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Working capital management

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Definition of Working capital management

Working Capital Management Image 1

Working capital management

The management of current assets and current liabilities to maximize shortterm liquidity.



Related Terms:

Margin call

A demand for additional funds because of adverse price movement. Maintenance margin
requirement, security deposit maintenance
Margin of safety With respect to working capital management, the difference between 1) the amount of longterm
financing, and 2) the sum of fixed assets and the permanent component of current assets.


Asset/liability management

Also called surplus management, the task of managing funds of a financial
institution to accomplish the two goals of a financial institution:
1) to earn an adequate return on funds invested, and
2) to maintain a comfortable surplus of assets beyond liabilities.


Average cost of capital

A firm's required payout to the bondholders and to the stockholders expressed as a
percentage of capital contributed to the firm. Average cost of capital is computed by dividing the total
required cost of capital by the total amount of contributed capital.


Bottom-up equity management style

A management style that de-emphasizes the significance of economic
and market cycles, focusing instead on the analysis of individual stocks.


Capital

Money invested in a firm.



Capital account

Net result of public and private international investment and lending activities.


Capital allocation

decision Allocation of invested funds between risk-free assets versus the risky portfolio.


Working Capital Management Image 2

Capital asset pricing model (CAPM)

An economic theory that describes the relationship between risk and
expected return, and serves as a model for the pricing of risky securities. The CAPM asserts that the only risk
that is priced by rational investors is systematic risk, because that risk cannot be eliminated by diversification.
The CAPM says that the expected return of a security or a portfolio is equal to the rate on a risk-free security
plus a risk premium.


Capital budget

A firm's set of planned capital expenditures.


Capital budgeting

The process of choosing the firm's long-term capital assets.


Capital expenditures

Amount used during a particular period to acquire or improve long-term assets such as
property, plant or equipment.


Capital flight

The transfer of capital abroad in response to fears of political risk.


Capital gain

When a stock is sold for a profit, it's the difference between the net sales price of securities and
their net cost, or original basis. If a stock is sold below cost, the difference is a capital loss.


Capital gains yield

The price change portion of a stock's return.


Capital lease

A lease obligation that has to be capitalized on the balance sheet.


Capital loss

The difference between the net cost of a security and the net sale price, if that security is sold at a loss.


Working Capital Management Image 3

Capital market

The market for trading long-term debt instruments (those that mature in more than one year).


Capital market efficiency

Reflects the relative amount of wealth wasted in making transactions. An efficient
capital market allows the transfer of assets with little wealth loss. See: efficient market hypothesis.



Capital market imperfections view

The view that issuing debt is generally valuable but that the firm's
optimal choice of capital structure is a dynamic process that involves the other views of capital structure (net
corporate/personal tax, agency cost, bankruptcy cost, and pecking order), which result from considerations of
asymmetric information, asymmetric taxes, and transaction costs.


Capital market line (CML)

The line defined by every combination of the risk-free asset and the market portfolio.


Capital rationing

Placing one or more limits on the amount of new investment undertaken by a firm, either
by using a higher cost of capital, or by setting a maximum on parts of, and/or the entirety of, the capital
budget.


Capital structure

The makeup of the liabilities and stockholders' equity side of the balance sheet, especially
the ratio of debt to equity and the mixture of short and long maturities.


Capital surplus

Amounts of directly contributed equity capital in excess of the par value.


Capitalization

The debt and/or equity mix that fund a firm's assets.


Capitalization method

A method of constructing a replicating portfolio in which the manager purchases a
number of the largest-capitalized names in the index stock in proportion to their capitalization.


Capitalization ratios

Also called financial leverage ratios, these ratios compare debt to total capitalization
and thus reflect the extent to which a corporation is trading on its equity. capitalization ratios can be
interpreted only in the context of the stability of industry and company earnings and cash flow.


Capitalization table

A table showing the capitalization of a firm, which typically includes the amount of
capital obtained from each source - long-term debt and common equity - and the respective capitalization
ratios.


Working Capital Management Image 4

Capitalized

Recorded in asset accounts and then depreciated or amortized, as is appropriate for expenditures
for items with useful lives greater than one year.



Capitalized interest

Interest that is not immediately expensed, but rather is considered as an asset and is then
amortized through the income statement over time.


Cash management bill

Very short maturity bills that the Treasury occasionally sells because its cash
balances are down and it needs money for a few days.


Complete capital market

A market in which there is a distinct marketable security for each and every
possible outcome.


Corporate financial management

The application of financial principals within a corporation to create and
maintain value through decision making and proper resource management.


Cost of capital

The required return for a capital budgeting project.


Cost of limited partner capital

The discount rate that equates the after-tax inflows with outflows for capital
raised from limited partners.


Dedicated capital

Total par value (number of shares issued, multiplied by the par value of each share). Also
called dedicated value.


Efficient capital market

A market in which new information is very quickly reflected accurately in share
prices.


Hard capital rationing

capital rationing that under no circumstances can be violated.


Human capital

The unique capabilities and expertise of individuals.


Issued share capital

Total amount of shares that are in issue. Related: outstanding shares.


Legal capital

Value at which a company's shares are recorded in its books.


Long-term debt/capitalization

Indicator of financial leverage. Shows long-term debt as a proportion of the
capital available. Determined by dividing long-term debt by the sum of long-term debt, preferred stock and
common stockholder equity.


Management/closely held shares

Percentage of shares held by persons closely related to a company, as
defined by the Securities and exchange commission. Part of these percentages often is included in
Institutional Holdings -- making the combined total of these percentages over 100. There is overlap as
institutions sometimes acquire enough stock to be considered by the SEC to be closely allied to the company.


Management buyout (MBO)

Leveraged buyout whereby the acquiring group is led by the firm's management.


Management fee

An investment advisory fee charged by the financial advisor to a fund based on the fund's
average assets, but sometimes determined on a sliding scale that declines as the dollar amount of the fund increases.


Market capitalization

The total dollar value of all outstanding shares. Computed as shares times current
market price. It is a measure of corporate size.


Market capitalization rate

Expected return on a security. The market-consensus estimate of the appropriate
discount rate for a firm's cash flows.


Money management

Related: Investment management.


Net working capital

Current assets minus current liabilities. Often simply referred to as working capital.


Nondiversifiability of human capital

The difficulty of diversifying one's human capital (the unique
capabilities and expertise of individuals) and employment effort.


Opportunity cost of capital

Expected return that is foregone by investing in a project rather than in
comparable financial securities.


Other capital

In the balance of payments, other capital is a residual category that groups all the capital
transactions that have not been included in direct investment, portfolio investment, and reserves categories. It
is divided into long-term capital and short-term capital and, because of its residual status, can differ from
country to country. Generally speaking, other long-term capital includes most non-negotiable instruments of a
year or more like bank loans and mortgages. Other short-term capital includes financial assets of less than a
year such as currency, deposits, and bills.


Outstanding share capital

Issued share capital less the par value of shares that are held in the company's treasury.


Passive investment management

Buying a well-diversified portfolio to represent a broad-based market
index without attempting to search out mispriced securities.


Pecking-order view (of capital structure)

The argument that external financing transaction costs, especially
those associated with the problem of adverse selection, create a dynamic environment in which firms have a
preference, or pecking-order of preferred sources of financing, when all else is equal. Internally generated
funds are the most preferred, new debt is next, debt-equity hybrids are next, and new equity is the least
preferred source.


Perfect capital market

A market in which there are never any arbitrage opportunities.


Perfect market view (of capital structure)

Analysis of a firm's capital structure decision, which shows the
irrelevance of capital structure in a perfect capital market.


Personal tax view (of capital structure)

The argument that the difference in personal tax rates between
income from debt and income from equity eliminates the disadvantage from the double taxation (corporate
and personal) of income from equity.


Pie model of capital structure

A model of the debt/equity ratio of the firms, graphically depicted in slices of
a pie that represent the value of the firm in the capital markets.


Planned capital expenditure program

capital expenditure program as outlined in the corporate financial plan.


Portfolio management

Related: Investment management


Pro forma capital structure analysis

A method of analyzing the impact of alternative capital structure
choices on a firm's credit statistics and reported financial results, especially to determine whether the firm will
be able to use projected tax shield benefits fully.


Real capital

Wealth that can be represented in financial terms, such as savings account balances, financial
securities, and real estate.


Risk management

The process of identifying and evaluating risks and selecting and managing techniques to
adapt to risk exposures.


"Soft" Capital Rationing

capital rationing that under certain circumstances can be violated or even viewed
as made up of targets rather than absolute constraints.


Static theory of capital structure

Theory that the firm's capital structure is determined by a trade-off of the
value of tax shields against the costs of bankruptcy.


Surplus management

Related: asset management


Top-down equity management style

A management style that begins with an assessment of the overall
economic environment and makes a general asset allocation decision regarding various sectors of the financial
markets and various industries. The bottom-up manager, in contrast, selects the specific securities within the
favored sectors.


Venture capital

An investment in a start-up business that is perceived to have excellent growth prospects but
does not have access to capital markets. Type of financing sought by early-stage companies seeking to grow rapidly.


Weighted average cost of capital

Expected return on a portfolio of all the firm's securities. Used as a hurdle
rate for capital investment.


Working capital

Defined as the difference in current assets and current liabilities (excluding short-term
debt). Current assets may or may not include cash and cash equivalents, depending on the company.


Working capital ratio

working capital expressed as a percentage of sales.


CAPITAL

The money, raised by selling stock or bonds or taking out loans, that you use to start, operate, and grow a business.


CAPITAL IN EXCESS OF PAR VALUE

What a company collected when it sold stock for more than the par value per share.


Capital

The shareholders’ investment in the business; the difference between the assets and liabilities
of a business.


Capital employed

The total of debt and equity, i.e. the total funds in the business.


Capitalize

To make a payment that might otherwise be an expense (in the Profit and Loss account) an asset
(in the Balance Sheet).


Capital market

The market in which investors buy and sell shares of companies, normally associated with a Stock Exchange.


Cost of capital

The costs incurred by an organization to fund all its investments, comprising the risk-adjusted
cost of equity and debt weighted by the mix of equity and debt.


Management accounting

The production of financial and non-financial information used in planning for the future; making decisions about products, services, prices and what costs to incur; and ensuring that plans are implemented and achieved.


Return on capital employed (ROCE)

The operating profit before interest and tax as a percentage of the total shareholders’ funds plus
the long-term debt of the business.


Strategic management accounting

The provision and analysis of management accounting data about a business and its competitors, which is of use in the development and monitoring of strategy (Simmonds).


Value-based management

A variety of approaches that emphasize increasing shareholder value as the primary goal of every business.


Weighted average cost of capital

See cost of capital.


Working capital

Current assets less current liabilities. Money that revolves in the business as part of the process of buying, making and selling goods and services, particularly in relation to debtors, creditors, inventory and bank.


Additional paid-in capital

Amounts in excess of the par value or stated value that have been paid by the public to acquire stock in the company; synonymous with capital in excess of par.


Capital in excess par

Amounts in excess of the par value or stated value that have been paid by the public to acquire stock in the company; synonymous with additional paid-in capital.


Contributed capital

The amount put into the business by the owners by purchasing stock and by paying more than the par value for the stock (additional paid-in capital or capital in excess of par).


capital

A very broad term rooted in economic theory and referring to
money and other assets that are invested in a business or other venture
for the general purpose of earning a profit, or a return on the investment.
Generally speaking, the sources of capital for a business are
divided between debt and equity. Debt, as you know, is borrowed money
on which interest is paid. Equity is the broad term for the ownership
capital invested in a business and is most often called owners’ equity.
Owners’ equity arises from two quite different sources: (1) money or
other assets invested in the business by its owners and (2) profit earned
by the business that is retained and not distributed to its owners (called
retained earnings).


capital budgeting

Refers generally to analysis procedures for ranking
investments, given a limited amount of total capital that has to be allocated
among the various capital investment opportunities of a business.
The term sometimes is used interchangeably with the analysis techniques
themselves, such as calculating present value, net present value,
and the internal rate of return of investments.


capital expenditures

Refers to investments by a business in long-term
operating assets, including land and buildings, heavy machinery and
equipment, vehicles, tools, and other economic resources used in the
operations of a business. The term capital is used to emphasize that
these are relatively large amounts and that a business has to raise capital
for these expenditures from debt and equity sources.


capital investment analysis

Refers to various techniques and procedures
used to determine or to analyze future returns from an investment
of capital in order to evaluate the capital recovery pattern and the
periodic earnings from the investment. The two basic tools for capital
investment analysis are (1) spreadsheet models (which I strongly prefer)
and (2) mathematical equations for calculating the present value or
internal rate of return of an investment. Mathematical methods suffer
from a lack of information that the decision maker ought to consider. A
spreadsheet model supplies all the needed information and has other
advantages as well.


capital recovery

Refers to recouping, or regaining, invested capital over
the life of an investment. The pattern of period-by-period capital recovery
is very important. In brief, capital recovery is the return of capital—
not the return on capital, which refers to the rate of earnings on the
amount of capital invested during the period. The returns from an
investment have to be sufficient to provide for both recovery of capital
and an adequate rate of earnings on unrecovered capital period by
period. Sorting out how much capital is recovered each period is relatively
easy if you use a spreadsheet model for capital investment analysis.
In contrast, using a mathematical method of analysis does not
provide this period-by-period capital recovery information, which is a
major disadvantage.


capital stock

Ownership shares issued by a business corporation. A business
corporation may issue more than one class of capital stock shares.
One class may give voting privileges in the election of the directors of the
corporation while the other class does not. One class (called preferred
stock) may entitle a certain amount of dividends per share before cash
dividends can be paid on the other class (usually called common stock).
Stock shares may have a minimum value at which they have to be issued
(called the par value), or stock shares can be issued for any amount
(called no-par stock). Stock shares may be traded on public markets such
as the New York Stock Exchange or over the Nasdaq network. There are
about 10,000 stocks traded on public markets (although estimates vary
on this number). In this regard, I find it very interesting that there are
more than 8,000 mutual funds that invest in stocks.


capital structure, or capitalization

Terms that refer to the combination of
capital sources that a business has tapped for investing in its assets—in
particular, the mix of its interest-bearing debt and its owners’ equity. In a
more sweeping sense, the terms also include appendages and other features
of the basic debt and equity instruments of a business. Such things
as stock options, stock warrants, and convertible features of preferred
stock and notes payable are included in the more inclusive sense of the
terms, as well as any debt-based and equity-based financial derivatives
issued by the business.


capitalization of costs

When a cost is recorded originally as an increase
to an asset account, it is said to be capitalized. This means that the outlay
is treated as a capital expenditure, which becomes part of the total
cost basis of the asset. The alternative is to record the cost as an expense
immediately in the period the cost is incurred. capitalized costs refer
mainly to costs that are recorded in the long-term operating assets of a
business, such as buildings, machines, equipment, tools, and so on.


cost of capital

Refers to the interest cost of debt capital used by a business
plus the amount of profit that the business should earn for its equity
sources of capital to justify the use of the equity capital during the
period. Interest is a contractual and definite amount for a period,
whereas the profit that a business should earn on the equity capital
employed during the period is not. A business should set a definite goal
of earning at least a certain minimum return on equity (ROE) and compare
its actual performance for the period against this goal. The costs of
debt and equity capital are combined into either a before-tax rate or an
after-tax rate for capital investment analysis.


management control

This is difficult to define in a few words—indeed, an
entire chapter is devoted to the topic (Chapter 17). The essence of management
control is “keeping a close watch on everything.” Anything can
go wrong and get out of control. management control can be thought of
as the follow-through on decisions to ensure that the actual outcomes
happen according to purposes and goals of the management decisions
that set things in motion. Managers depend on feedback control reports
that contain very detailed information. The level of detail and range of
information in these control reports is very different from the summarylevel
information reported in external income statements.


market capitalization, or market cap

Current market value per share of
capital stock multiplied by the total number of capital stock shares outstanding
of a publicly owned business. This value often differs widely from
the book value of owners’ equity reported in a business’s balance sheet.


weighted-average cost of capital

Weighted means that the proportions of
debt capital and equity capital of a business are used to calculate its
average cost of capital. This key benchmark rate depends on the interest
rate(s) on its debt and the ROE goal established by a business. This is a
return-on-capital rate and can be applied either on a before-tax basis or
an after-tax basis. A business should earn at least its weighted-average
rate on the capital invested in its assets. The weighted-average cost-ofcapital
rate is used as the discount rate to calculate the present value
(PV) of specific investments.



 

 

 

 

 

 

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