Watch this with a 10-15 minute audiotrack at http://vimeo.com/novusprogram/lesson14 Working Capital Management is a very important of managing a business. By properly managing your liquid assets, you can ensure that your business can pay off its obligations and take advantage of special opportunities. The lesson also introduces the common financial ratios used to evaluate working capital management: the current ratio, the quick ratio, and the cash ratio. The Novus project is a combination of video tutorials designed to be used in conjunction with a free business simulation software program. The Novus Business and IT Program contains 36 business and IT training videos, covering basic finance, accounting, marketing, economics, business strategy, Word, Excel, and PowerPoint. Users will have an opportunity to apply the lessons in the Novus Business Simulator. Over six rounds, the user or teams will have to make decisions on capital purchases, financing, production, financing, and human resources for a microbrewery. This channel has arranged the 36 video lessons into the order in which they are meant to be used with the simulator. To watch this slideshow as a video, please go to our Vimeo page at: https://vimeo.com/novusprogram. To download our free business simulation software, please go to our SourceForge page at: http://sourceforge.net/projects/novus/.

1. Working Capital Management
Objective: To understand how efficient use of working capital affects the
profitability of businesses
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2. Working Capital
Working
= Current Assets - Current Liabilities
Capital
Cash Short-term Debt
Current portion of Long-term
Short-term Investments
Debt
Inventory Accounts Payable
Accounts Receivable
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3. Why Do Businesses Need Cash?
• Transactions
– To buy and sell things
• Protection
– To have some extra money in case something goes
wrong
• Speculation
– To take advantage of opportunities
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4. Types of Inventory
• Raw Materials
• Work in Progress
• Finished Product
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5. Working Capital: Example
Star Hat Store Balance Sheet
Dec 31 2011 Dec 31 2010
Assets
Cash 20,000 65,000 20,000
Inventory 143,600 107,000 143,600 193,600
Accounts Receivable 30,000 0 30,000
Property, Plant & Equipment (gross) 60,000 60,000
Accumulated Depreciation -10,000 0 124,600
Net Property, Plant & Equipment 50,000 60,000
Total Assets 243,600 232,000
Liabilities
Accounts Payable 64,000 32,000 64,000
Current portion of long-term debt 5,000 0 69,000
5,000
Long-term Debt 60,000 90,000
Total Liabilities 129,000 122,000
Shareholders' Equity
Paid-In Capital 110,000 110,000
Retained Earnings 4,600 0
Total Shareholders Equity 114,600 110,000
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6. Liquidity – Current Ratio
Star Hat Store Balance Sheet
Dec 31 2011 Dec 31 2010
Assets
Cash 20,000 65,000 20,000
Inventory 143,600 107,000 143,600 193,600
Accounts Receivable 30,000 0 30,000
Property, Plant & Equipment (gross) 60,000 60,000
Accumulated Depreciation -10,000 0
Net Property, Plant & Equipment 50,000 60,000 = 2.8x
Total Assets 243,600 232,000
Liabilities
Accounts Payable 64,000 32,000 64,000
Current portion of long-term debt 5,000 0 69,000
5,000
Long-term Debt 60,000 90,000
Total Liabilities 129,000 122,000
Shareholders' Equity
Paid-In Capital 110,000 110,000
Retained Earnings 4,600 0
Total Shareholders Equity 114,600 110,000
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7. Liquidity – Quick Ratio
Star Hat Store Balance Sheet
Dec 31 2011 Dec 31 2010
Assets
Cash 20,000 65,000 20,000
Inventory 143,600 107,000 50,000
Accounts Receivable 30,000 0 30,000
Property, Plant & Equipment (gross) 60,000 60,000
Accumulated Depreciation -10,000 0
Net Property, Plant & Equipment 50,000 60,000 = 20.7x
Total Assets 243,600 232,000
Liabilities
Accounts Payable 64,000 32,000 64,000
Current portion of long-term debt 5,000 0 69,000
5,000
Long-term Debt 60,000 90,000
Total Liabilities 129,000 122,000
Shareholders' Equity
Paid-In Capital 110,000 110,000
Retained Earnings 4,600 0
Total Shareholders Equity 114,600 110,000
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8. Measuring Efficiency:
Inventory Turnover Ratio
Cost of Goods Sold
Inventory Turnover =
Average Inventory
Or, another way
Cost of Goods Sold
Inventory Turnover =
(Beginning Inventory + Ending Inventory) / 2
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9. Measuring Efficiency:
Inventory Turnover
Star Hat Store Income Statement Star Hat Store Balance Sheet
Year Ending Year Ending 31-Dec-11 31-Dec-10
31-Dec-2011 31-Dec-2010 Assets
Cash 20,000 65,000
Sales 100,000 80,000 Inventory 143,600 107,000
Cost of Goods Sold - 65,000 55,000 Accounts Receivable 30,000 20,000
Property, Plant & Equipment (gross) 60,000 60,000
Gross Income = 35,000 25,000 Accumulated Depreciation -10,000 0
Selling General and - 15,000 15,000 Net Property, Plant & Equipment 50,000 60,000
Admin Expenses Total Assets 243,600 232,000
Liabilities
Operating Income = 20,000 10,000 Accounts Payable 64,000 32,000
Other Income and Exp - 8,000 8,000 Current portion of long-term debt 5,000 0
Long-term Debt 60,000 90,000
Pre-Tax Income = 12,000 2,000 Total Liabilities 129,000 122,000
Taxes - 2,400 400 Shareholders' Equity
Paid-In Capital 110,000 110,000
Net Income = 9,600 1,600 Retained Earnings 4,600 0
Total Shareholders Equity 114,600 110,000
Inventory 65,000
= = 50%
Turnover ( 143,600 + 107,000 ) / 2
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10. Measuring Efficiency:
Inventory Turnover in Days
Inventory 365
=
Turnover (in days) Inventory Turnover Ratio
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11. Measuring Efficiency:
Inventory Turnover
Star Hat Store Income Statement Star Hat Store Balance Sheet
Year Ending Year Ending 31-Dec-11 31-Dec-10
31-Dec-2011 31-Dec-2010 Assets
Cash 20,000 65,000
Sales 100,000 80,000 Inventory 143,600 107,000
Cost of Goods Sold - 65,000 55,000 Accounts Receivable 30,000 20,000
Property, Plant & Equipment (gross) 60,000 60,000
Gross Income = 35,000 25,000 Accumulated Depreciation -10,000 0
Selling General and - 15,000 15,000 Net Property, Plant & Equipment 50,000 60,000
Admin Expenses Total Assets 243,600 232,000
Liabilities
Operating Income = 20,000 10,000 Accounts Payable 64,000 32,000
Other Income and Exp - 8,000 8,000 Current portion of long-term debt 5,000 0
Long-term Debt 60,000 90,000
Pre-Tax Income = 12,000 2,000 Total Liabilities 129,000 122,000
Taxes - 2,400 400 Shareholders' Equity
Paid-In Capital 110,000 110,000
Net Income = 9,600 1,600 Retained Earnings 4,600 0
Total Shareholders Equity 114,600 110,000
Inventory 65,000 Inventory 365
= = 50% Turnover (in = = 730 days
Turnover ( 143,600 + 107,000 ) / 2 0.5
days)
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12. Measuring Efficiency:
Accounts Receivable Turnover Ratio
Sales
Accounts Receivable Turnover =
Average Accounts Receivable
or
Sales
Accounts Receivable Turnover =
(Beginning Receivables + Ending Receivables) / 2
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13. Measuring Efficiency:
Accounts Receivable Turnover Ratio
Star Hat Store Income Statement Star Hat Store Balance Sheet
Year Ending Year Ending 31-Dec-11 31-Dec-10
31-Dec-2011 31-Dec-2010 Assets
Cash 20,000 65,000
Sales 100,000 80,000 Inventory 143,600 107,000
Cost of Goods Sold - 65,000 55,000 Accounts Receivable 30,000 20,000
Property, Plant & Equipment (gross) 60,000 60,000
Gross Income = 35,000 25,000 Accumulated Depreciation -10,000 0
Selling General and - 15,000 15,000 Net Property, Plant & Equipment 50,000 60,000
Admin Expenses Total Assets 243,600 232,000
Liabilities
Operating Income = 20,000 10,000 Accounts Payable 64,000 32,000
Other Income and Exp - 8,000 8,000 Current portion of long-term debt 5,000 0
Long-term Debt 60,000 90,000
Pre-Tax Income = 12,000 2,000 Total Liabilities 129,000 122,000
Taxes - 2,400 400 Shareholders' Equity
Paid-In Capital 110,000 110,000
Net Income = 9,600 1,600 Retained Earnings 4,600 0
Total Shareholders Equity 114,600 110,000
Accounts Receivable 100,000
= = 4.0x
Turnover ( 30,000 + 20,000 ) / 2
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14. Measuring Efficiency:
Collection Period
Collection 365
=
Period (in days) Accounts Receivable Turnover
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15. Measuring Efficiency:
Collection Period
Star Hat Store Income Statement Star Hat Store Balance Sheet
Year Ending Year Ending 31-Dec-11 31-Dec-10
31-Dec-2011 31-Dec-2010 Assets
Cash 20,000 65,000
Sales 100,000 80,000 Inventory 143,600 107,000
Cost of Goods Sold - 65,000 55,000 Accounts Receivable 30,000 20,000
Property, Plant & Equipment (gross) 60,000 60,000
Gross Income = 35,000 25,000 Accumulated Depreciation -10,000 0
Selling General and - 15,000 15,000 Net Property, Plant & Equipment 50,000 60,000
Admin Expenses Total Assets 243,600 232,000
Liabilities
Operating Income = 20,000 10,000 Accounts Payable 64,000 32,000
Other Income and Exp - 8,000 8,000 Current portion of long-term debt 5,000 0
Long-term Debt 60,000 90,000
Pre-Tax Income = 12,000 2,000 Total Liabilities 129,000 122,000
Taxes - 2,400 400 Shareholders' Equity
Paid-In Capital 110,000 110,000
Net Income = 9,600 1,600 Retained Earnings 4,600 0
Total Shareholders Equity 114,600 110,000
Accounts Receivable 100,000 Collection 365
= = 4.0x = = 91 days
Turnover ( 30,000 + 20,000 ) / 2 Period (in days) 4.0
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16. Measuring Efficiency:
Accounts Payable Turnover Ratio
Cost of Goods Sold
Accounts Receivable Turnover =
Average Accounts Payable
or
Cost of Goods Sold
Accounts Receivable Turnover =
(Beginning Payables + Ending Payables) / 2
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17. Measuring Efficiency:
Accounts Payable Turnover Ratio
Star Hat Store Income Statement Star Hat Store Balance Sheet
Year Ending Year Ending 31-Dec-11 31-Dec-10
31-Dec-2011 31-Dec-2010 Assets
Cash 20,000 65,000
Sales 100,000 80,000 Inventory 143,600 107,000
Cost of Goods Sold - 65,000 55,000 Accounts Receivable 30,000 20,000
Property, Plant & Equipment (gross) 60,000 60,000
Gross Income = 35,000 25,000 Accumulated Depreciation -10,000 0
Selling General and - 15,000 15,000 Net Property, Plant & Equipment 50,000 60,000
Admin Expenses Total Assets 243,600 232,000
Liabilities
Operating Income = 20,000 10,000 Accounts Payable 64,000 32,000
Other Income and Exp - 8,000 8,000 Current portion of long-term debt 5,000 0
Long-term Debt 60,000 90,000
Pre-Tax Income = 12,000 2,000 Total Liabilities 129,000 122,000
Taxes - 2,400 400 Shareholders' Equity
Paid-In Capital 110,000 110,000
Net Income = 9,600 1,600 Retained Earnings 4,600 0
Total Shareholders Equity 114,600 110,000
Accounts Receivable 65,000
= = 1.4x
Turnover ( 64,000 + 32,000 ) / 2
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18. Measuring Efficiency:
Accounts Payable Turnover (in days)
Collection 365
=
Period (in days) Accounts Receivable Turnover
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19. Measuring Efficiency:
Accounts Payable Turnover (in days)
Star Hat Store Income Statement Star Hat Store Balance Sheet
Year Ending Year Ending 31-Dec-11 31-Dec-10
31-Dec-2011 31-Dec-2010 Assets
Cash 20,000 65,000
Sales 100,000 80,000 Inventory 143,600 107,000
Cost of Goods Sold - 65,000 55,000 Accounts Receivable 30,000 20,000
Property, Plant & Equipment (gross) 60,000 60,000
Gross Income = 35,000 25,000 Accumulated Depreciation -10,000 0
Selling General and - 15,000 15,000 Net Property, Plant & Equipment 50,000 60,000
Admin Expenses Total Assets 243,600 232,000
Liabilities
Operating Income = 20,000 10,000 Accounts Payable 64,000 32,000
Other Income and Exp - 8,000 8,000 Current portion of long-term debt 5,000 0
Long-term Debt 60,000 90,000
Pre-Tax Income = 12,000 2,000 Total Liabilities 129,000 122,000
Taxes - 2,400 400 Shareholders' Equity
Paid-In Capital 110,000 110,000
Net Income = 9,600 1,600 Retained Earnings 4,600 0
Total Shareholders Equity 114,600 110,000
Accounts Receivable 65,000 Accounts Payable 365
= = 1.4x Turnover (in = = 269 days
Turnover ( 64,000 + 32,000 ) / 2 days) 1.4
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