FMS - working capital management strategies Flashcards
working capital
o The term used to describe the funds available for the short term financial commitments of a business
It can be calculated using the formula:
current assets - current liabilities
working capital and liquidity
o Working capital is closely aligned with the notion of liquidity.
o A business must have sufficient liquidity so that cash is available or current assets can be converted to cash to pay debts or current liabilities
o A lack of liquidity would require a business to sell non-current assets such as property and equipment to raise cash.
o In the longer term, this can lead to reduced profitability for owners and shareholders as these are productive assets.
working capital cycle
Working capital cycle Cash accounts payable stock/inventory accounts receivable
Value may be lost through excess charges for your business making late payments to suppliers
Value may be lost through inability to sell stock (over supply/obsolete), loss of stock and damage to stock
Value may be lost through customers not paying on time or at all.
working capital management
o Maintaining sufficient working capital is about controlling current assets and current liabilities to maintain value and minimise costs/losses associated with the working capital cycle
o This is achieved by determining the best mix of current assets and current liabilities needed to achieve the businesses objectives
working capital ratio
Current Assets ÷ Current Liabilities
o In order for the working capital of a business to a) be positive b) be composed of the most liquid of assets, financial managers need to:
- Control the value and composition of current assets
2. Control the value of current liabilities
controlling current assets
o The three most common current assets are cash, inventory/stock and accounts receivable
controlling cash
o The aim is to maintain a sufficient balance between safety and efficiency – enough but not too much
o Constructing a cash flow projection and on-going monitoring is key to striking this balance
controlling inventory/stock
o The aim is to ensure value of inventory is not lost through unsold, lost or damaged stock
o Mangers need to conduct regular stock takes and implement just-in-time inventory management
controlling accounts receivable
o The aim is to ensure working capital is not lost through bad debts or late payments from customers.
o This can be ensured through prompt invoicing assessing the credit rating of customers and considering factoring as to chase up late payments
controlling current liabilities
o The most common current liabilities include bank overdrafts, short term loans including credit cards and accounts payable
controlling short term loans
o The aim is to minimise the associated costs (interest fees and charges) with these short term loans
o Proactive planning of needs can reduce reliance, informed choice and prompt repayment can reduce associated costs.
controlling accounts payable
o The aim is to ensure suppliers and service providers are paid on time
o Businesses should take advantage of any credit free period and utilise any discounts for early payment to reduce overall accounts payable
Leasing
property and equipment can be rented in order to reduce the outflows of from purchases of new equipment or and property
