Free ACCA & CIMA online courses from OpenTuition

Free Notes, Lectures, Tests and Forums for ACCA and CIMA exams

Specially for OpenTuition students: 20% off BPP Books for ACCA & CIMA exams – Get your BPP Discount Code >>

Management of Working Capital  – Introduction – ACCA Financial Management (FM)

Reader Interactions

Comments

  2. Greetings sir,
    Could you confirm the validity of the following logic that I understood from the operating cycle that you explained with example 1:

    We purchased $518,400 of raw materials of which only $108,000 remains – the rest having moved onto the WIP stage. Therefore this would be equivalent to 76days wait time for the remaining raw material stock to become WIP if we took the whole amount of raw materials purchased as 365 days. Similarly we have 41 days wait time for the balance WIP valued at $75,600 which has not finished production to convert to finished products (valued at $675,000). Similarly we have 42 days wait time for the closing inventory finished goods ( valued at $86,400) to be sold and become COS (valued at $756,000). Similarly we have 73 days to wait for receivables not yet paid by customers from the credit sales made throughout the year (maybe due to late payments, allowables , etc). And 61 days of payables still pending after having taken care of the rest of credit purchases after having paid away the rest of the suppliers. So we add the receivable days and inventory days and deduct from payable days to find out how many days we remain cashless within the period after the balance payment is done of the payables and before the cash is received from the remaining receivables. We need to shorten this gap.

    Please correct me elaborately and generously if I have made any wrong understanding in any of the steps. Please confirm to me if I have obtained the correct understanding.

    Thankyou very much.

  3. Sir,

    As per below question i agree we need to deduct 1 year’s tax 30% of 20000, discount it and remove from the perpetuity value of tax. But why we did not remove 1-year discounted perpetuity value for the cash inflow also.

    A company receives a perpetuity of $20,000 per annum in arrears, and pays 30% corporation tax 12 months after the end of the year to which the cash flows relate. At cost of capital of 10%, what is the after tax present value?
    A. $140,000 B. $145,454 C. $144,000 D. $127,274

    Thank you
    Avinash

  4. Hello sir,

    Please clarify regarding below question:
    AW Co needs to have $100,000 working capital in place immediately for the start of a 2-year project. The amount will stay constant in real terms. Inflation is running at 10% per annum, and AW Co’s money cost of capital is 12%. What is the present value of the cash flows relating to working capital?
    A. $(21,060) B. $(20,300) C. $(108,730) D. $(4,090)

    My question is how do we know that the Working capital in question will be need yearly?
    It only mentioned need to have $100,000 working capital.

    Thanks
    Avinash.

    • Please post this sort of question in our Ask the Tutor Forum and not as a comment on a lecture.

      Your questions have nothing to do with the management of working capital but are related to investment appraisal and are explained in the lectures on investment appraisal.

  5. Hi Sir, I find this topic very contradictory. For example, we would want high working capital to reduce risk of liquidity problems. But then we don’t want high receivables/inventory because there would be money “tied up” in them leading to less cash hence liquidity problems. Isn’t receivables/inventory part of a current assets hence higher working capital and that reduces the risk of liquidity problems?

    • If you high receivables and high inventory then you do have high liquidity but the key thing here is is the receivables high due to higher receivables period or higher sales. what I mean here is when you have higher sales you are likely to have higher receivables but this doesn’t mean you have liquidity problem on the other hand you make have similar amount of receivables but the collection period is bigger. than in this case you have higher receivables but the liquidity is low.

    • The definition of working capital is current assets minus current liabilities. I appreciate that it is confusing when examining how it is financed, but the finance has to come from borrowings and questions are testing your understanding of the difference between using short-term borrowings and long-term borrowings to finance the other current assets and current liabilities.

    • Although I did not mean that current assets do not contribute to making profits (for example cash balances may earn interest), it is the non-current assets that really generate the profit.

      For your example, the company will need premises for offices and storage, computers etc., and if they want to expand they will need more premises, computers etc.. Without them they will not be in a position to sell the products and make profits.

  11. Hello, sir!
    I was wondering if you could help me to understand the following:
    Why current ratio and quick ratio increase when company sells some inventory on credit at a profit?

    I thought that current ratio would be the same because when we sell on credit inventory become receivables and we count both receivables and inventory as current assets when count current ration.
    Also, I thought that quick ratio will increase because we sell some of our inventory and we we take away less inventory in the formula. As a result, the numerator becomes larger than if we had not sold inventory and the quotient, finally, is also larger.

    Thank you.
    Hope to hear from you soon.

    • 1) when we are selling inventory on credit with a profit, we are selling it at a higher price and result in a higher amount of receivable, e.g. Selling inventory $50 at the price $75 gives raise a receivable of $75, therefore the current asset is increased by $25 overall and make the current ratio higher.

      2) for quick ratio, same example applies. We get a $75 receivable and minus $50 less if we are going to sell the inventory, give us 75-(50)=125 more of current asset less inventory figure, hence higher quick ratio.

      Hope this clarify the idea.

  12. hello sir,

    i am a little confused, what do you mean when you say Working capital is financed by long term ? Does this mean that the shares we issue and the loan that we get will result in cash with the company and thus increase in Working capital ? and if i got it right than the same logic goes for short term as well i.e. we get cash with us.

    Thank you

    • All companies need working capital. It has to be financed somehow and as I discuss in the lectures it can be financed either by raising long-term capital or short-term (i.e. overdraft finance). However, as I also explain, although using overdraft finance may be cheaper it is more risky that using long-term finance.

  16. Good day sir, I’m the notes there seems to be a mistake with the ratios, particularly with regards to the Receivable Turnover. I only came across it while learning the ratios before to attempt the questions with you only to realise we using the same figure just in reverse order… I’ll go with the solutions just posting this here in case anyone else gets confused

  18. Thanks John. I appreciate this video lecture. Working capital ratios are of little use unless they are compare to similar entities or industry average to that of competitors. It make sense to always look at the type of business the company is in when assessing the various ratios and the operating cycle itself.

Leave a Reply