Working Capital Management
Optimize cash, receivables, inventory, and payables to keep the firm liquid without tying up excess capital. Working capital management bridges the gap between accrual-based profitability and real cash availability. A firm can be profitable on paper yet fail if it cannot meet short-term obligations.
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Study Tips
- ✓Shorter cash conversion cycle usually means better efficiency
- ✓Balance liquidity against profitability
- ✓Watch for seasonal patterns in working capital
- ✓Link working capital changes to cash flow forecasting
Common Mistakes to Avoid
Ignoring working capital changes in capital budgeting problems. Every project that grows revenue typically requires additional working capital. Also, using sales instead of COGS when calculating DIO and DPO overstates the metrics.
Working Capital Management FAQs
Common questions about working capital management
Days of inventory plus days of receivables minus days of payables. It measures how long cash is tied up in operations from paying suppliers to collecting from customers.
Not necessarily. Some businesses like grocery chains and subscription services collect cash before paying suppliers, creating healthy negative working capital. It becomes a problem only when a firm cannot meet its obligations.
An increase in net working capital is a use of cash that reduces free cash flow. When a growing company needs more inventory and receivables, the cash outflow appears as a negative in the FCFF calculation even though the income statement shows higher revenue.
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