Global Financial Management - Rivier University Module 7

Sheet1global Financial Managaementrivier Universitymodule 7 Problem

This assignment presents multiple financial calculations and analysis scenarios relevant to working capital management, cash conversion cycles, and inventory ordering strategies. The core tasks involve computing working capital, analyzing cash conversion cycles, and determining optimal order quantities using fundamental financial formulas used by managers to sustain liquidity, optimize inventory, and improve cash flow efficiencies.

First, the problem requires calculating the working capital of different companies, considering their current assets and liabilities such as cash, accounts receivable, inventory, and accounts payable. Second, it involves assessing a company's cash conversion cycle (CCC) which measures the time span between cash outflows for inventory and cash inflows from sales, thus evaluating operational efficiency. Lastly, the task focuses on deriving an optimal order quantity employing the Economic Order Quantity (EOQ) model, balancing ordering and holding costs to minimize total inventory costs.

Paper For Above instruction

Understanding and managing working capital is fundamental for ensuring a company's liquidity and operational stability. By calculating working capital, a firm can assess its short-term financial health and operational efficiency. Similarly, analyzing the cash conversion cycle provides insight into how effectively a company manages its inventory, receivables, and payables, which directly influences cash flow and overall financial performance. The third aspect, determining the optimal order quantity using the EOQ model, aids in inventory management by minimizing costs associated with ordering and holding stock, thereby improving profitability and operational efficiency.

Working Capital Analysis

Working capital is a measure of a company's short-term liquidity and operational efficiency. It is calculated as the difference between current assets and current liabilities or current liabilities, depending on the context. For businesses managing inventory, receivables, and payables, understanding working capital helps in maintaining smooth operations and avoiding liquidity crises.

The first scenario involves a company with cash, accounts receivable, fixed assets, and accounts payable, along with a note payable and annual interest payments. The calculation simplifies to summing cash and receivables, then subtracting accounts payable and interest obligations. Here, fixed assets are a non-current asset and are not included in working capital calculations, which primarily focus on short-term assets and liabilities.

For example, a company with $20,000 cash, $10,000 in accounts receivable, and $12,500 in accounts payable has a working capital of ($20,000 + $10,000) - $12,500 = $17,500. The note payable and interest do not influence working capital unless they are current liabilities. Conversely, if a company has substantial inventories or other current liabilities, these would also factor into the analysis.

The second example features a larger receivable and inventory base with corresponding payables, providing a different perspective on liquidity. Proper assessment of working capital highlights the firm's ability to meet short-term obligations without external financing, critical for maintaining operational stability and investor confidence.

Cash Conversion Cycle (CCC)

The cash conversion cycle measures the duration between the expenditure on inventory and the cash receipt from sales. It encompasses three components: Inventory Conversion Period, Accounts Receivable Conversion Period, and Accounts Payable Conversion Period. Efficient management of CCC ensures a firm maximizes cash availability for reinvestment and growth.

Calculations involve dividing average inventory by daily COGS, average receivables by daily credit sales, and average payables by daily purchases. For example, given an average inventory of $10 million and COGS of $15 million, the inventory period is (10,000,000 / (15,000,000 / 365)) ≈ 243.33 days. Similarly, receivables and payables are computed, yielding a total CCC of approximately 310.25 days, indicating how long cash is tied up in operations.

Long CCC durations can strain liquidity, highlighting the importance of optimizing inventory turnover, collection processes, and payment terms. Reducing CCC can significantly enhance operational cash flow, enabling a company to invest or service debt more effectively.

Economic Order Quantity (EOQ)

The EOQ model provides a quantitative basis for determining the optimal order quantity that minimizes total inventory costs, including ordering and holding costs. The fundamental EOQ formula is:

Q* = √(2DS / H)

Where D is annual demand, S is the ordering cost per order, and H is the holding cost per unit per year. In the given scenario, with an annual demand of 150,000 units, a fixed order cost of $8, and a holding cost of $5 per unit, the calculation proceeds as follows:

Q = √(2 150,000 * 8 / 5) ≈ 693 units.

This quantity balances ordering costs and holding costs, preventing overstocking or stockouts. Implementing EOQ helps firms streamline procurement and reduce overall inventory expenses, contributing to improved profitability and customer service levels.

Conclusion

Efficient management of working capital, cash conversion cycle, and inventory ordering is essential for maintaining a company’s financial health and operational effectiveness. Accurate calculation of working capital ensures liquidity, a well-managed CCC optimizes cash flows, and applying the EOQ model reduces inventory-related costs. Together, these financial management tools equip managers with vital insights to enhance competitiveness and sustain long-term growth. As firms operate in dynamic environments, continuous monitoring and refinement of these metrics are vital for adapting to market conditions and optimizing financial performance.

References

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• Gaudin, P. (2020). Managing the Cash Conversion Cycle for Competitive Advantage. Harvard Business Review.
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