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650 wk3 db1 res | Business & Finance homework help

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How should a business use working capital analysis?

Every business requires working capital to function. According to Mueller (1953, as cited by Filbeck, Zhao & Knoll, 2017), “working capital is defined as the current assets used in generating revenues for the business through its operations after all current liabilities have been settled: (p. 266).  Ensuring there is a sufficient availability of working capital is essential to the continuing day-to-day operations.  A working capital analysis is a tool used to measure a firm’s liquidity and provide an assessment of its assets to liabilities to determine the company’s financial stability (Lapadusi & Caruntu, 2012).  Therefore, a business should use a working capital analysis to determine its borrowing capabilities and how much if any it should borrow to meet is short and long-term objectives and liabilities. 

Which is more important to the short-term lender: the stock of cash or the flow of cash?

When lending money, lenders measure a company’s probability of default, which is the possibility a company will have of being unable to pay its debt as one deciding factor when lending (Biery, 2013).  The lower the probability of default the more likely the bank will allow the business to borrow.  Therefore, short-term lenders are going to be more concerned with the amount of flow of cash versus stock of cash.  While stock of cash has value, however it is not as liquid as cash flow.  The greater the amount of positive cash flow the greater a firm’s liquid assets are and the higher the probability that the company will be able to pay back its debts.

Is it possible in today’s business to operate with no current liabilities?

Anything is possible; however, it would not be the most business practical decision for a company to try to operate with no current liabilities.  Current liabilities are payables, such as taxes, wages, and account payables that we due within a year (Byrd, Hickman, K & McPherson, 2013).  The ability for a business to fully operate without any current liabilities would requires an enormous amount liquidity, cash and assets readily available and also substantial working capital to pay all its bills and still have the ability of funds to stay competitive.  Current liabilities can be compared to risk in that some is required in order to successfully operate and stay competitive. 

References:

Biery, M.E. (2013, April 12). Businesses seeking working capital-survey. Forbes. Retrieved from http://www.forbes.com/sites/sageworks/2013/04/12/businesses-seeking-working-capital-survey/ (Links to an external site.)

Byrd, J., Hickman, K., & McPherson, M. (2013). Managerial Finance [Electronic version]. Retrieved from https://content.ashford.edu/ (Links to an external site.)

Filbeck, G., Zhao, X., & Knoll, R. (2017). An Analysis of Working Capital Efficiency and Shareholder Return. Review of Quantitative Finance and Accounting, 48(1), 265–288. https://doi-org.proxy-library.ashford.edu/https://link.springer.com/journal/volumesAndIssues/11156

LĂPĂDUŞI MIHAELA LOREDANA, & CĂRUNTU CONSTANTIN. (2012). The Financial Stability Analysis through the Working Capital. Analele Universităţii Constantin Brâncuşi Din Târgu Jiu : Seria Economie, (4.I), 146. Retrieved from http://search.ebscohost.com.proxy-library.ashford.edu/login.aspx?direct=true&db=edsdoj&AN=edsdoj.2cfba719abe34f46a7895ca605ffd812&site=eds-live&scope=site

Respond to…

  • How should a business use working-capital analysis?
    • Working capital (also known as net working capital) is the amount of liquid assets a company has available to use to run their business (Wilkinson, 2013).  In order for business to determine this (and use this information for analysis) they must calculate the current assets less the current liabilities.  Once this information is determined and the business can identify what important aspects of their every-day business required liquid capital on a regular basis, the company then analyze how to allocate these liquid assets accordingly.  This information is also used to determine the company’s financial health and operating efficiency, two vital factors to a company’s success (Wilkinson, 2013).  This information is then utilized by investors to decipher if the company can withstand difficult times, keeping their investment safe while managers of the company can use this information to forecast any potential downturns in business, helping them prepare better (Wilkinson, 2013).
  • Which is more important to the short-term lender: the stock of cash or the flow of cash?
    • The short-term lender will be more concerned with a company’s flow of cash rather than the stock of cash, because that will be a better indicator to how high or low the company’s probability of default is (Biery, 2013).  The lower the probability of default, the more clarity lenders have on the flow of cash of a company as they will have consistent assets coming in to add to their current stock of cash and be able to make their loan payments.
  • Is it possible in today’s business to operate with no current liabilities?
    • It would require a business to have an abundance of liquid assets in order to operate with no current liabilities.  Since liabilities can take the form of many different things, including taxes, it would be hard to imagine a business that would be able to continue to fund these payables off of their own assets for a long period of time.

Biery, M.E. (2013, April 12). Businesses seeking working capital-survey. Forbes. Retrieved from http://www.forbes.com/sites/sageworks/2013/04/12/businesses-seeking-working-capital-survey/ (Links to an external site.)

Wilkinson, J. (2013).  Working Capital Analysis. The Strategic CFO. Retrieved from https://strategiccfo.com/working-capital-analysis-2/