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THE COMPONENTS OF WORKING CAPITAL

Short-term, or current, assets and liabilities are collectively known as working capital. Table 2.1 gives a breakdown of current assets and liabilities for all manufacturing corporations in the United States in 1999. Total current assets were $1,352 billion and total current liabilities were $1,046 billion.

Current Assets. One important current asset is accounts receivable. Accounts receivable arise because companies do not usually expect customers to pay for their purchases immediately. These unpaid bills are a valuable asset that companies expect to be able to turn into cash in the near future. The bulk of accounts receivable consists of unpaid bills from sales to other companies and are known as trade credit. The remainder arises from the sale of goods to the final consumer. These are known as consumer credit. Another important current asset is inventory. Inventories may consist of raw materials, work in process, or finished goods awaiting sale and shipment. Table 2.1 shows that firms in the United States have about the same amount invested in inventories as in accounts receivable.

The remaining current assets are cash and marketable securities. The cash consists partly of dollar bills, but most of the cash is in the form of bank deposits. These may be demand deposits (money in checking accounts that the firm can pay out immediately) and time deposits (money in savings accounts that can be paid out only with a delay). The principal marketable security is commercial paper (short-term unsecured debt sold by other firms). Other securities include Treasury bills, which are short-term debts sold by the United States government, and state and local government securities.

In managing their cash companies face much the same problem you do. There are always advantages to holding large amounts of ready cash they reduce the risk of running out of cash and having to borrow more on short notice. On the other hand, there is a cost to holding idle cash balances rather than putting the money to work earning interest. In later we will tell you how the financial manager collects and pays out cash and decides on an optimal cash balance.

Current Liabilities. We have seen that a company`s principal current asset consists of unpaid bills. One firm`s credit must be another`s debit. Therefore, it is not surprising that a company`s principal current liability consists of accounts payable that is, outstanding payments due to other companies. The other major current liability consists of short-term borrowing. We will have more to say about this later in this material.