GROUP 2

WORKING
CAP I T A L
MANAGEMENT
 THE NATURE,
ELEMENTS, AND
IMPORTANCE OF
WORKING CAPITAL
WORKING CAPITAL

Working capital is the net of current

assets minus current liabilities. That is
working capital is equal to the value of
raw materials, work in progress, finished
goods inventories, and accounts
receivable less accounts payable.
 WHAT IS THE AIM OF
WORKING CAPITAL
MANAGEMENT?
The goal of working capital management is to
maintain a balance where the business has enough
capital to stay liquid but not so much that it hurts
profitability.
LIQUIDITY
Liquidity means that the
business has sufficient
inventory and cash so that
it can trade without its cash
or inventory depleting.
 WHY IS WORKING
CAP ITA L MANAGEMENT
IMPORTANT?
Working capital management is essential for the
long‐term success of a business. No business can
survive if it cannot meet its day‐to‐day
obligations. A business must therefore have clear
policies for the management of each component
of working capital
 MANAGEMENT OF
INVENTORIES,
ACCOUNTS RECEIVABLE,
ACCOUNTS PAYABLE
AND CASH
 CAN THE LEV EL OF W ORKING
CAPITAL BE FIXED FOR ALL
ORGANISATIONS AND WHY?
1. Different industries require varying levels of
working capital:
Service industries need little to no inventory.
Retailers need more inventory, depending on
their business.
Manufacturers require more for raw materials,
work-in-progress, and finished goods.
 CAN THE LEV EL OF W ORKING
CAPITAL BE FIXED FOR ALL
ORGANISATIONS AND WHY?
2. If supply deliveries are uncertain the level of
inventory will be greater.
3. If the level of activity increases specifically sales
then inventory, receivable and payables will
increase.
4. The company’s operating cycle will also determine
the level of working capital
 WHAT IS THE
OPERATING CYCLE?

The operating cycle is the length of

time between the company’s
outflow on raw materials, wages
and other expenditures and the
inflow of cash from the sale of
goods.
 WHAT ARE THE
CHARACTERISTICS OF
THE OPERATING CYC LE
The inventory turnover The average receivable
days collection days

The average payable days

 HOW IS THE
OPERATING CYCLE
CALCULATED?
 Inventory Days
Receivable Days
( Payable Days )
Operating Cycle
 INVENTORY
DAYS
Inventory
x 365 days
Cost of Sales
 RECEIVABLE
DAYS
Receivables
x 365 days
Sales
 PAYABLE
DAYS
Payables
x 365 days
Cost of Sales
 IMPORTANCE OF THE
OPERATING CYCLE
The operating cycle is crucial in determining
a business's working capital needs. If
inventory and receivables turnover slows or
payables are due sooner, the operating
cycle lengthens, increasing the working
capital requirement.
OVERTRADING
Overtrading is the term
applied to a company which
rapidly increase its turnover
without having sufficient
capital backing.
 CHARACTERISTICS
OF OVERTRAD ING
More intensive utilization More intensive use of
of existing fixed assets working capital

Reliance more heavily on short‐term sources

such as overdraft and trade creditors
 CHARACTERISTICS
OF OVERTRAD ING
Increase in
Declining
debtors as stock
liquidity
increases
 HOW CAN
OVERTRADING
BE MEASURED?
 CURRENT
RATIO
Current Assets
Current Liabilities
 QUICK
RATIO
Current Assets - Inventory

Current Liabilities
From surplus
to deficit
Payable days are
getting longer
Level of activity
rises sharply
 DETERMINING
WORKING CAPITAL
NEEDS AND FUNDING
STRATEGIES
 SOLUTION
A good solution to overtrading
would be to convert short‐term
financing with long‐term financing.
ADVANTAGES OF
SHORT-TERM
FINANCE
Cheaper Flexible

Easy to Arrange
 ADVANTAGES OF
LONG-TERM
FINANCE
No need to continually
Funds are renew finance. For
Permanent instance, equity is typically
not expected to be repaid.
 PERMANENT
CURRENT ASSET
Permanent current assets are the
normal level of stock and debtors that
the company needs in order to keep the
business going. The company will
always need a certain amount of stock
and having sell these stock they will
have the level of debtors that result
from selling these stock.
 FLUCTUATING
CURRENT ASSET
The levels of current assets that
normally increase and decrease
through the normal operating
cycle of the business such as
having gains and losses
periodically.
 WORKING CAPITAL
FINANCING POLICIES
AGGRESSIVE CONSERVATIVE
FUNDING POLICY FUNDING POLICY

HEDGING
FUNDING POLICY
 AGGRESSIVE
FUNDING POLICY
This is where the organization uses
short-term funds to finance its
permanent working capital. This is
cheaper but high risk because
short-term funds can be recalled
on demand.
 CONSERVATIVE
FUNDING POLICY

This is where the

organization uses long term
funding for the permanent
working capital.
 INGDGFUING
HEDGHE NDING
LICYPOLICY
POING
FUND

Not keeping money too

much and not too little. It is
always in the middle.
 SOME SHORT-TERM SOURCES OF FINANCE
Factoring - the debts of the company are effectively sold to a factor.
Invoice Discounting - selected invoices are used as security against
which the company may borrow funds.
Trade Credit - the delay of payment to suppliers on credit terms, no
interest funding.
Overdrafts - short-term borrowings from a financial institution.
Bank Loans - loans between one and three years.
Bills of Exchange - an agreement to pay a certain amount at a certain
date in the future.
 ASSET SPECIFIC
SOURCES OF FINA NCES

HIRED PURCHASE
FINANCE LEASE
OPERATING LEASE
 ADVANTAGES/
DISADVANTAGES TO
OFFERING CREDIT
ADVANTAGES DISADVANTAGES
Bad debts
Offering credit encourages Slow payers that increase
customers to take up our working capital
goods Administration of the sales ledger
Debt collection
 CREDIT
MANAGEMENT

Assessing credit status

Deciding the terms on which
credit will be offered
Day to Day management
COST OF FINANCING
RECEIVABLES

Interest cost
Discount
 INTEREST COST
INTEREST COST = RECEIVABLES BALANCE X INTEREST RATE

It is important to the company to know its

Receivables and how much cost of receivables
in one period. Any change to receivables
balance will cause a change to financing cost
of the business.
 DISCOUNTS
Discounts encourage customers to
pay early. The cost of the discount is
balanced against the savings the
company received from a lower
receivables balance and a shorter
average collecting period.
 VANTAGES
AD DISADVANTAGES
If discounts are too high it
Early payment will cost the company
reduces the If discounts are too low
many customers will not
debtor balance take it
and hence the Greater uncertainty as to
who will pay early and who
interest charge will not
Reduces bad May not reduce bad debts
Customer may pay over
debts arising normal term but still take
the cash discount
 FACTORING
3 MAIN FACTORING SERVICES:
Debt collection and Administration
Credit insurance - with recourse
and without recourse
Financing
 VANTAGES DISADVANTAGES
AD
Improve cash flow It is more costly than an
Savings on internal efficiently run internal
administration costs credit control department
Useful for small and fast Factoring has a bad
growing organisations who reputation associated with
credit department may not be failing companies
able to keep up Customers do not like
Reduction in the need for day- dealing with a factor.
to-day management control
Customers like to think
Debt collection is outsourced
that their suppliers can
therefore managers have
more time to run the
manage their own affairs
organisation Difficult to revert to an
The factor is more experience internal credit control
at enforcing credit terms Factors are more
leading to lower level of aggressive towards the
outstanding debts company’s customers
 MANAGING
INVENTORY

There needs to be
balance between the
benefits and cost of
holding stock.
 4 TYPES OF COST
ORDERING HOLDING
COST COST
STOCK-OUT PURCHASE
COST COST
ECONOMIC ORDER
QUANTITY
The ideal amount of stock a company should
order to keep costs low. It balances two things:
the cost of storing stock (holding cost) and the
cost of ordering stock (ordering cost). If you
order a lot of stock, it costs more to store it, but
you order less often. If you order small
amounts, you pay more for ordering but less
for storage. EOQ helps find the right amount to
order to keep both costs low.
JUST IN TIME
A way of managing stock by reducing
or avoiding storing too much. It
means getting materials only when
they are needed. This works if the
company can plan well and make
things without delays. For JIT to work,
suppliers must also deliver materials
on time when needed.
MANAGING CASH
It is about having enough to run the business
without holding too much. Too much cash sitting
idle doesn’t earn money.
There are three methods to manage cash:
Miller-Orr Model - Helps decide how much
cash to keep when there is uncertainty.
Baumol Model - Uses the EOQ idea to manage
cash.
Cash Budgets - Tracks cash coming in and
going out over time
THANK YOU
VERY MUCH!
Retrieved on September 6, 2024

The nature, elements and importance of working capital. (2018, February 12). studylib.net.
https://studylib.net/doc/8343065/the-nature--elements-and-importance-of-working-
capital