin Expenses Total Assets 243,600 232,000 LiabilitiesOperating Income = 20,000 10,000 Accounts Payable 64,000 32,000 Other Income and Exp - 8,000 8,000 Current portion of long-term debt 5,000 0 Long-term Debt 60,000 90,000Pre-Tax Income = 12,000 2,000 Total Liabilities 129,000 122,000 Taxes - 2,400 400 Shareholders Equity Paid-In Capital 110,000 110,000Net Income = 9,600 1,600 Retained Earnings 4,600 0 Total Shareholders Equity 114,600 110,000 Accounts Receivable 100,000 Collection 365 = = 4.0x = = 91 days Turnover ( 30,000 + 20,000 ) / 2 Period (in days) 4.0 Novus Business and IT Training Program 14
  16. 16. Measuring Efficiency: Accounts Payable Turnover Ratio Cost of Goods SoldAccounts Receivable Turnover = Average Accounts Payable or Cost of Goods SoldAccounts Receivable Turnover = (Beginning Payables + Ending Payables) / 2 Novus Business and IT Training Program 15
  17. 17. Measuring Efficiency: Accounts Payable Turnover Ratio Star Hat Store Income Statement Star Hat Store Balance Sheet Year Ending Year Ending 31-Dec-11 31-Dec-10 31-Dec-2011 31-Dec-2010 Assets Cash 20,000 65,000Sales 100,000 80,000 Inventory 143,600 107,000 Cost of Goods Sold - 65,000 55,000 Accounts Receivable 30,000 20,000 Property, Plant & Equipment (gross) 60,000 60,000Gross Income = 35,000 25,000 Accumulated Depreciation -10,000 0 Selling General and - 15,000 15,000 Net Property, Plant & Equipment 50,000 60,000 Admin Expenses Total Assets 243,600 232,000 LiabilitiesOperating Income = 20,000 10,000 Accounts Payable 64,000 32,000 Other Income and Exp - 8,000 8,000 Current portion of long-term debt 5,000 0 Long-term Debt 60,000 90,000Pre-Tax Income = 12,000 2,000 Total Liabilities 129,000 122,000 Taxes - 2,400 400 Shareholders Equity Paid-In Capital 110,000 110,000Net Income = 9,600 1,600 Retained Earnings 4,600 0 Total Shareholders Equity 114,600 110,000 Accounts Receivable 65,000 = = 1.4x Turnover ( 64,000 + 32,000 ) / 2 Novus Business and IT Training Program 16
  18. 18. Measuring Efficiency:Accounts Payable Turnover (in days) Collection 365 = Period (in days) Accounts Receivable TurnoverNovus Business and IT Training Program 17
  19. 19. Measuring Efficiency: Accounts Payable Turnover (in days) Star Hat Store Income Statement Star Hat Store Balance Sheet Year Ending Year Ending 31-Dec-11 31-Dec-10 31-Dec-2011 31-Dec-2010 Assets Cash 20,000 65,000Sales 100,000 80,000 Inventory 143,600 107,000 Cost of Goods Sold - 65,000 55,000 Accounts Receivable 30,000 20,000 Property, Plant & Equipment (gross) 60,000 60,000Gross Income = 35,000 25,000 Accumulated Depreciation -10,000 0 Selling General and - 15,000 15,000 Net Property, Plant & Equipment 50,000 60,000 Admin Expenses Total Assets 243,600 232,000 LiabilitiesOperating Income = 20,000 10,000 Accounts Payable 64,000 32,000 Other Income and Exp - 8,000 8,000 Current portion of long-term debt 5,000 0 Long-term Debt 60,000 90,000Pre-Tax Income = 12,000 2,000 Total Liabilities 129,000 122,000 Taxes - 2,400 400 Shareholders Equity Paid-In Capital 110,000 110,000Net Income = 9,600 1,600 Retained Earnings 4,600 0 Total Shareholders Equity 114,600 110,000Accounts Receivable 65,000 Accounts Payable 365 = = 1.4x Turnover (in = = 269 days Turnover ( 64,000 + 32,000 ) / 2 days) 1.4 Novus Business and IT Training Program 18

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