Post on 23-Dec-2015
Working Capital Net short-term investment needed to carry on
day-to-day activities Computed
Current Assets Current Liabilities
Minus
Working Capital Issues
1. Inconsistencies in the measurements of its components
2. Differences of opinion over what should be included as the elements
3. Lack of precision in defining the elements particularly with respect to the terms “liquidity” and
“current”
Purpose of the Chapter
1 Examine the foundation of the working capital concept
2 Review the concept and its components as currently understood
3 Illustrate how the adequacy of a company’s working capital can be evaluated
4 Discuss possible modifications
Development of the Working Capital Concept
Fixed vs. circulating capital The double-account system Creditor vs. investor point of view Liquidity as the basis for asset
classification on the balance sheet Will be vs. could be Anson Herrick and ARB No. 3 - the operating cycle Current usage - indication of liquidity and degree of
protection to short-term creditors
Components of Working Capital
ARB No. 43 Definition of working capital Examples of current assets and
current liabilities
Current Assets Temporary investments Alternative methods
Historical cost Fair value Lower of cost or market
Temporary Investments
SFAS No. 12 Why adopted
Problems with SFAS No. 12
Temporary investments under SFAS No. 115 Trading securities Available-for-sale securities Held-to- maturity securities Transfer between categories
Current Assets Receivables
Bad debts SFAS No. 114
InventoriesReceivablesPrepaids
Inventories Inventory quantity Flow assumption Market fluctuations
Prepaids
Financial Analysis of a Company’s Working Capital Position
How do liquidity problems occur?
Evaluate with ratio analysis
Cash Flow from Operations to Current Liabilities
Net cash provided from operating activities
Average current liabilities
Receivables
Accounts receivable turnover ratio
Days in receivables
Net Credit Sales
Average Accounts Receivable
365
Accounts Receivable Turnover Ratio
Inventory
Inventory turnover ratio
Average days in inventory
Cost of Goods Sold
Average Inventory
365
Inventory Turnover Ratio
Accounts Payable
Accounts payable turnover ratio
Average days payables outstanding
Inventory Purchases
Average Accounts Payable
365
Accounts Payable Turnover Ratio
Summary of Hershey’s Working Capital Position
1. Customers pay accounts receivable in approximately 37 days.
2. Inventory remains on hand for approximately 79 days.
3. Current operations are generating sufficient cash to repay current liabilities.
4. Accounts payable are being satisfied in approximately 19 days.
1. Accounts receivable are paid in approximately 22 days.
2. Inventory remains on hand for approximately 69 days.
3. Current operations are generating sufficient cash to repay current liabilities.
4. Accounts payable are being satisfied in approximately 23 days.
Summary of Tootsie’s Working Capital Position
InternationalAccounting Standards
The IASC has issued pronouncements on the following issues affecting working capital:1 Revised IAS No. 1, “Presentation of
Financial Statements” presentation of current assets and current
liabilities2 IAS No. 25, “Accounting for Investments”
accounting for and disclosure of investment securities in
3 IAS No. 2 , “Inventories”
IAS No. 1
The IASC did not attempt to deal with the valuation issues discussed earlier in the chapter
Discussed two views of current assets and current liabilities:1 A measure of liquidity2 Identification of circulating resources and obligations
Since these views are contradictory, it has lead to classifications of items by convention
Allows, but does not require, companies to decide whether or not to sub-classify assets and liabilities as current
FASB staff review indicated that it was quite similar to U. S. GAAP
IAS No. 25
Allows investments classified as current to be accounted for by market value or LCM
Value may be determined individually, by investment category, or on a total portfolio basis
Preference for the total portfolio or investment category methods
No review by FASB staff because topic was under reconsideration by both FASB and IASC at the time of the review
IAS No. 2
Objective of inventory reporting is to determine proper amount of cost to recognize as an asset
Specific identification method preferred If not feasible, FIFO or weighted average preferred LIFO is an allowable alternative If LIFO is used, must disclose lower of cost
and net realizable value FASB staff indicated that requirements were
similar to U.S. GAAP wide range of alternatives and lack of adequate
disclosure requirements in both make intercompany comparisons virtually impossible
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Prepared by Richard Schroeder, PhDKathryn Yarbrough, MBA