Discuss the Advantages and Disadvantages of Globalization

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CHAPTER 16 WORKING CAPITAL POLICY AND SHORT-TERM FINANCING

ANSWERS TO QUESTIONS:

1. The need for working capital arises because the normal operating cycle of the firm requires that expenditures for raw materials, labor, etc. be made prior to receipt of the funds from the sale of the output. Funds must be invested during the operating cycle in the various short-term assets that make up working capital--namely, cash, inventories, and accounts receivable.

2. The operating cycle represents the length of time involved in purchasing raw materials, manufacturing the product, and distributing (selling) the product. The cash conversion cycle represents the net time interval between the collection of cash receipts from sales and the cash payments for the various resources used by the firm. The operating cycle is equal to the sum of the inventory conversion period and the receivables conversion period. The cash conversion cycle is equal to the operating cycle less the payables deferral period.

3. A relatively large investment in working capital results in lower expected profitability and lower risk for the firm. The rate of return on current assets is normally less than the rate of return on fixed assets and hence a relatively large investment in current assets lowers the overall rate of return on the total assets of the firm. However, a relatively large investment in current assets also increases the working capital position of the firm and hence lowers the risk of the firm encountering financial difficulties. Similar reasoning also leads to the conclusion that a relatively small investment in working capital results in higher expected profitability and higher risk for the firm.

4. Permanent current assets are held to meet the company's long-term minimum needs (e.g., safety stocks of cash and inventories).…...

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