Economics of Lease, Working Capital and Mangement of Working Capital

Q. Explain the economics of lease.

The economics of leasing is determined by considering the time value of money for the cash flows for leasing vs. buying an asset.

The Determining Factors

Cash flows: What are the cash flows related to leasing or buying an asset and when do those cash flows occur?

Discount rate: What discount rate should be used to discount the cash flows to the present to arrive at the net present value?

Q. Define Working Capital and Management of Working capital.

Working capital: Working capital is a financial metric represents operating liquidity available to a business, organization or other entity, including governmental entity.

Net working capital is calculated as current assets minus current liabilities. Positive working capital is required to ensure that a firm is able to continue its operations and that it has sufficient funds to satisfy both maturing short-term debt and upcoming operational expenses.

Management of Working Capital:

Management will use a combination of policies and techniques for the management of working capital. The policies aim at managing the current assets and the short term financing that cash flow and returns are acceptable:

1. Cash management: Identify the cash balance which allows for the business to meet day to day expenses but reduces cash holding costs.

2. Inventory management: Identify the level of inventory which allows for uninterrupted production.

3. Debtors management: Identify the appropriate credit policy, i.e. credit terms which will attract customers.

4. Short term financing: Identify the appropriate source of financing, given the cash conversion cycle.