Forums › ACCA Forums › ACCA FM Financial Management Forums › 2 questions about working capital
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- January 26, 2014 at 2:34 pm #154465AnonymousInactive
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Hi Sir,
May I seek you help with regard to two questions about working capital, please? They are not computational, rather explanatory questions. Here below are they:
Q1: The advantages of having more working capital?
A: I am not sure about trading payables in the answer. It says the advantage is “Preserves of own cash; cheap source of finance”. Why is it so when we have a higher level of working capital?Q2: Can you help me out what is Aggressive/ Conservative Approaches regarding the working capital management policy?
In textbook, it says have a lower level of working capital than rivals is said to have an ‘aggressive’ approach; whereas a higher level of working capital has a ‘conservative’ approach.
An aggressive approach will result in higher profitability and higher risk; while a conservative one is vice versa.
But I thought the lower the level of working capital (aggressive approach), there would be less cash tied up to inventory/receivables/liquidity cash, etc. Thus that should be less risky; and the higher the level of working capital (conservative approach), there would be more cash tied up to above items. Thus make it more risky. I just don’t understand the logic.Thanks!
January 26, 2014 at 6:50 pm #154467With regard to Q1, although that you have typed are certainly advantages of having more payables, they are not advantages of having more working capital! More payables means less working capital!!
I don’t know where you have copied this from, but if that is what they say then they are wrong/With regard to Q2, aggressive and conservative relate to how the working capital is financed.
Conservative is when the working capital is financed from long-term finance, whereas aggressive is when it is financed from short term finance (overdraft).Using overdraft to finance working capital may be cheaper (because you pay interest on a day by day basis depending on the lever from day to day), but it is more risky (because the bank could demand repayment of the overdraft at any time).
A more sensible approach is to borrow the long term average working capital (we call it the ‘permanent’ working capital) need from long-term finance, and then to borrow short-term extra needs (we call this to the ‘temporary working capital using short-term finance.
Hope this helps 🙂
January 27, 2014 at 9:39 am #154486AnonymousInactive- Topics: 43
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Hi Sir,
For Q1, I have taken a picture from the provided answer (https://flic.kr/p/jxofhE). Can you tell me if this answer is correct or not regarding paybales?
For Q2, I still don’t understand why aggressive method have a lower level of working capital. Why lower level of working capital will result in higher profitability and higher risk?
Thanks!January 27, 2014 at 10:36 am #154490What is typed for question 1 is correct.
An aggressive policy of having low working capital means less use of long-term finance. This either means they can borrow less long-term and save interest, or they have more long-term capital left over to invest in profit-earning non-current assets. Either way it means more profit.
However there is more risk because they might run out of cash and be forced into liquidation.
January 27, 2014 at 11:04 am #154491AnonymousInactive- Topics: 43
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Hi sir,
Why the answer of payables to Q1 is correct? Thanks!January 27, 2014 at 11:10 am #154492Which part does not seem correct to you?
January 27, 2014 at 12:13 pm #154493AnonymousInactive- Topics: 43
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The payables: the advantages of higher working capitals, the text says “preserves of own cash; cheap source of finance”. Why?
January 27, 2014 at 1:40 pm #154497It does not say ‘advantage of higher working capital’ at all.
It says advantages of higher payables, and advantages of higher payables are that they are a cheap source of finance and it preserves own cash.
Higher payables means lower working capital.
January 28, 2014 at 9:30 am #154534AnonymousInactive- Topics: 43
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Hi Sir,
About Q1, I understand now.
However, about Q2, I am still confusing. Why use short-term financing will have a lower level of working capital, and thus making it an aggressive approach?
Thanks!January 28, 2014 at 10:44 am #154544Short term finance is payables and overdraft.
If these are higher, then working capital is lower.
January 31, 2014 at 7:11 am #154694AnonymousInactive- Topics: 43
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Thank you sir! I get it now. Because working capital = current assets – current liabilities, and short term finance is clearly a current liability. Am I correct?
January 31, 2014 at 7:38 am #154695Yes – that’s correct 🙂
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