| An important tool companies adopt to send a | | | | becomes lean enough cutting costs will become |
| message to the investors that the company means | | | | detrimental to its operations. |
| business is to cut capital expenditure and reduce | | | | Another attribute that strongly impacts working |
| non-core assets. Usually this is met with more | | | | capital is sales. It is the ability of a company to sell its |
| investment or better stock price from the market. | | | | products fast enough to get the money back to put |
| What is the message that the investors are receiving | | | | back into operations or supplies for producing more |
| that entices such a reaction? Usually, the message | | | | materials. Moving inventory fast is always a good plan |
| means that the company is trying to reduce cost and | | | | for a company. It also helps in reducing costs |
| become more efficient. They are indicating that the | | | | associated with holding and moving inventory. A good |
| company is trying to get more assets available that | | | | ratio that helps put the attribute in perspective is |
| they can use for operational expenses in the short | | | | inventory turnover ratio. |
| term for their financial health. In financial metrics this | | | | Inventory turnover ratio= sales / inventory |
| means increasing the current assets or decreasing | | | | Alternatively, |
| current liabilities. | | | | Inventory turnover ratio = Cost of goods sold / |
| A good measure to identify this is the Working | | | | inventory |
| Capital (WC). | | | | The ratio shows the efficiency the company has in |
| Working Capital = current assets - current liabilities. | | | | selling its products. The higher the ratio the better |
| Current assets are cash and other assets that can | | | | the company is able to move the products. Again this |
| be converted to cash within a year. Current liabilities | | | | could be dictated by the industry, for example, a |
| are obligations that the company plans to pay off | | | | daily products company is usually forced to sell its |
| within the year. Working capital indicates the assets | | | | products fast enough or lose it. The ratio also |
| the company has at its disposal for current expenses. | | | | provides a good insight into how a company is doing |
| It can be thought as the circulating capital of a | | | | within an industry. The direct ratio of companies can |
| business. The process of managing the WC efficiently | | | | be compared to see how well the company is able to |
| is called Working capital Management. It's one of the | | | | sell the products in comparison to its competitors. |
| important aspects of financial management. An | | | | Financing is another attribute of Working Capital |
| excess of working capital many mean that the | | | | management. Companies tend to finance their way |
| company is not managing its assets efficiently. It's | | | | out of a need for short term expenses by taking |
| not using its assets to get a bigger return or better | | | | loans. From the balance sheet it is clear that financing |
| profit. An aggressive company may keep its working | | | | increases liabilities, so the only option companies have |
| capital smaller. A very low working capital may mean | | | | to increase Working capital is though long-term debts |
| the company may not be suited well enough to | | | | that have a smaller impact on current liabilities. This |
| payoff its short term obligations. | | | | way their short term cash balance increases providing |
| This decision of how to manage the working capital | | | | the cushion the company needs for its short-term |
| of the company depends on the Working capital | | | | operating needs. Since obtaining long term debt |
| policy of the company. An important factor that | | | | depends on the credit rating of the company it |
| determines the policy is the industry in which the | | | | becomes difficult for smaller or newer companies to |
| company operates. For Example, an IT service | | | | use this attribute of working capital management. |
| company may not have a lot of shot-debt in terms | | | | Debt-Asset ratio provides a good insight into how |
| of inventory but it still needs to pay wages, | | | | much of the company's assets are being financed |
| insurances and other expenses like rent. The | | | | though debt |
| company needs to have a policy that makes sure it | | | | Debt-asset ratio = Total liabilities / Total assets |
| sets targets were it gets paid as the project | | | | Financing for short term operations may not |
| progresses so it can keep paying its staff in time. | | | | immediately signal an issue with the company, it may |
| The company has to manage its account receivables | | | | be that the company has realized an opportunity that |
| according to this policy. Some industries operate in a | | | | it needs to act on immediately which would increase |
| high profit margin that they can afford to have a | | | | the prospects of the company in the long term. |
| longer term on the account receivables because the | | | | Companies that have an aggressive working capital |
| higher cash balance part of the current assets. A | | | | management policy would be using this strategy. But |
| good example is a company like BP, which is able to | | | | this is always riskier since the company would |
| survive till now after the big oil spill disaster in the | | | | accumulate a lot of long-term debt that could eat |
| Gulf. | | | | away at the profits or even become so big that the |
| The Collection Ratio helps project this aspect of a | | | | interest expense can impact the current liabilities. |
| company | | | | Working capital management becomes a very |
| Collection Ratio = Accounts Receivable/ (Revenue/ | | | | important aspect for a company since it is the first |
| 365) | | | | line of defense against market downturn cycles and |
| Collection ratio tells us the average number of days it | | | | recession. A company with cash is usually in a good |
| takes a company to collect unpaid invoices. A ratio | | | | position to make better use of the opportunities the |
| which is very near to 30 days is very good since it | | | | markets provide. Its can spend the money on |
| means that the company is getting paid on a monthly | | | | R&D for coming up with better products. |
| basis. | | | | Increase in current assets, especially, increase in |
| Cutting costs and shedding non-essential assets to | | | | account receivables due to growth is sales have to |
| make the company leaner is one of the attributes of | | | | be managed efficiently. Ability to control working |
| working capital management. But this strategy cannot | | | | capital plays a significant role in the survival of the |
| be sustained. The company cannot keep cutting | | | | company. |
| costs without sacrificing service. Once the company | | | | |