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CFO Fundamentals: Your Quick Guide to Internal Controls, Financial Reporting, IFRS, Web 2.0, Cloud Computing, and More by ALLISON I. SHIM, JOEL G. SIEGEL, JAE K. SHIM

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CHAPTER TWENTY

Working Capital and Cash Management

THE ABILITY TO manage working capital will enhance the return and lower the risk of running short of cash. There are a number of ways to manage working capital and cash to result in optimal balances, including quantitative techniques. The amount invested in any current asset can change daily and requires close monitoring. Current assets are being improperly managed if funds tied up in them can be used more productively elsewhere.

EVALUATING WORKING CAPITAL

How can working capital be managed to achieve the best results?

Working capital equals current assets less current liabilities. In optimally managing working capital, current assets and current liabilities have to be constantly regulated. A consideration must be given to how assets should be financed (e.g., short-term debt, long-term debt, or equity). There is a trade-off between return and risk that has to be taken into account. If funds move from fixed assets to current assets, there is a reduction in liquidity risk, greater ability to obtain short-term financing, and more flexibility, because the company can better adjust current assets to changes in sales volume. However, typically less of a return is earned on current assets than fixed assets. The advantage with using noncurrent debt relative to short-term debt is that it involves less liquidity risk. However, long-term debt usually has a higher cost than short-term debt arising from the uncertainty of the longer time period. ...

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