Which Of The Following Best Demonstrates Cash Flow From Operations Working Capital Management

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Working Capital Management

Financial management decisions are divided into management of assets (investments) and liabilities (funding sources), long-term and short-term. It is common knowledge that the value of a company cannot be maximized in the long term if it cannot survive in the short term. Businesses most often fail because they are unable to meet their working capital needs; consequently, good working capital management is a prerequisite for the survival of the company.

About 60 percent of a finance manager’s time is devoted to working capital management, and many potential employees in finance-related fields will learn that their first job assignment will involve working capital. For these reasons, the policy and management of working capital is an important topic of study. In many textbooks, working capital refers to current assets, and net working capital is defined as current assets minus current liabilities. Working capital policy refers to decisions related to the level of current assets and how they are financed, while working capital management refers to all those decisions and activities that a company undertakes to effectively manage elements of current assets.

The term working capital comes from the old Yankee trader, who would load his cart with goods and then go on his route to sell his goods. The commodity is called working capital because it is what he actually sold, or “turned,” to produce his profit. A cart and a horse were his basic assets. He generally owned a horse and cart, so they were financed with “own” capital, but he borrowed funds to buy goods. These loans were called working capital loans and had to be repaid after each trip to show the bank that the credit was solid. If the merchant was able to repay the loan, then the bank would issue another loan, and these were good banking practices. The days of the Yankee trader are long gone, but the importance of working capital remains. Current asset management and short-term financing are still two basic elements of working capital and a daily headache for financial managers.

Working capital, sometimes called gross working capital, simply refers to a company’s total current assets (current), cash, marketable securities, accounts receivable, and inventory. While long-term financial analysis is primarily concerned with strategic planning, working capital management deals with day-to-day operations. Making sure that production lines don’t stop due to lack of raw materials, that inventory doesn’t build up because production continues unchanged when sales drop, that customers pay on time and that enough cash is on hand to pay when due. Obviously, without good working capital management, no company can be efficient and profitable.

Statements about the flexibility, cost and riskiness of short-term debt versus long-term debt depend to a large extent on the type of short-term credit that is actually used. Short-term credit is defined as any obligation that is originally planned for payment within one year. There are numerous sources of short-term funds, such as accruals, accounts payable (trade credit), bank loans, and commercial paper. The main elements of short-term liabilities are creditors and bank overdrafts, and they are analyzed further.

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