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Working Capital and The Financing Decision
Working Capital and The Financing Decision
Working Capital and The Financing Decision
Controlling Assets
• Two possible production alternatives in relation to
sales:
-- level production, which smoothes production schedules and
uses labor and equipment efficiently at a lower cost but leads
to fluctuation in current assets
-- matching sales and production, which eliminates the large
seasonal bulges or sharp reduction in current assets
• However, it is very difficult if not impossible to
match sales and production perfectly
• Most firms employ level production methods. It is
critical to control the fluctuation in current assets
TABLE 6-1
Yawakuzi sales forecast
(in units)
TABLE 6-2
Yawakuzi's production
schedule and inventory
TABLE 6-4
Total current assets,
first year ($ millions)
TABLE 6-5
Cash budget and assets for second year
with no growth in sales ($ millions)
FIGURE 6-7
Expanded
cash flow
cycle
Financing Alternatives
1. Hedged Approach:
• Matching the maturities of assets and liabilities (the most
desirable but almost impossible)
FIGURE 6-8
Matching long-term
and short-term needs
FIGURE 6-9
Using long-term financing
for part of short-term needs
FIGURE 6-10
Using short-term financing
for part of long-term needs
TABLE 6-7
Alternative financing plans
TABLE 6-8
Impact of financing plans on earnings
TABLE 6-9
Expected returns under
different economic conditions
TABLE 6-10
Expected returns for
high-risk firm
An Optimal Policy
• The combination of financing patterns (short-term versus
long-term) and asset liquidity produces 4 possible working
capital alternatives:
1. the aggressive firm borrows short term and maintains
relatively low levels of liquidity
2. the more moderate firm compensates for short-term financing
with highly liquid assets
3. the more moderate firm balances low liquidity with long-term
Financing
4. the more conservative firm utilizes long-term financing and
maintains a high degree of liquidity
TABLE 6-11
Current asset liquidity and asset financing plan