Working CapitalCurrent Assets
Now let's examine reducing Current Assets. Consider these
cases:
Sales: $100,000
CASE 1:
CASE 2:
CASE 1:
| ASSETS ($000) | |||
|---|---|---|---|
| Current Assets | |||
| Cash | $6,500 | ||
| Accts Receivable | $7,000 | ||
| Inventories | $6,500 | ||
| Current Assets | $20,000 | ||
| Current Ratio | 2.0 |
| LIABILITIES & OWNER'S EQUITY | |||
|---|---|---|---|
| Liabilities | |||
| Accts Payable | $6,000 | ||
| Current Debt | $4,000 | ||
| Current Liabilities | $10,000 | ||
Days of Working Capital |
36.5 | ||
CASE 2:
| ASSETS ($000) | |||
|---|---|---|---|
| Current Assets | |||
| Cash | $2,500 | ||
| Accts Receivable | $7,000 | ||
| Inventories | $2,500 | ||
| Current Assets | $12,000 | ||
| Current Ratio | 2.0 |
| LIABILITIES & OWNER'S EQUITY | |||
|---|---|---|---|
| Liabilities | |||
| Accts Payable | $6,000 | ||
| Current Debt | $0 | ||
| Current Liabilities | $6,000 | ||
Days of Working Capital |
21.9 | ||
Case 1 and 2 both have Current Ratios of 2.0, but Case 2 is much more worrisome. If demand increases, you stock out after selling only $2.5 million of inventory. If demand falls, you run out of cash after building only $2.5 million of additional inventory. You have little room for error.