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Chapter 5 FINANCING CURRENT OPERATIONS, RATIO AND CREDIT ANALYSIS Current financing encompasses managing and utilizing current assets, and incurring and repaying current debt. The current assets of a firm differ from fixed assets; these differences are not abrupt but represent a continuum. The current assets (cash, receivables, inventory, etc.) support the short-run operations of the business. Current assets are what the classical economists called “circulating capital.” Within the current asset grouping, however, some items remain in the firm’s possession longer than others.
1.
WORKING CAPITAL CONCEPTS
The reader was introduced the firm’s annual cash flow statement in the previous chapter. This chapter integrates current asset management, sources and uses of funds, and ratio analysis. In financial terminology the total current assets, primarily cash, and other items likely to be turned into cash within the year, is called the gross working capital of the firm. The current assets of the firm, less the current liabilities, are the net working capital of the firm. When the term working capital is used, net is usually intended. The net working capital of the firm is an important aspect of its financial strength. It represents the current assets, not offset by current creditor claims, that can be used to meet unexpected expenditures, absorb irregularities in the firm’s cash flow, and cushion any short-run interruption, seasonality, or lumpiness in the flow of funds through the firm.1 In addition, adequate working capital allows the firm to make especially opportune purchases and to take advantage of immediate expansion possibilities. Net working capital is not to be confused with cash, but it functions similarly as a sort of generalized short-term working balance for the firm. How much net working capital a firm should carry depends on many factors. Generally, the net working capital a firm carries depends on its sales volume, its needs for gross circulating capital relative to its sales volume, and the stability of its operations. A firm can increase its rate of
1.
WORKING CAPITAL CONCEPTS
The reader was introduced the firm’s annual cash flow statement in the previous chapter. This chapter integrates current asset management, sources and uses of funds, and ratio analysis. In financial terminology the total current assets, primarily cash, and other items likely to be turned into cash within the year, is called the gross working capital of the firm. The current assets of the firm, less the current liabilities, are the net working capital of the firm. When the term working capital is used, net is usually intended. The net working capital of the firm is an important aspect of its financial strength. It represents the current assets, not offset by current creditor claims, that can be used to meet unexpected expenditures, absorb irregularities in the firm’s cash flow, and cushion any short-run interruption, seasonality, or lumpiness in the flow of funds through the firm.1 In addition, adequate working capital allows the firm to make especially opportune purchases and to take advantage of immediate expansion possibilities. Net working capital is not to be confused with cash, but it functions similarly as a sort of generalized short-term working balance for the firm. How much net working capital a firm should carry depends on many factors. Generally, the net working capital a firm carries depends on its sales volume, its needs for gross circulating capital relative to its sales volume, and the stability of its operations. A firm can increase its rate of
