1. CHAPTER 8
WORKING CAPITAL 1

2. 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

3. 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

4. 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

5. 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

6. Components of Working Capital
ARB No. 43
Definition of working capital
Examples of current assets and current liabilities 6

7. Current Assets
Cash
Cash equivalents
Cash Equivalents
Cash 5

8. Temporary Investments
Current Assets
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
Trading securities
Available-for-sale securities
Held-to- maturity securities
Transfer between categories
Temporary Investments 7

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

10. Current Liabilities
Current Maturities
Payables
Deferrals
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. Current Ratio
Current assets
Current liabilities

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

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

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

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

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

19. Summary of Hershey’s Working Capital Position
Customers pay accounts receivable in approximately 37 days.
Inventory remains on hand for approximately 79 days.
Current operations are generating sufficient cash to repay current liabilities.
Accounts payable are being satisfied in approximately 19 days.

20. Summary of Tootsie’s Working Capital Position
Accounts receivable are paid in approximately 22 days.
Inventory remains on hand for approximately 69 days.
Current operations are generating sufficient cash to repay current liabilities.
Accounts payable are being satisfied in approximately 23 days.

21. 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. 25, “Accounting for Investments”
accounting for and disclosure of investment securities in
IAS No. 2 , “Inventories”

22. 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

23. 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

24. 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

25. Prepared by Richard Schroeder, PhD Kathryn Yarbrough, MBA
End of Chapter 8
Prepared by Richard Schroeder, PhD Kathryn Yarbrough, MBA
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