Working Capital Management Flashcards
What factors determine working capital requirements?
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.
Nature of business: depends on nature of business, product type and production techniques.
Size of business: larger the size, the greater the working capital requirements to support its scale of operation. Small businesses may also need a large amount of working capital due to high overhead charges, inefficient use of available resources and other economic disadvantages of smaller businesses.
Production policy: some manufacture products when orders received - others in anticipation
Seasonal fluctuations: working capital for that season will be higher.
Credit policies: liberal sales credit policy demands higher level of working capital as it prolongs debtors’ collection period and vice versa. Without consideration of creditworthiness - trouble. Tight policy from suppliers shortens settlement period and lengthens the WCC - needing alternative finance.
Changing technology: labour-orientated requires more working capital to pay wages
Growth and expansion: increases with size of firm to support larger scales of operation
Taxation policies: tax policy affects quantum of working capital requirements. Higher tax rate demands more working capital.
Why is working capital needed? What is the optimal level?
Total amount of cash tied up in current assets and current liabilities which normally includes inventories, receivables, cash and cash equivalents, less payables. All available for day-to-day operating activities. Enables:
- allow customers/trade receivables buy on credit - more competitive advantage
- carry inventories of finished goods to meet customer demand
- have cash to pay bills - salaries, wages, obligations
Optimum - results in no idle cash or unused inventory - without strain on liquid resources needed for daily running. Trade-off between profitability and liquidity. Optimum working capital ensures proper management.
High levels of working capital - holding idle funds with unnecessary cost implications - “overcapitalisation”. Low - firm unable to meet its demands.
How is working capital estimated from the working capital cycle?
WCC = sum of receivable days + inventory days (finished goods, WIP, raw material) - payables days
How does JIT system help company to improve its relationships with customers and suppliers?
Key objective - reduce flow times within production systems and response times from suppliers and to customers. Monden Yasuhiro - “producing the necessary items, in the necessary quantity at the necessary time”.
Reducing level of inventory not only reduces carrying costs. Also get more control over process - easier to respond quickly when needs of customers change. Reduce storage and labour costs.
Relationship with supplier = important part. If raw materials do not arrive on time - becomes v expensive for the business. JIT manufacturers prefer reliable, local supplier to meet small but frequent orders at short notice in return for a long-term relationship.
What are key features of ABC inventory control?
ABC inventory control classifies items based on items’ consumption values - into 3:
A:- requires highest investment
B:- medium level
C:- remaining items of stock with relatively low value of consumption
Helps companies maintain tighter control over costly items. Improves efficiency and overall profitability. E.g. stock management resources dedicated to higher valued categories to save time and money.
Focuses only on monetary values - ignores other factors important to business. Requires keeping track of all inventory items - only successful if proper standardisation of inventories.
What are the objectives of trade receivables managemnets?
Key aspect of working capital management - substantial amount of cash is tied up in receivables. Goal - maintain optimum level of receivables by achieving trade-off b/w profitability from credit sales and liquidity (reducing cost of allowed credit).
Objectives of receivables management:
- control costs associated with collection/management of receivables - admin costs (maintenance of records, collection costs, default costs and writing off bad debts)
- achieve and maintain an optimum level of receivables in accordance with the company’s credit policies
- achieve an optimum level of sales
What are the risks of delaying payment to suppliers?
- refuse to supply in future
- may only supply on a cash basis
- could exceed its credit period and risk its credit status with the supplier and result in supplies being stopped
- lose the benefit of any settlement discount offered by supplier for early payment
- loss of reputation
- suppliers may increase prices in the future
