Working capital

[Robert]

1.Working capital is defined as current assets minus currrent liabilities ( net current assets)
2.It represents the amount tied up in the net current assets
3.Working capital is a flow concept and not a static concept. One asset is converted into another or used to pay off a liability.e.g. goods are sold, creating receivables;receivables are realised, creating cash; cash is paid to suppliers, reducing a liability, and so on.
4.Working capital keeps fluctuating regularly in the course of business. e.g. the amount of receivables will increase with each credit sale and decrease with each cash collection
5.An entity has to plan for working capital right from the inception stage of a business. A business may even fail if working capital is found inadequate.
6.Working capital financing has to consider that a part of the working capital is fixed and another part is fluctuating.

[Siro]

This point was also tested today in the exam and was I think worth 3 marks in relation to working capital management and its clash or something dont remember exactly!

[hrinkaa]

Can a company have a current ratio / Acid test ratio of less than 1 and yet have no liquidity problems.

thanks for your response. hrinkaa

[Acid]

Can a company have a current ratio / Acid test ratio of less than 1 and yet have no liquidity problems.

thanks for your response. hrinkaa


Hi,

I m absolutely not sure , but I think It depends upon many factors like the industry average and the temporal factors under which the company is going through etc.


Best regards,

Acid

[Tia]

Hi

I'm not sure what you mean by "current ratio / acid test ratio", because they're two very different ratios. If you're using GTG's F9 material, and turn to Study Guide C2, you would see that the Current ratio is measured by Current assets of an entity over its Current Liabilities. It shows whether all of the entity's Current Assets will be able to generate sufficient funds to meet its Current Liabilities.

The Acid Test Ratio or the Quick Ratio on the other hand, equals the entity's Current Assets minus its Inventory over the entity's Current Liabilities minus its Bank Overdraft. This ratio indicates whether or not the entity's highly liquid Current Assets can cover its Current Liabilities.

Going strictly by the mathematical formula, a current ratio of less than one would indicate liquidity problems and a negative Working Capital for the entity. But to reiterate what Acid has said, other temporal factors and the general economic environment through what the company or industry is going through would also play part in the firms liquidity set up. Practically, there are companies in certain business sectors which operate successfully with current ratios less than one. These would be companies whose inventories could be readily converted into cash with healthy other financial ratios such as gearing, leverage, etc. Ideally a current ratio of 1.5:1 would be acceptable.

Pritika.