Business Finance 1 Dersi 8. Ünite Sorularla Öğrenelim

Working Capital basically refers to the money utilized by companies in their daily activities or operations. It is also defined as the available capital for day-to-day production of goods to be sold by a company represented by its net current assets (Adeniji, 2008).

The length of the company’s operating and cash conversion cycles determines the level of liquidity.

Inventory management aims to keep the inventories on optimal level, without stock- outs and excesses, by organizing, holding and replenishments for each item.

Some of the major methods of inventory valuation are:

- First in First Out Method (FIFO)

- Last in First Out Method (LIFO)

- Highest in First Out Method (HIFO)

- Nearest in First Out Method (NIFO)

- Average Price Method

The firms may create financing alternatives from internal (mainly in the form of accruals) and external sources:

1. Accruals
2. Trade credit
3. Working capitaladvance by commercial banks
4. Letter of credit
5. Factoring

Working capital management is the process of dealing with the activities for maintaining adequate working capital and ensuring the financing for the working capital with the best available terms and conditions.

The companies hold cash by different types of motivations:

-  Transaction Motive explains holding cash or near cash to meet routine cash requirements of a company to finance transactions in the normal course of business such as purchasing raw materials, paying expenses, taxes, dividends etc.

-  Precautionary Motive explains holding cash or near cash as a cushion to meet unexpected contingencies such as flood, strikes etc.

-  Speculative motive explains the situations in which there occurs extra ordinary opportunities for the companies to quickly take advantage. For example, in order to be able to utilize the cash discount provided by a supplier, certain amount of cash can be made available as a strategy.

From the “time” perspective, the working capital is conceptualized in two different forms: Permanentand Temporary. Generally, each company, depending on the peculiarities of their business, has a stable amount of working capital requirement. The permanent working capital represents the minimum level of investment in the current assets that is carried by the business at all times to carry out its activities.

Inventories can be classified into five major categories:

Generally three types of working capital policies are accepted, Hedging Policy, Conservative policy and Aggressive policy.

Hedging policy, which is also named as matching policy, proposes a strategy by which the fluctuating part of the current assets are financed by the current liabilities. Consequently, the fixed and permanent current assets are financed through long-term sources.

Aggressive policy, as the name suggests, is specified as the most risky working capital financing policy as a higher proportion of current assets including permanent ones is financed by the short-term debt.

Safety stock implies extra inventories that can be drawn down when actual lead time and/or usage rates are greater than expected. Safety stocks are determined by opportunity cost and carrying cost of inventories.

EOQ is the short form of Economic Order Quantity and it refers to the level of inventory that minimizes total cost of inventory ordering cost and carrying cost.

There exist many types of costs incurred in the course of receivables management, these are;

1. Administrative cost
2. Capital cost
3. Delinquency cost
4. Default cost

The current liabilities are those claims to be paid in less than 1 year time. Current liabilities include but are not limited to short-term payables to bank loans, trade creditors, accruals, taxation payable, outstanding expenses, dividends payable.

The Baumol model is based on the following assumptions:

-  The cash is used evenly over a period of time.

-  The cash requirements of the firm are known with certainty in advance.

-  The transaction cost is known and isconstant.

-  By holding the cash balances, the firm would incur the opportunity cost of interest forgone by not investing in marketable securities. The rate of carrying cost is known and is assumed to be constant.

-  The short term marketable securities can be freely bought and sold.

Short-term financing refers to borrowing funds or raising credit for a maximum of 1 year period.