What is the matching principle of working capital financing?
The matching principle states that short-term needs should be financed with short-term debt and long-term needs should be financed with long-term sources of funds. It’s also known as the hedging or matching approach. The rationale behind it is flexibility and cost-effectiveness.
What is working capital financing?
Working capital financing, or a working capital loan, is when a business borrows money to cover relatively small expenses such as day-to-day operations and payroll. These loans are not used to buy long-term assets or investments. Long-term assets are often financed with a leasing finance option.
How would you define working capital?
Simply put, working capital is the money used to cover a company’s short-term expenses. It’s the difference between a company's current assets and current liabilities.
The formula is: working capital = current assets – current liabilities.
Examples of current assets are: cash, accounts receivable/customers' unpaid bills, inventories of raw materials and finished goods. Examples of current liabilities are: accounts payable and debts
What is really meant by working capital requirement?
Working capital requirement is the amount of funds required to meet a business's short-term obligations – in the next 12 months. It’s not the same as cash flow.
Cash flow is the amount of funds that are actually available in the business. Working capital is what is needed or required. They may not be the same and cause funding headaches if the difference between them is not properly managed and considered.
How does a credit policy determine your working capital?
Credit policy refers to payment terms and the average time it takes for the collection of sales proceeds. If a business has a lenient credit policy, it will require more working capital. If it has a strict or short-term credit policy, then it can manage with less working capital.
In how many ways can working capital be used?
Working capital is used to purchase inventory, pay short-term debt, and cover day-to-day operating expenses. Operating expenses (OPEX) include rent, equipment, inventory costs, marketing, payroll, insurance, step costs, and funds allocated for research and development.
What is working capital management?
Working capital management represents the relationship between a firm's short-term assets and its short-term liabilities. It is essentially an accounting strategy with a focus on keeping a sufficient balance between a company’s current assets and its liabilities. An effective working capital management system helps businesses not only cover their financial obligations but also boost their earnings.
The goal of working capital management is to ensure that a company can afford its day-to-day operating expenses while, at the same time, investing the company's assets in the most productive way.
What is the importance of working capital?
Working capital serves as a metric for how efficiently a company is operating and how financially stable it is in the short term. The working capital ratio, which divides current assets by current liabilities, indicates whether a company has adequate cash flow to cover short-term debts and expenses.
How can you describe the components of working capital?
A well-run business manages its short-term debt and current and future operational expenses through its management of working capital, the components of which are inventories, accounts receivable, accounts payable, and cash.
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