WK8AssgnJacksonM

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School

Walden University *

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6070

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Finance

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Feb 20, 2024

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docx

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Uploaded by EarlExploration6672

Module 3 Assignment: Capital Budget Decision Making for an Organization Report prepared by: Marquis Jackson Date: December 10, 2022 Walden University WMBA 6070: Managerial Finance 1

Executive Summary The purpose of this report is to acknowledge the importance and impact of understanding short term and long-term working capital considerations. When making decisions pertaining to working capital, you should understand how to get the most value out of your investments. “Effective working capital management is a mark of a good business, but growing businesses and high sales will strain cash flow and offset the balance of working capital. It’s a paradoxical challenge that a growing business causes increased expenses and a lack of working capital while cash is needed the most.” (Mills, 2021). When looking at capital budget needs, it is important to be able to determine what makes sense for your specific organization. “Capital budgeting is the act of laying out a financial plan for your business’s growth strategy. Looking at the short and long-term financial effects of a large purchase can focus your planning and help you make informed decisions.” (Anderson, 2019). The best way to do this is by understanding the most accurate and effective method at which to evaluate and assign value to the organization. For example, understanding the difference and increased accuracy of using modified internal rate of return in certain scenarios rather than the original internal rate of return. I would recommend that in the short term, the organization looks to raise money through a business line of credit. This would give the flexibility to address outstanding debt and create a method for improving cashflow. In the long term, I would encourage placing funds in a high yield account. This savings rate will continue to grow your money and prevent it from losing value due to inflation. 2

Part 1: Short-Term Working Capital Considerations As organizational financial health becomes a larger discussion, it is important to understand all of the components associated. Another component of maintaining a positive financial position is understanding working capital. “When it comes to business finance, the terms "working capital" and "net working capital" are often used interchangeably. However, there is a big difference between the two concepts. Working capital is a measure of a company's short-term liquidity, while net working capital is a measure of a company's overall liquidity.” (Causal, n.d.) The main difference is the time frame and how it impacts the cash conversion cycle. The cash conversion cycle accounts for how long cash is committed to working capital and how much funding is needed to remain operating. The goal is to keep your organizations cash conversion cycle as short as possible to allow for the most amount of cash on hand. As the owner continues to evaluate this new business venture, it is the additional expense of $50,000 per month that causes some hesitation. To make this a possibility, I would encourage looking into short term financing options. “Short-term finance can be defined as any financing that a borrower pays off over a shorter repayment period. More specifically, though, short-term finance refers to any loan that a business pays off in under a year.” (Wood, 2022). Two potential short term financing options are a short term loans and a business line of credit. A business line of credit can be advantageous because it allows you to only take what you need, when you need it. This means that you will only need to pay interest on the 4

funds necessary at the time. The downfall can be the elevated interest rates associated with a line of credit. “Although they're not usually as expensive as a business credit card, business lines of credit have high-interest rates. These are generally in the double-digit APR range, sometimes over 20%.” (Smith, 2019). For this reason, the additional funding cost could be damaging to the financial position of the company. This would also mean that the company requires more working capital available. A short-term loan would have opposite advantages and disadvantages associated with utilization that what you find in a line of credit. A short-term loan would allow for fixed cost and easier cash flow projections. “You’ll receive a lump sum of capital from your lender at the beginning of your loan, and you’ll pay off that lump sum, plus interest, with regularly scheduled payments.” (Wood, 2022). In addition, short term loans typically have lower interest rates. The disadvantage is that despite the lower interest rates, you could be paying interest on money that you don’t need in that moment. Due to the potential of paying the financing cost of money that you may not need in the moment, or potentially at all, I find a line of credit to be the more effective financing option. Cash Conversion Cycle “The cash conversion cycle (CCC) is a metric that expresses the time (measured in days) that it takes for a company to convert its investments in inventory and other resources into cash flows from sales.” (Hayes, 2022). The length of the cash conversion cycle for this organization is 51 days. To shorten the cash conversion cycle, you would 5

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