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Working Capital Management

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Inventory Management Queuing Theory Stock-out Cost Minimum Re-Order levels Stock Holding Costs Obsolescence Risk Just in Time Inventories Floor Plan Financing ... – PowerPoint PPT presentation

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Title: Working Capital Management


1
Working Capital Management
  • Dr. Clive Vlieland-Boddy
  • FCA FCCA MBA PhD

2
Summary of the Course
  • Learning Objectives
  • Understand and appreciate the importance of
    liquidity.
  • Understand and appreciate the relationship of
    Current Assets and Current Liabilities.
  • Be able to evaluate and recommend improvements in
    cash and working capital.

3
The Firms Capital Structure
Working Capital Capital Structure Cost of
Capital
Current Assets ------------ Non Current Assets
Current Liabilities ------------ Long-Term Debt E
quity
4
What is Working Capital
  • The Balance Sheet is divided into two distinctive
    asset/liability groups. There are the long term
    ones referred to as Non Current and there are the
    short term ones referred to as Current.
  • Essentially we differentiate these by looking at
    utilisability/settlement periods. Normally
    assets/ liabilities with less than 12 months are
    categorised as Current whilst those over as Non
    Current.

5
Non Current Assets
  • These are normally financed by Non Current
    Liabilities and Shareholders Funds.
  • They represent assets which are expected to last
    for more than 12 months.
  • They are acquired to enable the company to
    function. E.g Plant Equipment. Aeroplanes,
    Boats and Vehicles.
  • It is not recommended to finance Non Current
    Assets with Current Liabilities!

6
Current Assets
  • These are the day to day assets that a company
    has. They are consumed normally within 12
    months. E.g Inventories, Accounts Receivable and
    Bank Balances.
  • These can be financed by Current Liabilities but
    be careful!...

7
Current Assets
  • Used in the day to day trading These are assets
    of the business.
  • Examples
  • Accounts Receivable ( Debtors)
  • Inventory ( Stocks)
  • Work in Progress ( WIP)
  • Prepayments

8
Current Liabilities
  • These are liabilities that fall due in less than
    one year.
  • Examples
  • Accounts Payable ( Creditors)
  • Bank Overdraft
  • Short Term Loans
  • Accruals

9
Working Capital Does NOT include...
  • Non Current Assets Assets
  • Share Capital
  • Loans over 12 months to maturity.
  • Investments - ( Excluding Marketable Securities)
  • Intangibles ( such as goodwill, patents and
    trademarks)

10
Why is managing Working Capital so important?
  • LIQUIDITY
  • LIQUIDITY
  • LIQUIDITY

11
WORKING CAPITAL
Managing Liquidity
Source Essentials of Managing Corporate Cash
12
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13
Cash Conversion
  • We need to consider control in all areas of
    working capital to maximise return, reduce cost.
  • Some areas are not controlled by the Finance
    Function Stock/inventory
  • Some areas have shared control payables and
    receivables
  • Some areas are controlled by the Finance
    Function short term borrowing and investment

14
Management of Working Capital - Tools of the
Trade!
  • Cash Cycle
  • Cash Flow Statement
  • Cash Forecasts
  • Profit Forecasts
  • Pro forma Statements
  • Inventory Management
  • Credit Control
  • Using Accounts Payable to release cash.

15
Evaluating Working Capital
  • As with any asset , management must ensure
    efficiency.
  • Money tied up wrongly is an opportunity lost.
  • Working Capital can require substantial
    investment. E.g. retail clothing requires
    substantial inventories.
  • The Cash Cycle brings together all the components
    of Working Capital and evaluates their
    efficiency.

16
The Cash Cycle
  • This is summarised as the total time in days that
    money is used to buy goods, convert them as
    required, sell them and be paid.
  • Days held in Raw Inventory Days in WIP days
    in Finished Goods Inventory Days in Accounts
    Receivable Less Days in Accounts Payable.

17
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18
Calculating the Cash Conversion Cycle
The Operating Cycle (OC) is the time between
ordering materials and collecting cash from
receivables.
The Cash Conversion Cycle (CCC) is the time
between when a firm pays its suppliers
(payables) for inventory and collecting cash from
the sale of the finished product.
19
The Cash Cycle
Converts into Finished Goods
Finish Goods Stocks
Cash Back Here!
Raw Material Goods Received
Cash Out Here!
Customer Pays for Goods
Pay Suppliers for goods
Customer Orders Goods
Invoice Customer
Deliver Goods to Customer
20
The Cash Cycle
Converts into Finished Goods
Finish Goods Stocks
Cash Back Here!
Raw Material Goods Received
Cash Out Here!
Customer Pays for Goods
Pay Suppliers for goods
Customer Orders Goods
Invoice Customer
Deliver Goods to Customer
21
Calculating the Cash Cycle...
  • Days of Inventory Inventory divided by
    Purchases or Cost of Sales x 365
  • Days of Accounts Receivable Accounts Receivable
    divided by Sales x 365
  • Days of Accounts Payable Accounts Payable
    divided by Cost of Sales x 365

22
Cash Cycle - Summary
  • Returns the cash By looking at the speed that a
    company converts cash into products, sells them
    and returns the cash enables us to see how
    efficient the cash management is.
  • Using Accounts Payable will obviously reduce the
    time that funds are tied up.

23
Strategies for Managing the CCC
  1. Turn over inventory as quickly as possible
    without stock outs that result in lost sales.
  2. Collect accounts receivable as quickly as
    possible without losing sales from high-pressure
    collection techniques.
  3. Manage, mail, processing, and clearing time to
    reduce them when collecting from customers and to
    increase them when paying suppliers.
  4. Pay accounts payable as slowly as possible
    without damaging the firms credit rating.

24
Sources and Uses(Application) of Funds ( Cash
Statement)
  • See the manual Chapter 13.
  • These statements are now normally required as
    part of standard reporting accounts of most
    medium to large companies.
  • The statement is a comparison between two balance
    sheets. It shows where where money has come from
    and where it has been expended.

25
The Various Cycles
  • Inventory Conversion
  • Inventory x 365
  • Cost of Goods Sold
  • Payables Conversion
  • Payables/Creditors x 365
  • Cost of Goods Sold
  • Receivables Conversion
  • Receivables/Debtors x 365
  • Turnover

26
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27
Inventory Management
  • Inventories are often one of the largest Working
    Capital items. Consider the following
  • Seasonal trading but level production.
  • Obsolete stocks.
  • Balancing discounts given by suppliers against
    capital tied up.

28
Inventory Management
  • Queuing Theory
  • Stock-out Cost
  • Minimum Re-Order levels
  • Stock Holding Costs
  • Obsolescence
  • Risk
  • Just in Time Inventories
  • Floor Plan Financing
  • Consignment
  • Reservation of Title

29
Credit Control
  • Accounts Receivable are usually the highest
    working capital investment. Consider the
    following
  • More effective Credit Control chasing at agreed
    due date and regularly thereafter.
  • Offering discounts for early payment.
  • Factoring of Accounts Receivable!

30
Accounts Payable - Source of Funds.
  • Most companies have to pay their suppliers within
    30-60 days.
  • Earlier payment may attract a discount!
  • Consider a monopoly position such as a major
    supermarket chain. They could extend the time
    they pay their suppliers!

31
Additional Considerations
  • Financing of Working Capital should be by way of
    Current Liabilities supported by Shareholders
    funds if necessary Non Current Liabilities.
  • Planning and Forecasting is essential.
  • Dividend policies should take account of this.

32
Working Capital Management - Summary
  • We will look into all these issues over the next
    few weeks.
  • It is important to appreciate that liquidity is
    king. Without it a company will fail!
  • To understand and appreciate the inter
    relationships with the components of working
    capital is essential for all managers.
  • Profitability is important, and highly profitable
    companies can get access to funding.

33
Coffee Break 19.9.1
34
Bye for now!
Im ready forsome leisure time.
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