{"id":40289,"date":"2022-10-22T11:32:55","date_gmt":"2022-10-22T11:32:55","guid":{"rendered":"https:\/\/analystprep.com\/cfa-level-1-exam\/?p=40289"},"modified":"2025-04-08T12:57:12","modified_gmt":"2025-04-08T12:57:12","slug":"financing-working-capital","status":"publish","type":"post","link":"https:\/\/analystprep.com\/cfa-level-1-exam\/corporate-issuers\/financing-working-capital\/","title":{"rendered":"Financing Working Capital"},"content":{"rendered":"\n<script type=\"application\/ld+json\">\n{\n  \"@context\": \"https:\/\/schema.org\",\n  \"@type\": \"VideoObject\",\n  \"name\": \"Working Capital and Liquidity (2025 Level I CFA\u00ae Exam \u2013 Corporate Issuers \u2013 Module 5)\",\n  \"description\": \"This video lesson covers working capital and liquidity management in corporate finance. It explains how firms manage current assets and liabilities, internal and external funding sources, short-term funding strategies, and liquidity ratios. The session also explores working capital approaches\u2014conservative, aggressive, and moderate\u2014and how these choices impact profitability, risk, and financial flexibility.\",\n  \"uploadDate\": \"2022-09-30T00:00:00+00:00\",\n  \"thumbnailUrl\": \"https:\/\/img.youtube.com\/vi\/qwQXR6SdLvA\/maxresdefault.jpg\",\n  \"contentUrl\": \"https:\/\/www.youtube.com\/watch?v=qwQXR6SdLvA\",\n  \"embedUrl\": \"https:\/\/www.youtube.com\/embed\/qwQXR6SdLvA\",\n  \"duration\": \"PT47M50S\"\n}\n<\/script>\n\n\n\n<p>[vsw id=&#8221;qwQXR6SdLvA&#8221; source=&#8221;youtube&#8221; width=&#8221;611&#8243; height=&#8221;344&#8243; autoplay=&#8221;no&#8221;]<br \/>\nCurrent assets less current liabilities equals working capital.<\/p>\n<p>$$\\text{Working capital = Current assets &#8211; Current liabilities}$$<\/p>\n<p>A company&#8217;s short-term assets and obligations are managed through working capital management. Its objective is to prevent excess reserves that might be expensive and, consequently, have a detrimental impact on shareholder returns. At the same time, working capital management ensures that a firm has easy access to the money it requires for day-to-day operations.<\/p>\n<p>Companies base their financing choices on market circumstances, legal requirements, and the costs and risks involved for both the firm and the capital provider.<\/p>\n<p>Working capital is represented by cash, accounts receivable, inventories, and marketable securities (short-term investments). In contrast, short-term financing is provided by accounts payable, credit lines, short-term loans, and short-term instruments, such as commercial paper, that a firm issues.<\/p>\n<h2><strong>Internal Financing<\/strong><\/h2>\n<p>Companies can generate internal financing and liquidity from shorter-term operating activities in several ways, including:<\/p>\n<ul>\n<li>Generating larger after-tax operating cash flow.<\/li>\n<li>Increasing working capital efficiency, for example, by shortening the asset conversion cycle.<\/li>\n<li>Converting liquid assets into cash.<\/li>\n<\/ul>\n<h3><strong>Operating Cash Flow<\/strong><\/h3>\n<p>These are a company&#8217;s after-tax operating cash flows (adjusted for taxes), minus interest and dividend payments, that can be utilized to invest in assets. A corporation that generates higher, more predictable after-tax operating cash flows can better fund itself internally.<\/p>\n<h3><strong>Accounts Payable<\/strong><\/h3>\n<p>Accounts payable are unpaid amounts owed to suppliers of products and services. They are derived from trade credit, a spontaneous kind of credit in which a buyer of goods or services effectively funds a transaction by deferring payment.<\/p>\n<h3><strong>Accounts Receivable<\/strong><\/h3>\n<p>These are amounts that customers owe a company. Companies prefer delaying making payments for what they owe. Interestingly, they, on the other hand, prefer receiving what is owed to them as quickly as possible. The faster a company can collect what it is owed, the lesser its need to finance its operations in some other way.<\/p>\n<h3><strong>Inventory<\/strong><\/h3>\n<p>Inventory is a current asset on the balance sheet. Investing in and holding inventory costs money. Companies had rather not invest a significant amount in inventory when they could spend the money on more productive activities.<\/p>\n<h3><strong>Marketable Securities<\/strong><\/h3>\n<p>Marketable securities are financial instruments, such as stocks and bonds, that can swiftly be sold and converted into cash. Companies frequently invest in marketable securities to obtain a higher rate of return than they would if they held cash.<\/p>\n<h2><strong>External Financing<\/strong><\/h2>\n<p>These include both bank and non-bank lenders. Short-term bank financing includes uncommitted bank lines of credit, committed bank lines of credit, and revolving credit agreements.<\/p>\n<h3><strong>Lines of Credit<\/strong><\/h3>\n<p><strong>Uncommitted lines of credit<\/strong>: These are the least reliable. A bank can provide an uncommitted line of credit for a lengthy period, but it retains the authority to refuse any request to use it.<\/p>\n<p><strong>Committed (regular) lines of credit<\/strong>: These are reliable because of a bank&#8217;s formal commitment. They are in effect for less than a year, ensuring that they are classified as short-term liabilities on financial statements. In addition, they are unsecured.<\/p>\n<p><strong>Revolving credit arrangements or revolvers<\/strong>: They are the most reliable form of short-term bank borrowing. They have been in effect for multiple years. Borrowers can draw down and pay back amounts periodically.<\/p>\n<h3><strong>Loans and Factoring<\/strong><\/h3>\n<p><strong>Secured loans<\/strong>, also known as <strong>asset-based loans,<\/strong> require companies to provide collateral against a loan. These may be available to companies with credit quality to qualify for unsecured loans.<\/p>\n<p>Through the <strong>assignment of accounts receivables<\/strong>, receivables can be used as collateral for loans, enabling a business to generate cash flows from its accounts receivables.<\/p>\n<p>In a factoring deal, a business can also sell its accounts receivable to a lender, also known as the factor, for a discount. The factor subsequently assumes the task of collecting the receivables.<\/p>\n<p><strong>Web-based <\/strong>or <strong>non-bank<\/strong> lenders are recent innovations that offer loans in small amounts and operate primarily on the internet.<\/p>\n<h3><strong>Capital Markets<\/strong><\/h3>\n<p><strong>Short-term commercial paper<\/strong>: This is a short-term unsecured loan instrument usually issued by a large company with a good credit rating. They typically range from a few days to 270 days. The issuer&#8217;s good credit rating and short-term nature make them low-risk investments for investors.<\/p>\n<p><strong>Long-term Debt<\/strong>: Long-term debt is a debt with a maturity of over one year. Remember that money market instruments have maturities of less than a year, notes have maturities of between one to ten years, and bonds have maturities of over ten years. Due to their long-term maturities, bonds are riskier than notes and money market instruments. For this reason, lenders and borrowers will agree to bond covenants that specify a lender&#8217;s rights and restrictions on the borrower.<\/p>\n<p><strong>Common Equity<\/strong>: Common equity represents ownership in a company and is considered a long-term source of funds. Shareholders receive dividends and are entitled to the residual value of a company&#8217;s assets if the company goes out of business. They also elect the directors and therefore control the management of a company.<\/p>\n<blockquote>\n<h2 style=\"text-align: left;\"><strong>Question<\/strong><\/h2>\n<p style=\"text-align: left;\">Which of the following is <em>least likely<\/em> a short-term financing method?<\/p>\n<ol style=\"list-style-type: upper-alpha; text-align: left;\">\n<li>Common equity.<\/li>\n<li>Commercial paper.<\/li>\n<li>Revolving credit arrangements.<\/li>\n<\/ol>\n<p style=\"text-align: left;\">The correct answer is <strong>A<\/strong>.<\/p>\n<p style=\"text-align: left;\">Common equity is a long-term external option for financing. It represents ownership in a company. Shareholders receive dividends and are entitled to the residual value of a company\u2019s assets if the company goes out of business.<\/p>\n<p style=\"text-align: left;\"><strong>B is incorrect<\/strong>. &nbsp;Commercial paper is a short-term unsecured loan instrument usually issued by a large company with a good credit rating. It typically ranges from a few days to 270 days.<\/p>\n<p style=\"text-align: left;\"><strong>C is incorrect<\/strong>. Revolving credit arrangements, also known as revolvers, are short-term bank borrowing in which borrowers can draw down and pay back amounts periodically.<\/p>\n<\/blockquote>","protected":false},"excerpt":{"rendered":"<p>[vsw id=&#8221;qwQXR6SdLvA&#8221; source=&#8221;youtube&#8221; width=&#8221;611&#8243; height=&#8221;344&#8243; autoplay=&#8221;no&#8221;] Current assets less current liabilities equals working capital. $$\\text{Working capital = Current assets &#8211; Current liabilities}$$ A company&#8217;s short-term assets and obligations are managed through working capital management. Its objective is to prevent excess&#8230;<\/p>\n","protected":false},"author":15,"featured_media":0,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"_acf_changed":false,"footnotes":""},"categories":[25],"tags":[],"class_list":["post-40289","post","type-post","status-publish","format-standard","hentry","category-corporate-issuers","blog-post","no-post-thumbnail","animate"],"acf":[],"yoast_head":"<!-- This site is optimized with the Yoast SEO plugin v26.9 - https:\/\/yoast.com\/product\/yoast-seo-wordpress\/ -->\n<title>Financing Working Capital | CFA Level 1 - AnalystPrep<\/title>\n<meta name=\"description\" content=\"Learn how companies manage short-term assets and liabilities through effective working capital financing strategies.\" \/>\n<meta name=\"robots\" content=\"index, follow, max-snippet:-1, max-image-preview:large, max-video-preview:-1\" \/>\n<link rel=\"canonical\" href=\"https:\/\/analystprep.com\/cfa-level-1-exam\/corporate-issuers\/financing-working-capital\/\" \/>\n<meta property=\"og:locale\" content=\"en_US\" \/>\n<meta property=\"og:type\" content=\"article\" \/>\n<meta property=\"og:title\" content=\"Financing Working Capital | CFA Level 1 - 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