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State the working capital ratio - HSC - SSCE Business Studies - Question 23 - 2007 - Paper 1

Question 23

State the working capital ratio. Explain why working capital is important to business. Recommend TWO strategies to manage working capital.

Worked Solution & Example Answer:State the working capital ratio - HSC - SSCE Business Studies - Question 23 - 2007 - Paper 1

Step 1

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Answer

The working capital ratio is calculated as:

$\text{Working Capital Ratio} = \frac{\text{Current Assets}}{\text{Current Liabilities}}$

Alternatively, it can also be expressed as:

$\text{Current Ratio} = \frac{\text{Current Assets}}{\text{Current Liabilities}} \times 100$

Step 2

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Answer

Working capital is crucial for businesses for several reasons:

Liquidity Management: Adequate working capital allows a business to meet its short-term liabilities as they come due. It ensures that the company can pay its bills and avoid insolvency.
Operational Efficiency: A positive working capital position enables businesses to invest in new materials and manage inventory levels effectively, ensuring smooth operations and meeting customer demand without delays.
Financial Flexibility: Sufficient working capital provides the flexibility to take advantage of new opportunities, such as purchasing at discounts or expanding product offerings.

Step 3

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Answer

Leasing and Sale-Leaseback: Businesses can consider leasing assets rather than purchasing them outright to conserve cash flow. This strategy can free up capital for other business needs while maintaining essential operational capabilities.
Factoring Receivables: This involves selling accounts receivable to a third party at a discount. This strategy helps improve cash flow by converting outstanding invoices into immediate cash, allowing the business to manage working capital more effectively.