NATURE OF WORKING CAPITAL Working capital is defined as the total firms investment in current assets used in its day-to-day operations. Some refer to it as a revolving capital or operating assets. Rationale for the need of working capital are: Enable the firm to settle all its maturing obligations on time Be able to defray all expenses incurred in the business operations such as salaries, utilities, rentals, insurance premia, taxes, etc. To replenish inventories within the time frame To support its credit sales and Provide for any possible contingencies or opportunities for investment. The principal current assets of a firm: Cash-refers to current assets comprising currency or currency equivalents that can be accessed immediately or near- immediately
Marketable securities-Very liquid securities that can be converted into cash quickly at a reasonable price. Include commercial paper, banker's acceptances, Treasury bills and other money market instruments
Account receivable-money owed to a business by its clients (customers) and shown on its Balance Sheet as an asset. money owed to a business by its clients (customers) and shown on its Balance Sheet as an asset.
Inventories -A complete list of items such as property, goods in stock, or the contents of a building. These assets responds normally to the seasonal fluctuation in the sales of the firm because they arise in the process of generating income that are related to sales activities. An efficient administration of current assets would mean a profitable endeavour for the business. Sufficient and proper financing is needed to keep the business going. Permanent working capital when the firm uses working capital sufficient to support a normal level of operations. Emergency or seasonal working capital when operations start to pick up, the firm need additional funds to finance the peak season. Factors affecting the required amount of working capital The firms term of purchase and sale A firm that purchases its inventories on credit will require a small amount of working capital If inventories are acquired on cash basis, a bigger working capital will be needed The turnover of merchandise inventory A firm that produces goods that are fast moving item or saleable ones do not need a bigger working capital A firm producing slow moving items may require a bigger working capital Volume of goods on hand to satisfy customers demand A firm that maintains safety stocks needs a bigger working capital than that which do not maintain such stocks Factors affecting the required amount of working capital The type of business activity A business that requires a big investment in inventories (manufacturing) requires a much bigger working capital to be able to maintain the needed volume of inventories Firm like merchandising needs smaller working capital The turnover of its receivables Collection of receivables within a short period of time means cash inflows in short period of time thus requiring smaller working capital Firm that allows a longer period for the payment of sales on credit will require a bigger working capital as a support to the receivables Business influenced by business cycles A firm that is influenced by the ups and downs of business cycles, is going to need a bigger working capital, for a certain period determined by the firm, production must be increased thus a need for bigger working capital
Management of cash Cash is the most liquid yet the least productive assets. It enables payment of obligations when due but lessens productivity when it is hoarded. Strategies in cash management are formulated aiming at two important goals: 1) to make cash available when needed to meet the firms payments 2) to maintain the least amount of idle cash being held by the firm. There are two assets being regarded as liquid asset:
Cash- is composed of bills and coins that the firm holds in its possession. Near Cash - its ability to be easily converted into cash like marketable securities. Three reasons for holding cash To maintain a state of solvency Solvency is the degree to which the current assets of an individual or entity exceed the current liabilities of that individual or entity. ability of a corporation to meet its long-term fixed expenses and to accomplish long-term expansion and growth As a precautionary motive In order to patch up contingencies that are beyond human control As a speculative motive Profit making opportunity for a business firm Strategies in cash management A good financial management involves efficient management of cash. This could be attained by accelerating cash collections and decelerating cash disbursements. Accelerating cash collection: Cash discounts Concentration banking Synchronizing cash inflows and cash outflow Collection from Post dated checks ATM Decelerating Cash Disbursement: Stretching payables through PN
Management of receivables Receivables are created when a firm sells its product and/or service on credit in the use of credit cards and purchase orders. The more credit sales the firm has, the bigger receivables be determined as a result of credit sales With credit policies the granting of credit to its customers will be subject to existing companys policies: Terms of sales refers to the time period in which buyers must pay and the terms of the sale. Type of customers Collection procedures Credit standard- a measure of determining those who will be extended credit facilities or not Consequences to credit sales The consequence of credit is that the capital of the firm is transformed into an investment in the form of accounts receivable. When the greater portion of its sales are on credit, mounting account receivables as a consequence may create a problem of how much needed capital should be made available to support such an accumulation of receivables originating form credit sales. Inventory management it is necessary in controlling the assets being produced and sold. At the same time the company can minimize entailing the cost of producing and maintaining said goods in its normal course of operations. The assets that are referred to here are the raw materials, goods in process, finished goods and spare parts.