1. 1 Chapter 14 Working Capital Management Key Sections (pages 441 - 446) Risk/return trade-offs in Working Capital Management Hedging principle

2. 2 Introduction Net WC – current assets less current liabilities Liquidity management – establish current asset and liability levels so firm can meet its obligations Short-term – under one year. How much and from what sources? On average, 15% of sales in working capital

3. 3 Current Liabilities Advantages –Flexibility –Lower interest cost on short-term debt Disadvantages - Causes increase in risk of illiquidity especially if financial condition deteriorates - Uncertain interest costs year to year

4. 4 Risk/Return Trade-off Liquidity versus Profitability Large current assets reduce risk of production stoppages, lost sales and inability to pay bills But as WC , no increase in returns –With no increase in profits, ROI drops Greater reliance on current liabilities, greater risk of illiquidity

5. 5 Short-term, Long-term Trade-offs Risk of illiquidity –What happens if can’t obtain or roll over S-T debt? –Xerox, GM, Ford, etc as ratings deteriorated S-T less costly than L-T and more flexible Uncertainty of interest costs from year to year Trade-off – increased risk of illiquidity versus increased profitability

6. 6 Sources of Financing Assets – temporary (seasonal) or permanent Spontaneous sources – arise in normal course of business Trade credit – accounts payable Other payables and accruals Discretionary sources – from an explicit decision by management, both short and long-term borrowings

7. 7 Hedging Principle Maturity should follow cash flows of asset being financed - S-T Financing should be self-liquidating After spontaneous sources used, finance - Temporary assets with current liabilities. - Permanent assets with permanent financing, including permanent part of working capital

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9. 9 Hedging Principle