1. RICHARD G. SCHROEDER MYRTLE W. CLARK JACK M. CATHEY
FINANCIAL ACCOUNTING
THEORY AND ANALYSIS: TEXT AND CASES
11TH EDITION
RICHARD G. SCHROEDER
MYRTLE W. CLARK
JACK M. CATHEY 4

2. CHAPTER 8
WORKING CAPITAL 1

3. Working Capital Minus Current Assets Current Liabilities
Net short-term investment needed to carry on day-to-day activities
Computed
Minus
Current Assets
Current Liabilities 2

4. Working Capital Issues
Inconsistencies in the measurements of its components
Differences of opinion over what should be included as the elements
Lack of precision in defining the elements
Particularly with respect to the terms “liquidity” and “current” 2

5. Purpose of the Chapter
Examine the foundation of the working capital concept
Review the concept and its components as currently understood
Illustrate how the adequacy of a company’s working capital can be evaluated
Discuss possible modifications 3

6. 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 4

7. Components of Working Capital
ARB No. 43
Definition of working capital
Examples of current assets and current liabilities
Affirmed in No. 115 (FASB ASC 330) 6

8. Temporary Investments
Current Assets
Cash
Cash equivalents
Temporary investments
Alternative methods
Historical cost
Fair value
Lower of cost or market
SFAS No. 12
Why adopted
Problems with SFAS No. 12
Temporary investments under SFAS No. 115 (FASB ASC 320)
Trading securities
Available-for-sale securities
Held-to- maturity securities
Transfer between categories
Temporary Investments 7

9. Current Assets Receivables Inventories Prepaids Categories Trade
Nontrade
Bad debts
SFAS No. 114
Inventories
Inventory quantity
Flow assumption
Market fluctuations
Prepaids 8

10. Current Liabilities Payables Current Maturities Payables Deferrals
Current maturities of long-term debt
Current Maturities
Payables 9

11. Financial Analysis of a Company’s Working Capital Position
How do liquidity problems occur?
Evaluate with ratio analysis

12. Working Capital Problems with its use Current Assets
Current Liabilities
Problems with its use

13. Working Capital Hershey Current Assets Liabilities Working Capital
2011
$2,046,558 -
$1,173,775 =
$872,783
2010
$2,005,217
1,298,845
706,372
Tootsie Roll
Current
Assets
Liabilities
Working
Capital
2011
$212,201 -
58,355 =
$153,846
2010
$235,167
58,505
$176,662
Working Capital for both companies’ has worsened, although Tootsie Roll is in a better position in both years, with respect to this metric alone.

14. Current Ratio
Current assets
Current liabilities

15. Current Ratio Hershey 2011 $2,046,558 $1,173,775 = 1.74:1 2010
$2,005,217
$1,298,845
1.54:1
Tootsie Roll
2011
$212,201
$ 58,355 =
3.64:1
2010
$235,167
$ 58,505
4.02:1
The current ratio for both companies is worsening.
Tootsie Roll’s current ratio is better than Hershey’s for both years.

16. Acid Test (Quick) Ratio
Cash + Marketable Securities + Receivables
Current liabilities

17. Acid Test (Quick) Ratio
Hershey
2011
$693, ,499
$1,173,775 =
0.93:1
2010
$884, ,061
$1,298,845
0.98:1
Tootsie Roll
2011
$78, , ,895
$58,355 =
2.25:1
2010
$115, , ,996
$58,505
2.76:1
Quick ratio is worsening for both companies.
Tootsie Roll’s quick ratio is significantly better than Hershey’s for both years.

18. Cash Flow from Operations to Current Liabilities
Net cash provided from operating activities
Average current liabilities

19. Cash Flow from Operations to Current Liabilities
Hershey
2011
$580,867
($1,173, ,298,845) /2 =
0.47:1
2010
$901,423
($1,298, ,628) /2
0.82:1
Tootsie Roll
2011
$50,390
($58, ,505) /2 =
0.86:1
2010
$825,805
($58, ,628) /2
1.45:1
This metric is deteriorating for both companies.

20. Receivables Accounts receivable turnover ratio Days in receivables
Net Credit Sales
Average Accounts Receivable
365
Accounts Receivable Turnover Ratio

21. Accounts Receivable Turnover Ratio
Hershey
2011
$6,080,788
($399, , ,061,+ 15,200) /2 =
14.84
2010
$5,671,009
($390, , , ,700) /2
13.64
Tootsie Roll
2011
$528,369
($41, , , ,531) /2 =
12.80
2010
$492,742
($37, , , ,356) /2
13.13
This metric is improving for both Hershey but worsening for Tootsie Roll.

22. Days in Receivables Ratio
Hershey
2011
365
14.84 =
24.60
2010
13.64
26.75
Tootsie Roll
2011
365
12.80 =
28.51
2010
13.13
27.81

23. Inventory Turnover Ratio
Average days in inventory
Cost of Goods Sold
Average Inventory
365
Inventory Turnover Ratio

24. Inventory Turnover Ratio
Hershey
2011
$3,548,896
($648, ,622) /2 =
6.00
200
$3,255,801
($533, ,712) /2
6.18
Tootsie Roll
2011
$365,255
($42, , , ,236) /2 =
5.69
2010
$349,334
($35, , , ,817) /2
6.18
This metric is worsening for both companies.
Both companies turned their inventory at approximately the industry average.

25. Days in Inventory Hershey 2011 365 6.00 = 60.81 2010 6.18 59.04
Tootsie Roll
2011
365
5.69 =
64.17
2010
6.18
59.05

26. Accounts Payable Accounts payable turnover ratio
Average days payables outstanding
Inventory Purchases
Average Accounts Payable
365
Accounts Payable Turnover Ratio

27. Accounts Payable Turnover Ratio (Nordstrom)
2011
$6,592 – 201
($ ) /2 =
7.71
2010
$5,897 – 49
($ ) /2
7.57
This metric is worsening for Nordstrom.

28. Days in payables outstanding (Nordstrom)
2011
365
7.71 =
47.2 days
2010
7.57
48.2 days

29. Summary of Hershey’s Working Capital Position
Customers pay accounts receivable in approximately 25 days.
Inventory remains on hand for approximately 61 days.
Current operations are generating sufficient cash to repay current liabilities.

30. Summary of Tootsie Roll’s Working Capital Position
Accounts receivable are paid in approximately 29 days.
Inventory remains on hand for approximately 64 days.
Current operations are generating sufficient cash to repay current liabilities.

31. International Accounting Standards
The IASC has issued pronouncements on the following issues affecting working capital:
Revised IAS No. 1, “Presentation of Financial Statements”
presentation of current assets and current liabilities
IAS No. 39, “Financial Instruments: Recognition and Measurement”
IAS No. 2 , “Inventories”

32. 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:
A measure of liquidity
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

33. 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

34. 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
Revised IAS No. 2: LIFO is no longer allowed
Inventory must be written down to net realizable value on item-by-item basis

35. End of Chapter 8 Prepared by Kathryn Yarbrough, MBA
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