advantages of working capital , determinants of working capital , estimation of working capital , management of cash

Working Capital Management Notes

IV. Adequate Working Capital

Definition: Optimal level of current assets to operate smoothly, meet obligations, and seize opportunities.

Consequences of Inadequate Working Capital:

• Inability to pay bills (penalties, credit damage).
• Missed opportunities.
• Inventory shortages (lost sales).
• Reliance on expensive short-term financing.
• Possible insolvency.

Consequences of Excessive Working Capital:

• Idle funds (missed investment opportunities).
• High inventory holding costs.
• Risk of obsolescence/damage.
• Inefficient resource use.
• Lower ROI.

Determining Adequacy:

• Ratios:
  • Current Ratio (Current Assets / Current Liabilities)
  • Quick Ratio (Quick Assets / Current Liabilities)
• Cash Flow Forecasting: Project future inflows/outflows.
• Industry Benchmarks: Compare to industry averages.
• Operational Analysis: Evaluate inventory, receivables, and payables management.

V. Determinants of Working Capital

Factors influencing working capital needs:

• Nature of Business: Manufacturing vs. Service (Manufacturing requires more). Seasonal businesses.
• Size of Business: Larger companies need more.
• Production Cycle: Longer cycle = more work-in-progress inventory.
• Credit Policy: Liberal credit increases receivables.
• Inventory Turnover: Low turnover = more tied up in inventory.
• Availability of Credit: Easier access reduces cash balance needs.
• Operating Efficiency: Efficient operations reduce needs (e.g., JIT).
• Inflation: Higher costs may require more capital.
• Growth Rate: Rapid growth often needs more capital.
• Business Cycle: Expansions increase needs, recessions decrease.
• Technology: Improvements reduce needs.
• Profit Margins: High margins may reduce needs.
• Price Level Changes: Increased material and labor costs require more.

VI. Estimation of Working Capital

• Based on calculating current assets and liabilities.
• Key Inputs:
  • Projected Sales
  • Production Cycle
  • Credit Terms (to/from suppliers & customers)
  • Operating Expenses
  • Contingency (safety margin)

VII. Management of Cash

Objective: Sufficient cash to meet obligations, minimizing holding costs.

Techniques:

• Cash Budgeting: Forecast inflows/outflows.
• Cash Collection Management: Speed up collections.
• Cash Disbursement Management: Optimize payment timing.
• Investment of Surplus Cash: Short-term marketable securities.
• Electronic Funds Transfer (EFT): Speed up transactions.
• Lockbox System: Accelerate payment collection.
• Zero Balance Account (ZBA): Transfer funds only when needed.
• Concentration Banking: Centralize cash management.

VIII. Management of Inventory (Theory Only)

Objective: Optimal inventory level, meet demand, minimize holding costs.

Techniques:

• Economic Order Quantity (EOQ): Optimal order size.
• Just-in-Time (JIT) Inventory: Materials arrive just in time for production.
• Materials Requirement Planning (MRP): Planning material requirements based on schedules.
• ABC Analysis: Classify inventory by value (A, B, C).
• Vendor-Managed Inventory (VMI): Suppliers manage inventory.
• Perpetual Inventory System: Continuous record of inventory.
• Periodic Inventory System: Physical counts at intervals.

IX. Management of Debtors (Accounts Receivable) - (Theory Only)

Objective: Collect payments quickly, minimize bad debt risk.

Techniques:

• Credit Policy: Clear terms and procedures.
• Credit Analysis: Assess creditworthiness.
• Invoice Management: Prompt and accurate invoicing.
• Collection Procedures: Follow up on overdue accounts.
• Discounts for Early Payment: Incentives for early payment.
• Factoring: Sell receivables at a discount.
• Securitization: Bundle and sell receivables to investors.
• Letters of Credit: Guarantee payment.
• Aging Schedule: Group receivables by age (outstanding time).