last source, reorganization through bankruptcy, may also be considered a liquidity tool because a
KCA UNIVERSITY company under bankruptcy protection that generates operating cash will be liquid and generally
FINANCIAL MANAGEMENT able to continue business operations until a restructuring has been devised and approved.
WORKING CAPITAL MANAGEMENT
Drags and Pulls on Liquidity
______________________________________________________________________________
Cash flow transactions—that is, cash receipts and disbursements—have significant effects on a
MANAGING AND MEASURING LIQUIDITY company’s liquidity position. We refer to these effects as drags and pulls on liquidity.
Liquidity is the extent to which a company is able to meet its short-term obligations using assets A drag on liquidity is when receipts lag, creating pressure from the decreased available funds.
that can be readily transformed into cash. A pull-on liquidity is when disbursements are paid too quickly or trade credit availability is limited,
Defining Liquidity Management requiring companies to expend funds before they receive funds from sales that could cover the
Liquidity management refers to the ability of an organization to generate cash when and where it liability.
is needed. Liquidity refers to the resources available for an entity to tap into cash balances and to Major drags on receipts involve pressures from credit management and deterioration in other
convert other assets or extend other liabilities into cash for use in keeping the entity solvent (i.e., assets and include:
being able to pay bills and continue in operation). Uncollected receivables. The longer these are outstanding, the greater the risk that they
The challenges of managing liquidity include developing, implementing, and maintaining a liquidity will not be collected at all. They are indicated by the large number of days of receivables
policy. To do this effectively, a company must manage all of its key sources of liquidity efficiently. and high levels of bad debt expenses. Just as the drags on receipts may cause increased
pressures on working capital, pulls on outgoing payments may have similar effects.
These key sources may vary from company to company, but they generally include the primary
Obsolete inventory. If inventory stands unused for long periods, it may be an indication
sources of liquidity, such as cash balances, and secondary sources of liquidity, such as selling assets.
that it is no longer usable. Slow inventory turnover ratios can also indicate obsolete
Primary Sources of Liquidity
inventory.
Primary sources of liquidity represent the most readily accessible resources available. They may be Once identified, obsolete inventory should be attended to as soon as possible in order
held as cash or as near-cash securities. Primary sources include:
to minimize storage and other costs.
Ready cash balances, which is cash available in bank accounts, resulting from payment
Tight credit. When economic conditions make capital scarcer, short-term debt becomes
collections, investment income, liquidation of near-cash securities (i.e., those with more expensive to arrange and use. Attempting to smooth out peak borrowings can help
maturities of less than 90 days), and other cash flows.
blunt the impact of tight credit as can improving the company’s collections.
Short-term funds, which may include items such as trade credit, bank lines of credit, and
short-term investment portfolios. In many cases, drags may be alleviated by stricter enforcement of credit and collection practices.
Cash flow management, which is the company’s effectiveness in its cash management However, managing the cash outflows may be as important as managing the inflows. If suppliers
system and practices, and the degree of decentralization of the collections or payments and other vendors who offer credit terms perceive a weakened financial position or are unfamiliar
processes. The more decentralized the system of collections, for example, the more with a company, they may restrict payment terms so much that the company’s liquidity reserves
likely the company will be to have cash tied up in the system and not available for use. are stretched thin.
Secondary Sources of Liquidity Major pulls on payments include:
The main difference between the primary and secondary sources of liquidity is that using a primary Making payments early. By paying vendors, employees, or others before the due dates,
source is not likely to affect the normal operations of the company, whereas using a secondary companies forgo the use of funds. Effective payment management means not making
early payments.
source may result in a change in the company’s financial and operating positions.
Payables managers typically hold payments until they can be made by the due date.
Secondary sources include:
Reduced credit limits. If a company has a history of making late payments, suppliers may
Negotiating debt contracts, relieving pressures from high interest payments or principal
cut the amount of credit they will allow to be outstanding at any time, which can squeeze
repayments.
the company’s liquidity. Some companies try to extend payment periods as long as
Liquidating assets, which depends on the degree to which short-term and/or long-term
possible, disregarding the possible impact of reduced credit limits.
assets can be liquidated and converted into cash without substantial loss in value.
Limits on short-term lines of credit. If a company’s bank reduces the line of credit it
Filing for bankruptcy protection and reorganization.
offers the company, a liquidity squeeze may result. Credit line restrictions may be
Use of secondary sources may signal a company’s deteriorating financial health and provide government mandated, market-related, or simply company-specific. Many companies
liquidity at a high price—the cost of giving up a company asset to produce emergency cash. The try to avert this situation by establishing credit lines far in excess of what they are likely
to need. This “overbanking” approach is often commonplace in emerging economies or
1
, even in more developed countries where the banking system is not sound and the Current liabilities are those claims of outsiders which are expected to mature for payment
economy is shaky. within an accounting year and include creditors, bills payables, and outstanding expenses.
Low liquidity positions. Many companies face chronic liquidity shortages, often because Net working capital can be positive or negative. A positive net working capital will arise
of their particular industry or from their weaker financial position. The major remedy for when current assets exceed current liabilities. A negative Net working capital occurs when current
this situation is, of course, to improve the company’s financial position, or else the liabilities are in excess of current assets.
company will be heavily affected by interest rates and credit availability. Most
Net Working Capital = Current Assets - Current Liabilities
companies facing this situation have to deal with secured borrowing to obtain any
Definitions Favoring Net Working Capital Concept:-
working capital funds.
According to C.W.Gestenbergh
"It has ordinarily been defined as the excess of current assets over current liabilities".
Meaning and Types of Finance:
Finance- Finance is the Art & Science of Managing Money . It is the Art of passing currency from According to Lawrence. J. Gitmen
hand to hand until it finally disappears " The most common definition of net working capital is the difference of firm's current assets and
current liabilities".
Types & Sources of Finance
Classification of Working Capital
Long Term Sources of Finance
- Finance required to meet Capital Expenditure. Also, known as Fixed Capital Finance (1) On the Basis of Concept: -
Short Term Sources of Finance (i) Gross Working Capital
(ii) Net Working Capital
- Finance required to meet day-to-day Business requirements. Also, known as Working Capital
(2) On the Basis of time or Need:-
Meaning of Working capital (i) Permanent Working Capital
Working Capital is the amount of Capital that a Business has available to meet the day-to-day cash (ii) Temporary Working Capital /Seasonal working capital
requirements of its operations
II. On the basis of time or need
Working Capital is the difference between resources in cash or readily convertible into cash
(Current Assets) and organizational commitments for which cash will soon be required (Current (1) Permanent or Fixed Working Capital:-
Liabilities) .It refers to the amount of Current Assets that exceeds Current Liabilities (i.e. CA - CL) The need for working capital fluctuates from time to time. However, to carry on day-to-day
operations of the business without any obstacles, a certain minimum level of raw materials,
- Working Capital refers to that part of the firm’s Capital, which is required for Financing Short-
work-in-progress, finished goods and cash must be maintained on a continuous basis. The amount
Term or Current Assets such as Cash, Marketable Securities, Debtors and Inventories.
-Working Capital is also known as Revolving or Circulating Capital or Short-Term Capital needed to maintain current assets on this minimum level is called permanent or regular working
capital.
Concepts of Working Capital:- The amount involved as permanent working capital has to be meet from long-term sources
of finance, e.g.
There are two concepts of working capital-
(i) Capital
(1) Gross Working Capital Concept
(2) Net Working Capital Concept. (ii) Debentures
(iii) Long-term loans.
(1) Gross working capital:
(2) Temporary or Variable or Fluctuating Working Capital
Gross working capital; refers to firm's investment in current assets. Current assets are the assets
which can be converted into cash within an accounting year and include cash, short-term Depending upon the changes in production and sales, the need for working capital, over and above
securities, debtors, bill receivables and stock. the permanent level of working capital is called temporary, fluctuating or variable working capital.
It may be two types:-
According to this concept, working capital means Gross working Capital which is the total of all
(a)Seasonal-Due to seasonal changes, level of business activities is higher than normal during
current assets of a business. It can be represented by the following equation:
Gross Working Capital = Total Current Assets some months of year and therefore additional working capital will be required along with the
Definitions favoring this concept are:- permanent working capital. It is so because during peak season, demand rises and more stock is
to be maintained to meet the demand.
According to Mead, Mallot and Field :
(b) Special- Additional doses of working capital may be required to face cut throat competition in
"Working Capital means total of Current Assets".
the market or other contingencies like strikes, lock outs, theft etc.
(2) Net Working Capital Concept:
Net working capital refers to the difference between current assets and current liabilities. ADEQUATE WORKING CAPITAL:
2
KCA UNIVERSITY company under bankruptcy protection that generates operating cash will be liquid and generally
FINANCIAL MANAGEMENT able to continue business operations until a restructuring has been devised and approved.
WORKING CAPITAL MANAGEMENT
Drags and Pulls on Liquidity
______________________________________________________________________________
Cash flow transactions—that is, cash receipts and disbursements—have significant effects on a
MANAGING AND MEASURING LIQUIDITY company’s liquidity position. We refer to these effects as drags and pulls on liquidity.
Liquidity is the extent to which a company is able to meet its short-term obligations using assets A drag on liquidity is when receipts lag, creating pressure from the decreased available funds.
that can be readily transformed into cash. A pull-on liquidity is when disbursements are paid too quickly or trade credit availability is limited,
Defining Liquidity Management requiring companies to expend funds before they receive funds from sales that could cover the
Liquidity management refers to the ability of an organization to generate cash when and where it liability.
is needed. Liquidity refers to the resources available for an entity to tap into cash balances and to Major drags on receipts involve pressures from credit management and deterioration in other
convert other assets or extend other liabilities into cash for use in keeping the entity solvent (i.e., assets and include:
being able to pay bills and continue in operation). Uncollected receivables. The longer these are outstanding, the greater the risk that they
The challenges of managing liquidity include developing, implementing, and maintaining a liquidity will not be collected at all. They are indicated by the large number of days of receivables
policy. To do this effectively, a company must manage all of its key sources of liquidity efficiently. and high levels of bad debt expenses. Just as the drags on receipts may cause increased
pressures on working capital, pulls on outgoing payments may have similar effects.
These key sources may vary from company to company, but they generally include the primary
Obsolete inventory. If inventory stands unused for long periods, it may be an indication
sources of liquidity, such as cash balances, and secondary sources of liquidity, such as selling assets.
that it is no longer usable. Slow inventory turnover ratios can also indicate obsolete
Primary Sources of Liquidity
inventory.
Primary sources of liquidity represent the most readily accessible resources available. They may be Once identified, obsolete inventory should be attended to as soon as possible in order
held as cash or as near-cash securities. Primary sources include:
to minimize storage and other costs.
Ready cash balances, which is cash available in bank accounts, resulting from payment
Tight credit. When economic conditions make capital scarcer, short-term debt becomes
collections, investment income, liquidation of near-cash securities (i.e., those with more expensive to arrange and use. Attempting to smooth out peak borrowings can help
maturities of less than 90 days), and other cash flows.
blunt the impact of tight credit as can improving the company’s collections.
Short-term funds, which may include items such as trade credit, bank lines of credit, and
short-term investment portfolios. In many cases, drags may be alleviated by stricter enforcement of credit and collection practices.
Cash flow management, which is the company’s effectiveness in its cash management However, managing the cash outflows may be as important as managing the inflows. If suppliers
system and practices, and the degree of decentralization of the collections or payments and other vendors who offer credit terms perceive a weakened financial position or are unfamiliar
processes. The more decentralized the system of collections, for example, the more with a company, they may restrict payment terms so much that the company’s liquidity reserves
likely the company will be to have cash tied up in the system and not available for use. are stretched thin.
Secondary Sources of Liquidity Major pulls on payments include:
The main difference between the primary and secondary sources of liquidity is that using a primary Making payments early. By paying vendors, employees, or others before the due dates,
source is not likely to affect the normal operations of the company, whereas using a secondary companies forgo the use of funds. Effective payment management means not making
early payments.
source may result in a change in the company’s financial and operating positions.
Payables managers typically hold payments until they can be made by the due date.
Secondary sources include:
Reduced credit limits. If a company has a history of making late payments, suppliers may
Negotiating debt contracts, relieving pressures from high interest payments or principal
cut the amount of credit they will allow to be outstanding at any time, which can squeeze
repayments.
the company’s liquidity. Some companies try to extend payment periods as long as
Liquidating assets, which depends on the degree to which short-term and/or long-term
possible, disregarding the possible impact of reduced credit limits.
assets can be liquidated and converted into cash without substantial loss in value.
Limits on short-term lines of credit. If a company’s bank reduces the line of credit it
Filing for bankruptcy protection and reorganization.
offers the company, a liquidity squeeze may result. Credit line restrictions may be
Use of secondary sources may signal a company’s deteriorating financial health and provide government mandated, market-related, or simply company-specific. Many companies
liquidity at a high price—the cost of giving up a company asset to produce emergency cash. The try to avert this situation by establishing credit lines far in excess of what they are likely
to need. This “overbanking” approach is often commonplace in emerging economies or
1
, even in more developed countries where the banking system is not sound and the Current liabilities are those claims of outsiders which are expected to mature for payment
economy is shaky. within an accounting year and include creditors, bills payables, and outstanding expenses.
Low liquidity positions. Many companies face chronic liquidity shortages, often because Net working capital can be positive or negative. A positive net working capital will arise
of their particular industry or from their weaker financial position. The major remedy for when current assets exceed current liabilities. A negative Net working capital occurs when current
this situation is, of course, to improve the company’s financial position, or else the liabilities are in excess of current assets.
company will be heavily affected by interest rates and credit availability. Most
Net Working Capital = Current Assets - Current Liabilities
companies facing this situation have to deal with secured borrowing to obtain any
Definitions Favoring Net Working Capital Concept:-
working capital funds.
According to C.W.Gestenbergh
"It has ordinarily been defined as the excess of current assets over current liabilities".
Meaning and Types of Finance:
Finance- Finance is the Art & Science of Managing Money . It is the Art of passing currency from According to Lawrence. J. Gitmen
hand to hand until it finally disappears " The most common definition of net working capital is the difference of firm's current assets and
current liabilities".
Types & Sources of Finance
Classification of Working Capital
Long Term Sources of Finance
- Finance required to meet Capital Expenditure. Also, known as Fixed Capital Finance (1) On the Basis of Concept: -
Short Term Sources of Finance (i) Gross Working Capital
(ii) Net Working Capital
- Finance required to meet day-to-day Business requirements. Also, known as Working Capital
(2) On the Basis of time or Need:-
Meaning of Working capital (i) Permanent Working Capital
Working Capital is the amount of Capital that a Business has available to meet the day-to-day cash (ii) Temporary Working Capital /Seasonal working capital
requirements of its operations
II. On the basis of time or need
Working Capital is the difference between resources in cash or readily convertible into cash
(Current Assets) and organizational commitments for which cash will soon be required (Current (1) Permanent or Fixed Working Capital:-
Liabilities) .It refers to the amount of Current Assets that exceeds Current Liabilities (i.e. CA - CL) The need for working capital fluctuates from time to time. However, to carry on day-to-day
operations of the business without any obstacles, a certain minimum level of raw materials,
- Working Capital refers to that part of the firm’s Capital, which is required for Financing Short-
work-in-progress, finished goods and cash must be maintained on a continuous basis. The amount
Term or Current Assets such as Cash, Marketable Securities, Debtors and Inventories.
-Working Capital is also known as Revolving or Circulating Capital or Short-Term Capital needed to maintain current assets on this minimum level is called permanent or regular working
capital.
Concepts of Working Capital:- The amount involved as permanent working capital has to be meet from long-term sources
of finance, e.g.
There are two concepts of working capital-
(i) Capital
(1) Gross Working Capital Concept
(2) Net Working Capital Concept. (ii) Debentures
(iii) Long-term loans.
(1) Gross working capital:
(2) Temporary or Variable or Fluctuating Working Capital
Gross working capital; refers to firm's investment in current assets. Current assets are the assets
which can be converted into cash within an accounting year and include cash, short-term Depending upon the changes in production and sales, the need for working capital, over and above
securities, debtors, bill receivables and stock. the permanent level of working capital is called temporary, fluctuating or variable working capital.
It may be two types:-
According to this concept, working capital means Gross working Capital which is the total of all
(a)Seasonal-Due to seasonal changes, level of business activities is higher than normal during
current assets of a business. It can be represented by the following equation:
Gross Working Capital = Total Current Assets some months of year and therefore additional working capital will be required along with the
Definitions favoring this concept are:- permanent working capital. It is so because during peak season, demand rises and more stock is
to be maintained to meet the demand.
According to Mead, Mallot and Field :
(b) Special- Additional doses of working capital may be required to face cut throat competition in
"Working Capital means total of Current Assets".
the market or other contingencies like strikes, lock outs, theft etc.
(2) Net Working Capital Concept:
Net working capital refers to the difference between current assets and current liabilities. ADEQUATE WORKING CAPITAL:
2
