Tag Archives | current assets

Working Capital Analysis

See Also:
Balance Sheet
How to Collect Accounts Receivable
Factoring
Working Capital from Real Estate
Quick Ratio Analysis
Current Ratio Analysis
Financial Ratios

Working Capital Analysis Definition

Working capital (WC), also known as net working capital, indicates the total amount of liquid assets a company has available to run its business. In general, the more working capital, the less financial difficulties a company has.

Working Capital Analysis Formula

Use the following formula to calculate working capital:

WC = Current assetsCurrent liabilities

Working Capital Analysis Calculation

For example, a company has $10,000 in current assets and $8,000 in current liabilities. Look at the following formula to see the calculation.

Working capital = 10,000 – 8,000 = 2,000

Applications

Working capital measures a company’s operation efficiency and short-term financial health. For example, positive working capital shows that a company has enough funds to meet its short-term liabilities. In comparison, negative working capital shows that a company has trouble in meeting its short-term liabilities with its current assets.

Working capital provides very important information about the financial condition of a company for both investors and managements. For investors, it helps them gauge the ability for a company to get through difficult financial periods. Whereas, for management members, it helps them better foresee any financial difficulties that may arise. In conclusion, it is very important for a company to keep enough working capital to handle any unpredictable difficulties.

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Working Capital

See Also:
Balance Sheet
How to collect accounts receivable
Factoring
Quick Ratio Analysis
Current Ratio Analysis
Financial Ratios

What is Working Capital?

Use the following formula to figure out what is working capital.

Formula: Current Assets – Current Liabilities = Working Capital

Working Capital Definition

The Working Capital definition or WC is the difference between Current Assets versus Current Liabilities. Current Assets are those assets that will be turned into cash within one year, whereas Current Liabilities are those liabilities due within one year. This calculation represents the liquidity that a company has to meet its obligations coming due in the next 12 months. Though the amount should be positive, it can be a negative amount in times of distress.

Often used as a management tool, track the change in WC on a weekly basis. A company that is generating profits is usually increasing their WC. In comparison, declining profits often consume WC.

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Working Capital Definition
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Quick Ratio Analysis

Quick Ratio Analysis Definition

The quick ratio, defined also as the acid test ratio, reveals a company’s ability to meet short-term operating needs by using its liquid assets. It is similar to the current ratio, but is considered a more reliable indicator of a company’s short-term financial strength. The difference between these two is that the quick ratio subtracts inventory from current assets and compares the quick asset to the current liabilities. Similar to the current ratio, value for the quick ratio analysis varies widely by company and industry. In theory, the higher the ratio is, then the better the position of the company is; however, a better benchmark is to compare the ratio with the industry average.

Quick Ratio Explanation

Quick ratios are often explained as measures of a company’s ability to pay their current debt liabilities without relying on the sale of inventory. Compared with the current ratio, the quick ratio is more conservative because it does not include inventories which can sometimes be difficult to liquidate. For lenders, the quick ratio is very helpful because it reveals a company’s ability to pay off under the worst possible condition.

Although the quick ratio gives investors a better picture of a company’s ability to meet current obligations the current ratio, investors should be aware that the quick ratio does not apply to the handful of companies where inventory is almost immediately convertible into cash (such as retail stores and fast food restaurants).

Quick Ratio Formula

The current ratio formula is as follows:

Current ratio = (Current assets – Inventories) / Current liabilities

Or = Quick assets / Current liabilities

Or = (Cash + Accounts Receivable + Cash equivalents) / Current liabilities


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Resources

For statistical information about industry financial ratios, please go to the following websites: www.bizstats.com and www.valueline.com.

See Also:
Balance Sheet
Working Capital
Current Ratio Analysis
Financial Ratios
Quck Ratio Analysis Benchmark Example

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Operating Capital Definition

Operating Capital Definition

The operating capital definition is the cash used for daily operations in a company. As a result, it is essential to the survival of each and every business. Whether small or large, across industries, and under any other conditions that a business faces, lack of cash is one of the main reasons why a company fails. Due to this fact, it is of key importance that businesses monitor and plan for future cash holdings to assure that the business will have the money needed to continue doing commerce.


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Operating Capital Explanation

Operating capital, explained as the most essential asset in any business, allows a company to stay open. Also known as working capital, it can come from many sources. Operating capital vs working capital is a similar comparison to red vs maroon apples: there is no difference.

The initial operating capital for small business will come from investors. This could come in the form of savings of the owners, friends and family of the owners, banks and the S.B.A., angel investors, or venture capital.

For an existing business, operating capital outlay will come from more providers than for the startup. The same options exist with current owners, friends and family, banks and the S.B.A., and more. Additionally, however, a business can receive operating capital loans from mezzanine financiers, factoring, or becoming a public company and selling stock on the open market.

Operating Capital Formula

Though the operating capital formula is a simple function of subtraction it is actually quite complicated. The difficult part of operating capital requirements is the research associated with finding current asset and current liability amounts. Once these questions are answered the operating capital ratio comes naturally.

Operating Capital = Current Assets – Current Liabilities

Operating Capital Calculation

The operating capital calculation is quite simple.

If:

Current Assets = $1,000,000

Current Liabilities = $250,000

Operating Capital = $1,000,000 – $250,000 = $750,000

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Operating Capital Example

For example, Chris is the CFO of a large company – a series of retail stores which sell plants for home decor. Chris plans the company finances to assure smooth operations. This includes managing company operating capital.

Recently, the company has experienced enormous growth. While this is a great signal that the business model is sound, it can also form a operating capital crisis. Consequently, Chris must move forward carefully to avoid financial ruin for the company.

First, Chris wants to know where the company stands. He then performs this working capital calculation to see where the business is currently:

Current Assets = $1,000,000

Current Liabilities = $250,000

Operating Capital = $1,000,000 – $250,000 = $750,000

Chris knows that $750,000 is not enough money to get the company through this quarter. He also knows that with insufficient working capital the company will have to seek financing from a lender who is less risk averse. So Chris does his research.

The two choices Chris learns are possible are factoring and mezzanine lending. Therefore, Chris will need to do a lot of research to evaluate both options. As he does this research, he is empowered by the importance of his work: the fate of the company rests upon it.

Conclusion

In conclusion, Chris chooses mezzanine lending as the option for the company. With mezzanine lending, he can have a total cost of capital lower than that with factoring. Additionally, mezzanine lenders will offer more money that that in the value of the receivables of the company.

Chris moves forward carefully in order to avoid a mistake. Because his nature as a planner makes this path an easy one, Chris will wait until he is prepared and then make the proper decision.

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Operating capital

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Notes Receivable

See Also:
Notes Payable
Treasury Notes (t notes)
Accounts Receivable
How to collect accounts receivable
Balance Sheet

Notes Receivable Definition

The notes receivable is an account on the balance sheet usually under the current assets section if its life is less than a year. Specifically, a note receivable is a written promise to receive money at a future date. The money is usually made up of interest and principal.

Notes Receivable Explained

A note receivable is often formed when a business, usually a bank, makes a loan to another business. A note will often be for less than a year, but some can be well in excess of this time frame. Recognize notes receivable income as interest income on the income statement. Thus, when payment is made the amounts effect the balance sheet as well as the income statement.

Notes Receivable Example

Money Bank is extending a $100,000 90 day note to Toys Inc. so that they can fund some of its short term needs for financing during the year. The note has an interest rate of 5% and is recorded by the bank as a note receivable on Money’s balance sheet under the current assets section. At the end of the term, Toys inc. will pay the $100,000 in principal back to Money Bank, and approximately $1,233 (100,000 * 90/365 * .05) worth of interest. Record the amount as interest income on the incomes statement at the end of the year.

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Notes Receivable

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Current Assets

See Also:
Current Liabilities
Fixed Assets
Chart of Accounts (COA)
Working Capital Analysis
Financial Ratios
Intangible Assets

Current Assets Definition

Current assets, defined as a category of assets on the balance sheet which are expected to be used within one year or one normal operating cycle of the business (whichever is longer), are commonly part of the measures of liquidity in a company. Other asset categories on the balance sheet may include: non-current assets (or long-term assets); investments; property, plant and equipment; intangible assets and other assets.

Current Assets Explanation

Current assets, explained as some of the most useful assets in a company, are very valuable. Examples of items considered current assets include cash, inventory and accounts receivable. Items within this category are listed in order of liquidity – the items most easily converted into cash are listed first, the items that would take longer to be converted into cash are listed last. Two key liquidity ratios, the current ratio and the quick ratio, are calculated using current assets items. Accounting and finance professionals believe they are some of the most important assets because they are useful in good times or bad.

Current Assets Formula

A concise current assets formula does not exist as expected. Rather, the current assets balance sheet account is compiled from several smaller accounts.

Current Assets = Cash + Bank accounts + Prepaid Expenses + Debtors +Accounts Receivable + Short Term Investment + Inventory This extends into the current ratio

Current Ratio = Current Assets / Current Liabilities Current Assets, current liabilities included, also form net working capital

Net Working Capital = Current Assets minus Current Liabilities


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Calculation

Calculate these assets by combining several smaller accounts, is a simple addition problem.

Current Assets = $100,000 + $25,000 + $2,500 + $4,000 + $15,000 + $20,000 + $75,000 = $241,500

Where:
Cash = $100,000
Bank Accounts = $25,000
Prepaid Expenses = $2,500
Debtors = $4,000
Accounts Receivable = $15,000
Short Term Investment = $20,000
Inventory = $75,000

Current Asset Example

Liz is the owner of an industrial smoothing company. Working mainly with floors, walls, and other warehouse and plant projects, Liz has broken boundaries to start her company and rise to success. As with many industrial companies, Liz has taken out a bank loan. She now wants to make sure she is compliant and does not let her current assets fall under the required amount for her loan. Doing so would affect her relationship with the bank. Liz has her accountant perform these calculations. The accountant begins by taking a look at her financials. He finds the following:

Cash = $100,000
Bank Accounts = $25,000
Prepaid Expenses = $2,500
Debtors = $4,000
Accounts Receivable = $15,000
Short Term Investment = $20,000
Inventory = $75,000

He then performs this basic function:

$100,000 + $25,000 + $2,500 + $4,000 + $15,000 + $20,000 + $75,000 = $241,500

Conclusion

The accountant finds that Liz has current assets of $241,500. This is below the banks required amount of $245,000. Liz knows that her company is doing fine and that the bank merely keeps these levels as a protective measure. Still, Liz wants to keep true to the requirements of her loan and loan officer. She resolves to assemble her salespeople in a meeting and align them around the goal of increasing accounts receivable levels by $3,500. She knows this is possible by the next bank period.

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Commercial Paper

See Also:
Convertible Debt Instrument
NonInvestment Grade Bonds
Collateralized Debt Obligations
External Sources of Cash
Certificate of Deposit (CD)
What Your Banker Wants You To Know
Commercial Bank
Convertible Debt Instrument

Commercial Paper Definition

Commercial paper is a short-term debt instrument. Companies can borrow money by issuing it to investors.

It is unsecured, meaning collateral does not back it up. Values range from $25,000 and up. Furthermore, the typical value is $100,000. Maturities range from 2 days to 270 days, and the typical maturity is 30 days. As long as the maturity is less than 270 days, you do not have to register the debt with the SEC. It is often issued at a discount from par value, issued with interest payments, or both. Credit rating agencies rate commercial paper.

When to Issue Commercial Paper

Companies that issue commercial paper are typically large corporations with good credit. They issue it because the debt instruments have flexible maturities. They are also usually cheaper than bank loans. Finance the current assets and short-term obligations using the proceeds. Then issue it directly to investors or via a dealer.

Investors that invest in commercial paper, usually large-scale institutional investors such as mutual funds, consider it issued by a creditworthy corporation to be a safe investment. However, the returns earned on it are low.

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