Chapter 8 - Test your knowledge

Question 1

What factors determine working capital requirements?

Answer 1

Working capital requirements change from time to time as per the size and
nature of industries as well as other internal and external factors. In general, the following factors affect requirement or working capital.

1. Nature of business
   The investment in working capital depends on the nature of the business,
   product type and production techniques.

For example, retail companies have
a low cash cycle with few credit customers, high supplies on credit terms
and a large inventory to cater to the demands of customers. Manufacturing
companies have a long cycle with significant current assets.

2. Size of business:

The larger the size of business, the greater the working capital requirements to support its scale of operation.
However, a small business may also need a large amount of working capital due to high overhead charges, inefficient use of
available resources and other economic disadvantages of a smaller business.

3. Production policy:

Some companies manufacture their products when orders are received while
others manufacture products in anticipation of future demands.

4. Seasonal fluctuations:

If the demand for the product is seasonal, the working capital required in that season will be higher. For example, there is greater demand for air conditioners in summer.

Question 2

How does the JIT system help a company to improve its relationships with customers and suppliers?

Answer 2

The key objective of the JIT system is to reduce flow times within production systems as well as response times from suppliers and to customers. It is defined
by Monden Yasuhiro as a methodology used in ‘producing the necessary items, in the necessary quantity at the necessary time’.

Reducing the level of inventory does not just reduce carrying costs.

By using this technique, manufacturers also get more control over their manufacturing process,
making it easier to respond quickly when the needs of customers change.

This also reduces the amount of storage and labour costs a business needs.

The relationship with suppliers is an important aspect of the JIT system. If
the supplier doesn’t deliver the raw materials in time, it could become very expensive for the business.

A JIT manufacturer prefers a reliable, local supplier to
meet the small but frequent orders at shorter notice, in return for a long-term business relationship

Question 3

What are the key features of ABC inventory control?

Answer 3

ABC inventory control classifies inventory items based on the items’
consumption values. In this method of inventory management, the materials are divided into three categories:

A being the items requiring the highest
investment,

B being the medium level and

C being the remaining items of stock
with relatively low value of consumption.

This method of inventory control helps companies to maintain tighter controls over costly items.

Better control over high-value inventory improves efficiency and improves overall profitability.

For example, stock management resources
can be dedicated to higher valued categories to save time and money. However, since this method focuses only on monetary values, it could ignore other factors
which may be important to the business.

It also requires keeping track of all inventory items and will be successful only if there is proper standardisation of
inventories.

Question 4

What are the objectives of trade receivables management?

Answer 4

The management of receivables is a key aspect of working capital management
as a substantial amount of cash is tied up in receivables. The ultimate goal of receivables management is to maintain an optimum level of receivables by
achieving a trade-off between:

A. profitability from credit sales and

B. liquidity (reducing the cost of allowed credit)

The objectives of receivables management are:

1. to control the costs associated with the collection and management
   of receivables:

administration costs associated with receivables include
maintenance of records, collection costs, default costs and writing off bad
debts;

2. to achieve and maintain an optimum level of receivables in accordance
   with the company’s credit policies; and
3. to achieve an optimum level of sales

Question 5

What are the risks of delaying payment to suppliers?

Answer 5

Companies may encounter the following problems by delaying payment to
suppliers:

1. suppliers may refuse to supply in future
2. suppliers may only supply on a cash basis
3. a company could exceed its credit period which could risk its credit status with the supplier and could result in supplies being stopped
4. a company could also lose the benefit of any settlement discount offered by the supplier for early payment
5. there may be loss of reputation suppliers may increase prices in future