Working capital constitutes current liabilities and current assets, with significant drivers as prepaid balances in account payable and current assets, inventory, the unearned income in current liabilities, and account receivables. In this context, the working capital position of a firm is the difference between the money in current assets subtracted by current liabilities. Lets know about the research report on Working capital management here.
Positive vs Negative Capital Position
A positive working capital position depicts a situation where the company’s current assets exceed current liabilities. By contrast, when current assets are less than current liabilities, the working capital is negative. In the case study, the company’s current assets equal current liabilities because the net working capital in 2019, excluding cash, is similar to 2018’s. In this case, the firm has a neutral working capital position. It means that the major factors driving current liabilities and assets match in consecutive years. This neutral working capital position avoids funding from one year to the next. Unfortunately, the firm does not experience the same advantages as one that grows with a negative working capital position. When the drivers of current assets are less than current liabilities, the position becomes dangerous as it fosters ultimate financial harm for organizations, except for others such as Amazon and Microsoft, which engage in responsible bookkeeping and business practices. Importantly, the negative working capital position is efficient for entities with growing revenues as opposed to those whose rates are declining. If revenues begin decreasing, the advantages conferred to an establishment with a similar structure of the working capital position needs annual capital investment.
Positive working capital translates into the availability of capital that ensures that short-term liabilities are covered in the next 12 months. This aspect denotes the financial strength that propels the organization towards achieving its goals and objectives. Conversely, unproductive use of available resources in the company manifests when records of unused current assets appear in financial reports. In this regard, the management considers financing the extra funds in receivables and inventories by long-term liabilities instead of the short-term liabilities. The former is necessary to facilitate longer-term investments, increasing efficiency in the process. For this reason, maintaining a working capital of 20% to 100% of the total current liabilities balances the needed financial strength of the company.
Top-3 Ratios for Rational Financial Decisions
In most cases, investors need to properly understand and apply some fundamental financial ratios to make an informed decision. The financial analysis of company positions relies on data from corporate financial statements based on these four components: earnings per share, price-earnings (P/E), return on equity (ROE), and debt-to-equity. For example, the working capital demonstrates the establishment’s ability to use available assets to pay existing liabilities. In this regard, stakeholders use the element to evaluate the financial health of people who can lend the company money and their ability to pay all debts within a year. In essence, the health of companies depends on how easily they can turn assets into cash for required short-term payments: liquidity. Secondly, the quick ratio depicts how well ready cash and items cover current liabilities. Thirdly, stockholders who buy stocks in share risk losing or future earnings.
The purpose of Earnings Per Share (EPS) is to measure the net income of each share on the common stock. Fourthly, the Price-Earnings (P/E) Ratio P/E reflects the future earnings of investor assessments. Finding the P/E ratio entails defining the share price of the stock through a division by the P/E ratio. Importantly, investors are often willing to make payments that exceed the EPS 20 times for specified stocks if data proves that future earnings portend sufficient return on investment. Furthermore, adding short and long-term debt before dividing the resulting book value of shareholder’s equity gives the debt-equity ratio, which indicates whether the prospective investment target depends on over-borrowing. Lastly, the Return on Equity (ROE) shows how profitable the capital invested in the business is in the long run. The company records a ROE of 35.8%, which increases in subsequent years. This return on investment indicates the company’s ability to successfully utilize resources and accumulated profits in generating income. The low asset to equity ratio of 1:2 indicates that the business has been financed in a conservative manner, especially with low debt and a large proportion of investor funding. The net earnings entail calculating the return on equity, which involves taking net earnings after dividend and tax subtraction before the division of the results by the equity dollars.
Long-, Short-, and Medium-term Stock Performance
The company is a hold because recommendations from the financial analysis process illustrate that investors and stakeholders can neither sell nor buy security. For this reason, the firm’s status illustrates an average performance in the market. Essentially, being on hold is more significant than the sell or buy because investors with long-term positions do not sell while those without positions do not buy. A hold recommendation demonstrates what specific stocks investors hold as they continue to purchase more of it. Provided an investor decides to hold a stock, two potential options present themselves. First, holding onto the equity is prudential for investors who already own shares of the stock. The purpose of proceeding in this manner is to see how the stock performs over the long-term, short-term, and medium-term. Investors wait to purchase other stocks depending on prospects, where variations from the buy-and-hold strategy manifest as an equity security purchase occurs with the understanding that the stock will hold for a long time. This strategy is crucial as it makes investors remain with their stock to cover the cost of market recessions and retractions. The phenomenon prevents sales during times of volatility to sell at peak times.
Risk Management and Value Accretion
Value accretion is the direct impact of reducing the inherent risk levels in an organization. The process is beneficial because it reduces the cost of capital in the firm in question. In this case, capitalization and discount rates present plausible returns that investors need depending on the weaknesses and strengths of the company, coupled with the opportunities and threats in the industry. The level of risk management of the company relies on its ability to retain customer concentration and stability. The company has a low asset to equity ratio of 1:2, which is essential in comprehending its performance in the market. A high asset to equity ratio limits funding from lenders who do not extend additional funding to an entity in this position. Understanding these variables increases the ease of operations by determining the barriers to exit, which help to reduce risks and secure repeat business. The process reduces the loss of critical customers over avoidable issues. In this context, the main disadvantage for holding stock in the company is inflation, particularly when its rate occasions the decline of stock prices. Besides, instances of negative working capital increase the cost of operations, lowering the return on investment on stocks over a long time. For this reason, stakeholders can opt to sell all their stocks, citing unprofitability in the organization, leading to negative publicity of the brand. This phenomenon is dangerous because it curtails future investments on the company stocks based on an unacceptable reputation. Proceeding with caution is necessary to avert such an instance, especially when the overall growth towards achieving preset objectives and goals is in jeopardy.
Final Words
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