Working Capital Ratio and the Importance of Working Capital Management

The company needs some amount of liquid assets and capital that would help the company manage its daily activities and this capital is known as working capital. 
If you made a comparison of the company's current assets against its current liabilities, you would arrive at the working capital ratio for the particular company. In order to better understand the working capital ratio let us take a look at the definition of current assets and current liabilities.

Current Assets: Current assets are the short term assets of the company that we are going to consider for the working capital ratio in the form of cash, accounts receivable, inventory, short term investments and pre-paid expenses.

Current liabilities: Current liabilities are the short term liabilities of the company that we are going to consider for the working capital ratio in the form of accounts payable, outstanding expenses, payable taxes and short term loans.

Thus, the working capital ratio is useful in telling us whether the business can support itself with its current assets despite its current liabilities. The mathematical formula to calculate the working capital ratio is:

Working capital ratio = current assets / current liabilities

In order to calculate the working capital ratio we can assume the current assets of a company to be USD 250,000 against

Deferred Tax Assets (Deferred Tax Liabilities)

International Accounting Standard defines,

Deferred tax assets as “the amounts of income taxes recoverable in future periods in respect of:

(a) Deductible temporary differences;

(b) The carry forward of unused tax losses; and

(c) The carry forward of unused tax credits.”

Deferred tax liabilities are defined by this Standard as “the amounts of income taxes payable in future periods in respect of taxable temporary differences”.The temporary differences are the differences between the carrying amount of an asset and liability and its tax base. 

Tax base is the value of an asset or liability for the tax purposes. The tax base of a liability is usually its carrying amount less amounts that will be deductible for tax in the future. The tax base of an asset is the amount that will be deductible for tax purposes.The carrying values of assets and liabilities are not always the same as tax bases. 

It is believed that the liabilities will be settled and the assets will be recovered eventually over time and at that point of time their tax consequences will crystallize.Two types of temporary differences can arise 

i.e. taxable temporary difference and deductible temporary difference.

The taxable temporary difference results in the payment of taxes when the carrying amount of a liability is settled or the carrying amount of an asset is recovered. Taxable temporary differences give rise to deferred tax liabilities. A deferred tax liability arises·  

   - If the carrying value of an asset is greater than its tax base OR·  

  - If the carrying value of a liability is less than its tax base.

Deductible temporary differences result in amounts being deductible when determining the taxable profit or loss in the future period when assets or liabilities are recovered or settled. Deductible temporary differences give rise to deferred tax assets. A deferred tax assets arises· 

   - If the carrying value of an asset is less than its tax base OR·         

   - If the carrying value of a liability is greater than its tax base.

Definition of 'Tax Holiday'

A government incentive program that offers a tax reduction or elimination to businesses. Tax holidays are often used to reduce sales taxes by local governments, but they are also commonly used by governments in developing countries to help stimulate foreign investment.

Used in the hopes of increasing the gross domestic product (GDP) in developing countries, tax holidays are a way in which governments attract foreign investors. Tax holidays are often put in place in particular industries to help promote growth.

Net Profit Margin

Net Profit Margin tells you exactly how the managers and operations of a business are performing. Net Profit Margin compares the net income of a firm with total sales achieved. The formula for Net Profit Margin is: Net Profit Margin = Net Income / Sales

For example, consider a firm that has an annual net income of $500,000 while the total sales achieved during the

Operating Profit Margin

The Operating Profit Margin will illustrate to you how efficiently the managers of a firm are using business operations to generate profit. This ratio also shows the success rate of these managers. The formula for Operating Profit Margin is: Formula: Operating Profit Margin = Earnings before Interest & Taxes / Sales

For example, consider a firm that has $2 million sales this year and an EBIT (Earnings before Interest & Taxes)

GROSS PROFIT MARGIN

GROSS PROFIT MARGIN (GPM) is one of the key performance indicators. The gross profit margin gives an indication on whether the average markup on goods and services is sufficient to cover expenses and make a profit. GPM shows the relationship between sales and the direct cost of products/services sold. It measures the ability of both to control costs and to pass along price

Cash Flow Statement

Cash flow statement may provide considerable information about what is really happening in a business beyond that contained in either the income statement or the balance sheet.  Analyzing this statement should not present an intimidating task, instead it will quickly become obvious that the benefits of understanding the sources and uses of a company’s cash far outweigh the costs of undertaking some very straightforward analyzes.  

Who cares about a Cash Flow Statement?

            • Executives want to know if the cash generated by the company will be sufficient to fund their

Statement of Cash Flows

Format of the Statement of Cash Flows

The statement of cash flows has four distinct sections:

1. Cash involving operating activities
2. Cash involving investing activities
3. Cash involving financing activities
4. Supplemental information.

Assuming that the cash flow statement is being prepared using the indirect method (the method used by most

Sample Balance Sheet:

Example Company
Balance Sheet
December 31, 2010

ASSETS					LIABILITIES
Current Assets					Current Liabilities
	Cash		$   2,100			Notes Payable		$   5,000
	Petty Cash		100			Accounts Payable		35,900

Balance Sheet

The balance sheet presents a company's financial position at the end of a specified date. Some describe the balance sheet as a "snapshot" of the company's financial position at a point (a moment or an instant) in time. For example, the amounts reported on a balance sheet dated December 31, 2010 reflect that instant when all the transactions through December 31 have been recorded.

Because the balance sheet informs the reader of a company's financial position as of one moment in time, it

What is the difference between net cash flow and net income?

Under the accrual method of accounting, net income is calculated as follows: revenues earned minus the expenses incurred in order to earn those revenues. If a company earns revenues in December 2008 but allows those customers to pay in 30 days, the cash from the December revenues will likely be received in January 2009. In this situation the December 2008 revenues will increase the December 2008 net income, but

What is included in cash and cash equivalents?

The term cash and cash equivalents includes: currency, coins, checks received but not yet deposited, checking accounts, petty cash, savings accounts, money market accounts, and short-term, highly liquid investments with a maturity of three months or less at the time of purchase such as U.S. treasury bills and commercial paper. The

What is the difference between cash flow and free cash flow?

A corporation’s cash flow from operations is available from the first section of the statement of cash flows. Usually the calculation begins with the accrual accounting net income followed by adding back depreciation

What are some examples of financing activities?

Financing activities involve long-term liabilities and stockholders’ (or owner’s) equity. Financing activities are reported in its own section of the financial statement known as the statement of cash flows (SCF) or cash flow statement.

Examples of financing activities that involve long-term liabilities include the issuance or redemption of bonds.

What are some examples of investing activities?

Investing activities are identified with changes in a corporation’s long-term assets. Investing activities are reported in a separate section of the financial statement, statement of Cash Flows (SCF) - also referred to as the cash flow statement.

Examples of investing activities include the acquisition (purchase) of long-term investments, equipment used in

What are some example of operating activities?

Cash from operating activities usually refers to the net cash inflow reported in the first section of the statement of cash flows. Cash from operating activities focuses on the cash inflows and outflows from a company’s main business activities of buying and selling merchandise, providing services, etc.

What is the purpose of the cash flow statement?

The purpose of the cash flow statement or statement of cash flows is to provide information about a company’s gross receipts and gross payments for a specified period of time.
The gross receipts and gross payments will be reported in the cash flow statement according to one of the following classifications: operating activities, investing activities, and financing activities. The net change from these three classifications should equal the change in a company’s cash and cash equivalents during the reporting period. For instance, the cash flow statement for the calendar year 2010 will report the causes of the change in a company’s cash and cash equivalents between its balance sheets of December 31, 2009 and

What Can The Statement of Cash Flows Tell Us?

Because the income statement is prepared under the accrual basis of accounting, the revenues reported may not have been collected. Similarly, the expenses reported on the income statement might not have been paid. You could review the balance sheet changes to determine the facts, but the cash flow statement already has integrated all that information.

Here are a few ways the statement of cash flows is used.

1. The cash from operating activities is compared to the company's net income. If the cash from operating

Cash Flow Statement

The cash flow statement and the statement of cash flows are the same, we can use both.

The statement of cash flows is one of the main financial statements. (The other financial statements are the balance sheet, income statement, and statement of stockholders' equity.)

The cash flow statement reports the cash generated and used during the time interval specified in its heading.

Equity

What Does Equity Mean?
1. A stock or any other security representing an ownership interest.

2. On a company's balance sheet, the amount of the funds contributed by the owners (the stockholders) plus the retained earnings (or losses). Also referred to as "shareholders' equity".

3. In the context of margin trading, the value of securities in a margin account minus what has been borrowed