FINANCIAL ACCOUNTING
THEORY AND ANALYSIS:
TEXT AND CASES
11TH EDITION
RICHARD G. SCHROEDER
MYRTLE W. CLARK
JACK M. CATHEY
CHAPTER 8
WORKING
CAPITAL
Working Capital
Net short-term investment needed to carry on
day-to-day activities
Computed
Minus
Current Assets
Current Liabilities
Working Capital Issues
1.
2.
3.
Inconsistencies in the measurements
of its components
Differences of opinion over
what should be included as
the elements
Lack of precision in defining the elements
Particularly with respect to the terms “liquidity” and
“current”
Purpose of the Chapter
1
2
3
4
Examine the foundation of the working
capital concept
Review the concept and its components
as currently understood
Illustrate how the adequacy of a
company’s working capital can be
evaluated
Discuss possible modifications
Development of the Working
Capital Concept
Fixed vs. circulating capital
The double-account system
Creditor vs. investor point of view
Liquidity as the basis for asset
classification on the balance sheet
Will be vs. could be
Anson Herrick and ARB No. 3 - the operating cycle
Current usage - indication of liquidity and degree of
protection to short-term creditors
Components of
Working Capital
ARB No. 43
Definition of working capital
Examples of current assets and
current liabilities
Affirmed in No. 115 (FASB ASC 330)
Current Assets
Cash
Cash equivalents
Temporary investments
Alternative methods
Historical cost
Fair value
Lower of cost or market
SFAS No. 12
Why adopted
Problems with
SFAS No. 12
Temporary investments under
SFAS No. 115 (FASB ASC 320)
Trading securities
Available-for-sale securities
Held-to- maturity securities
Transfer between categories
Current Assets
Receivables
Categories
Trade
Nontrade
Bad debts
SFAS No. 114
Inventories
Inventory quantity
Flow assumption
Market fluctuations
Prepaids
Current Liabilities
Payables
Deferrals
Current maturities of long-term debt
Current
Maturities
Payables
Financial Analysis of a Company’s
Working Capital Position
How do liquidity problems
occur?
Evaluate with ratio
analysis
Working Capital
Current Assets
Problems with its use
Current Liabilities
Working Capital
Hershey
Current
Assets
Current
Liabilities
Working
Capital
2011
$2,046,558 - $1,173,775
=
$872,783
2010
$2,005,217 -
=
706,372
1,298,845
Tootsie Roll
Current
Assets
Current
Liabilities
Working
Capital
2011
$212,201 -
58,355
=
$153,846
2010
$235,167 -
58,505
=
$176,662
Working Capital for both companies’ has worsened, although Tootsie Roll is in
a better position in both years, with respect to this metric alone.
Current Ratio
Current assets
Current liabilities
Current Ratio
Hershey
2011
$2,046,558
$1,173,775 =
1.74:1
2010
$2,005,217
=
$1,298,845
1.54:1
Tootsie Roll
2011
$212,201
$ 58,355 =
3.64:1
2010
$235,167
=
$ 58,505
4.02:1
The current ratio for both companies is worsening.
Tootsie Roll’s current ratio is better than Hershey’s for both years.
Acid Test (Quick) Ratio
Cash + Marketable Securities + Receivables
Current liabilities
Acid Test (Quick) Ratio
Hershey
2011
$693,686 + 399,499
$1,173,775
=
0.93:1
2010
$884,642 + 390,061
$1,298,845
=
0.98:1
2011
$78,612 + 41,895 + 10,895
$58,355
=
2.25:1
2010
$115,976 + 37,394 + 7,996
$58,505
=
2.76:1
Tootsie Roll
Quick ratio is worsening for both companies.
Tootsie Roll’s quick ratio is significantly better than Hershey’s for both
years.
Cash Flow from Operations to
Current Liabilities
Net cash provided from operating activities
Average current liabilities
Cash Flow from Operations to Current
Liabilities
Hershey
2011
$580,867
($1,173,775 + 1,298,845) /2
=
0.47:1
2010
$901,423
($1,298,845+ 910,628) /2
=
0.82:1
2011
$50,390
($58,355 + 58,505) /2
=
0.86:1
2010
$825,805
($58,505 + 910,628) /2
=
1.45:1
Tootsie Roll
This metric is deteriorating for both companies.
Receivables
Accounts receivable turnover ratio
Net Credit Sales
Average Accounts Receivable
Days in receivables
365
Accounts Receivable Turnover Ratio
Accounts Receivable Turnover Ratio
Hershey
2011
$6,080,788
($399,499 + 15,000 + 390,061,+ 15,200) /2
=
14.84
2010
$5,671,009
($390,061 + 15,200 + 410,390 + 15,700) /2
=
13.64
2011
$528,369
($41,895 + 1,731 + 37,394 + 1,531) /2
=
12.80
2010
$492,742
($37,394 + 1,531 + 37,512 + 2,356) /2
= 13.13
Tootsie Roll
This metric is improving for both Hershey but worsening for Tootsie Roll.
Days in Receivables Ratio
Hershey
2011
365
14.84
=
24.60
2010
365
13.64
=
26.75
2011
365
12.80
=
28.51
2010
365
13.13
=
27.81
Tootsie Roll
Inventory
Inventory turnover ratio
Cost of Goods Sold
Average Inventory
Average days in inventory
365
Inventory Turnover Ratio
Inventory Turnover Ratio
Hershey
2011
$3,548,896
($648,953 + 533,622) /2
=
6.00
200
$3,255,801
($533,622 + 519,712) /2
=
6.18
Tootsie Roll
2011
$365,255
($42,676 + 29,084 + 35,416 + 21,236) /2
2010
$349,334
($35,416 + 21,236 + 35,570 + 20,817) /2
=
=
5.69
6.18
This metric is worsening for both companies.
Both companies turned their inventory at approximately the industry
average.
Days in Inventory
Hershey
2011
365
6.00
=
60.81
2010
365
6.18
=
59.04
2011
365
5.69
=
64.17
2010
365
6.18
=
59.05
Tootsie Roll
Accounts Payable
Accounts payable turnover ratio
Inventory Purchases
Average Accounts Payable
Average days payables outstanding
365
Accounts Payable Turnover Ratio
Accounts Payable Turnover Ratio (Nordstrom)
Nordstrom
2011
$6,592 – 201
($917 + 845) /2
=
7.71
2010
$5,897 – 49
($845 + 726) /2
=
7.57
This metric is worsening for Nordstrom.
Days in payables outstanding (Nordstrom)
Nordstrom
2011
365
7.71
=
47.2 days
2010
365
7.57
=
48.2 days
Summary of Hershey’s Working
Capital Position
1.
2.
3.
Customers pay accounts receivable
in approximately 25 days.
Inventory remains on hand for
approximately 61 days.
Current operations are generating
sufficient cash to repay current
liabilities.
Summary of Tootsie Roll’s Working
Capital Position
1.
2.
3.
Accounts receivable are paid in approximately
29 days.
Inventory remains on hand for approximately
64 days.
Current operations are generating sufficient
cash to repay current liabilities.
International
Accounting Standards
The IASC has issued pronouncements on the
following issues affecting working capital:
1
Revised IAS No. 1, “Presentation of Financial Statements”
2
3
presentation of current assets and current liabilities
IAS No. 39, “Financial Instruments: Recognition and
Measurement”
IAS No. 2 , “Inventories”
IAS No. 1
The IASC did not attempt to deal with the
valuation issues discussed earlier in the
chapter
Discussed two views of current assets and current liabilities:
1
A measure of liquidity
2
Identification of circulating resources and obligations
Since these views are contradictory, it has lead to classifications of
items by convention
Allows, but does not require, companies to decide whether or not to
sub-classify assets and liabilities as current
FASB staff review indicated that it was quite similar to U. S. GAAP
IAS No. 25
Allows investments classified as current to be accounted for by market
value or LCM
Value may be determined individually, by
investment category, or on a total portfolio
basis
Preference for the total portfolio or
investment category methods
IAS No. 2
Objective of inventory reporting is to determine proper amount of
cost to recognize as an asset
Specific identification method preferred
If not feasible, FIFO or weighted average preferred
Revised IAS No. 2: LIFO is no longer allowed
Inventory must be written down to net realizable value on item-byitem basis
End of Chapter 8
Prepared by Kathryn Yarbrough, MBA
Copyright © 2014 John Wiley & Sons, Inc. All rights reserved.
Reproduction or translation of this work beyond that permitted in
Section 117 of the 1976 United States Copyright Act without the
express written consent of the copyright owner is unlawful. Request
for further information should be addressed to the Permissions
Department, John Wiley & Sons, Inc. The purchaser may make backup copies for his/her own use only and not for distribution or
resale. The Publisher assumes no responsibility for errors,
omissions, or damages, caused by the use of these programs or from
the use of the information contained herein.
