Working Capital
Working capital is a company’s short term assets, which include cash, inventory, and accounts receivable, minus the short term liabilities, which include accounts payable and short term notes. Short term creditors usually look at the current ratio to determine if a company has the ability to pay off current dept within the agreed terms. The current ratio = current assets / current liabilities and the higher the value, the better for short term creditors. If the current ratio is less than 1, a company may not have the ability to pay the short term liabilities on time which would make it difficult to obtain financing if needed. Organizations should not allow their inventory levels to increase to high level because this would cause a lot of the working capital to be tied up in inventory which is harder to turn into cash if needed. High inventories usually mean several things including that management over estimated sales, had a reduction in sales, or are not controlling operations, which causes a reduction in operating cash flows. We can measure liquidity by the quick ratio which is current assets – inventory / current liabilities. Organizations should plan to keep on hand enough cash to cover all expenses, including payroll, for 3 to 6 months which will allow the ability to withstand the ups and downs in the market without causing great harm to the company.
Some organizations should look at the financial policies and make adjustments to better manage the company’s needs. If a company has notes that are due in the coming year, they should look at ways to increase cash and increase the number of times they turn over the inventory. Some ways that can be used to increase cash which will give more money to pay off short term dept include increasing the long term dept through borrowing, increasing equity through the sale of some stock, increasing current liabilities, decreasing current assets except for cash, and decreasing some fixed assets. Organizations may consider the cash cycle and find ways in which they can decrease the period, which will make the company stronger. A lower cash cycle means that a company has less invested in inventory and receivables which increase the turnover rate. The operating cash flow is one of the best measures to see how well a company is doing and by finding ways which will increase cash, a company will be in a better position to obtain financing or have cash to pay off our short term depts.
Some of the key ratios that should be considered include working capital, current ratio, operating cycle, cash cycle, and the quick ratio. As I have stated, working capital is short term assets which include cash, inventory, and accounts receivable minus the short term liabilities which include accounts payable and short term notes. The current ratio = current assets / current liabilities and the quick ratio is current assets – inventory / current liabilities. The operating cycle is the acquisition of inventory and the collection of cash from receivables: operating cycle = inventory period + accounts receivable period. The operating cycle lets us know how long it takes for a company to convert raw inventory to a product, sell the product, and collect the cash for the product. The cash cycle is the time between cash disbursement and cash collection: cash cycle = operating cycle – accounts payable period. It is good to know the ratios so sound decisions based on accurate information can be made to gain a competitive advantage in the market.
Organizations should maintain a flexible financial policy by managing current assets and current liabilities. By managing cash flows, a company should be able to save money which will increase the profits. Organizations need to be careful not to keep to much cash on hand due to the fact that the cash is not earning money in the bank. Companies also need to watch current assets and current liabilities and find the best combination to increase cash flow. If additional cash is required, companies should know the best sources to raise capital for their needs and how they are going to pay the dept.
J. Taylor
Some organizations should look at the financial policies and make adjustments to better manage the company’s needs. If a company has notes that are due in the coming year, they should look at ways to increase cash and increase the number of times they turn over the inventory. Some ways that can be used to increase cash which will give more money to pay off short term dept include increasing the long term dept through borrowing, increasing equity through the sale of some stock, increasing current liabilities, decreasing current assets except for cash, and decreasing some fixed assets. Organizations may consider the cash cycle and find ways in which they can decrease the period, which will make the company stronger. A lower cash cycle means that a company has less invested in inventory and receivables which increase the turnover rate. The operating cash flow is one of the best measures to see how well a company is doing and by finding ways which will increase cash, a company will be in a better position to obtain financing or have cash to pay off our short term depts.
Some of the key ratios that should be considered include working capital, current ratio, operating cycle, cash cycle, and the quick ratio. As I have stated, working capital is short term assets which include cash, inventory, and accounts receivable minus the short term liabilities which include accounts payable and short term notes. The current ratio = current assets / current liabilities and the quick ratio is current assets – inventory / current liabilities. The operating cycle is the acquisition of inventory and the collection of cash from receivables: operating cycle = inventory period + accounts receivable period. The operating cycle lets us know how long it takes for a company to convert raw inventory to a product, sell the product, and collect the cash for the product. The cash cycle is the time between cash disbursement and cash collection: cash cycle = operating cycle – accounts payable period. It is good to know the ratios so sound decisions based on accurate information can be made to gain a competitive advantage in the market.
Organizations should maintain a flexible financial policy by managing current assets and current liabilities. By managing cash flows, a company should be able to save money which will increase the profits. Organizations need to be careful not to keep to much cash on hand due to the fact that the cash is not earning money in the bank. Companies also need to watch current assets and current liabilities and find the best combination to increase cash flow. If additional cash is required, companies should know the best sources to raise capital for their needs and how they are going to pay the dept.
J. Taylor
posted by J. Taylor's Blog at 1:13 AM
2 Comments:
If only the NC state government operated the way private businesses do. While the private sector operates in a capitalist system, the government behaves like a college kid with his first credit card.
I got this in my e-mail and it's an important story for NC taxpayers and business leaders:
Time For Leadership on NC budget
By North Carolina State Senator Fred Smith
During the 2006 election, many candidates for office faced questions from voters about the increasing size of North Carolina state government. Questions about the fiscal responsibility of the Easley Administration and Democratic legislative leaders are timely. The past ten years, General Fund spending has grown 24% faster than combined inflation and population growth – translating into a $1,116 increase in real dollars for a typical North Carolina family.(1)
State government spending continues to be out of control with a projected $500 Million revenue shortfall in 2007. The most recent state budget increased spending 9.7%, on top of an 8% increase last year. The failure of the Democratic legislature and Governor Easley to prioritize and control spending has resulted in millions of dollars of inefficient expenditures – instead of worthwhile investments like educating our children or building and maintaining roads. Ultimately, this careless, undisciplined spending has also forced North Carolina to impose on its citizens the highest tax burden in the southeast. Meanwhile, the local tax burden is also increasing.(2) Irresponsible year-after-year increases in spending strain family budgets, stifle private sector growth and damage the ability of small businesses and entrepreneurs to create new jobs.
Even Lt. Gov. Perdue, one of the most liberal Democratic officeholders in our state's history, seems to recognize the problem. She recently penned an email to supporters touting her hot new "reform" idea: a permanent state efficiency commission. The commission, she says, would "present a maximum of ten separate governmental efficiency proposals" to "counter the pressures in the system favoring wasteful spending and loopholes."(3)
Taken as a stand-alone plan, her proposal is not a bad idea. However, Perdue's latest press release misses the larger point. The failure to control spending isn't for lack of boards, commissions, or processes – it's for lack of leadership. The governor already has the power to appoint advisors or seek outside counsel on fiscal issues – or any other state problem. The governor has the veto power on the budget. He controls the Office of State Budget and Management. He has the bully pulpit.
On the campaign trail in 2004, Gov. Easley's "solution" to the spending problem was a self-enforced spending cap. During the 2005-2006 General Assembly, Easley promptly broke that pledge by signing two budgets that blew through his own cap. Now, Perdue has the magic bullet: her permanent efficiency commission. She says the group will create the "institutional momentum" needed to fight spending. Why add a new commission to the over four hundred boards and commissions already in existence, rather than just rolling up our sleeves and tackling the spending problem? Real leaders take excuses off the table, use the tools they have and get the job done.
Some skeptics may look at Perdue's record and fear that her efficiency commission proposal is just political lip service. She can prove the skeptics wrong though by signing on to support the constitutional amendment I have introduced to cap state spending growth.
Our rapidly growing, rapidly changing state doesn't have time for bureaucratic piddling with new processes. Instead of tinkering with the system, we must make real change which requires leadership. My Taxpayer Protection Amendment limits government spending growth to inflation and population growth. This legislation would immediately put real limits on government growth, finally forcing the legislature to prioritize spending.
Talking about fiscal restraint, finding government efficiencies, and getting tough on spending is a lot like talking about going on a diet. There are a lot of gimmicks and new fads, but we all know there's only one real solution: discipline. We don't need a new "fad" plan, we just need a leader with the discipline to make sure government eats less and exercises more. A constitutional spending cap would force government to create a strategic plan for growth, prioritizing what we consume and cutting outmoded, irrelevant spending.
We don't need a new blue ribbon commission. We don't need to pass the buck. We need results – and that takes disciplined leaders who will roll up their sleeves and make tough decisions. At the end of the day, improving government efficiency and reducing unnecessary spending reduces the demand that government places on the private sector, so the private sector can create jobs and economic growth.
(1) "The State Budget." John Locke Foundation: http://www.johnlocke.org/agenda2006/statebudget.html
(2) Lowrey, Michael. "By the Numbers: What Government Costs in North Carolina Cities and Counties." The Center for Local Innovation. http://www.johnlocke.org/acrobat/policyReports/btn2006.pdf
(3) Perdue News Update, December 29, 2006.
And you definitely need to understand working capital in oder to avoid needing working capital loans, which no one wants.
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