Professional Documents
Culture Documents
CAPITAL
Definition of Working
Capital
Working Capital refers to that part of the firms capital which is required
for financing short-term or current assets such a cash marketable
securities, debtors and inventories. Find thus invested , in current assets
keep revolving fast and are constantly converted into cash and this cash
flow out again and exchange for other current assets. Working Capital
also known as revolving or circulating capital or short term capital.
Components of Working
Capital
The Working Capital cycle is made up of four core components:
Cash & cash equivalent
Creditors / accounts payable
Inventory / stock in hand
Debtors / accounts receivables
Determination of Working
Capital Requirements
into
Cash Requirements
- The firm needs cash to pay for expenditures that arise from time to time. Even if the
anticipated
cash receipts is equal to the anticipated cash expenditures, it is still necessary to
maintain a
sufficient cash fund for the firm to meet its cash commitments. It is, therefore, required
that a positive cash balance be maintained so that the firms obligations are settled they
become due.
The amount of cash needed depends upon the following:
1. The amount of the firms purchases and cash sales;
2. The time period for which the firm receives and grants credit;
3. The time period from the dates of purchase of raw materials and
payment of wages to the dates of cash receipts from sales;
4. The amount of cash to be used for investment in inventories; and
5. The amount of cash needed for other purposes such as cash
dividends.
LIQUIDITY MANAGEMENT
Liquidity refers to the ability of the firm to pay its bills on time or otherwise meet its current
obligations. Activities geared towards achieving the liquidity management.
The objective of management is to acquire sufficient amounts of funds to cover the cash
requirements
of the firm. The cash inflows of the firm come from various sources which are briefly described
as follows.
1. Cash Sales
- The percentages of cash derived from sales vary from company to company and
from industry to industry.
2. Collection of Accounts Receivables
- The credit policies and the pattern of company sales determine the frequency
and
volume of collections form receivables.
3. Loans
- Loans from banks and other creditors may be availed of by management mostly
on
its own initiative.
4. Sale of Assets
-Assets are sometimes sold by the company for various reasons.
Obsolescence is one of those.
5. Ownership Contribution
- Additional contribution from the owners are sometimes tapped to
the liquidity posture of the firm.
6. Advances from Customers
- Manufacturers, at times, require cash advances from customers soon as
order is made and before production is started.
improve
an
Cash Management
- Idle cash earns nothing and even if it is kept in a bank, the interest it earns in
minimal. If sufficient amounts of profit must be attained, cash should be invested.
Sufficient cash must be maintained, however, to cover the firms cash
expenditures. The activity involved in achieving these two opposite goals is called
cash management.
Money Mobilization
- Some companies maintain branches and agencies in distant places. Those that
serve customers directly may find that they are also serving customers from farflung areas.
Improved Cash Flow Forecasting
- A cash flow forecast with a high degree of precision and reliability provides the
firm with realistic approaches to planning and budgeting. The disadvantages of
cash excess and cash shortages are eliminated if not minimized.
contd
Assessment of the probable amount of cash required if each of the contingencies happens.
To illustrate, assume that a labor strike happening in the premises of the company will
paralyze operations. Borrowing funds to cover the necessary expenditures of the firm will
penalize
the firm with interest charges amounting to one million pesos. It has also been ascertained
that
if a reserve fund has to be carried for the contingency, the firm will be penalized with eight
thousand
pesos in the form of lost income which could have been otherwise earned by the idle cash
reserve.
If the probability of the strike happening is placed at 50%, the expected value of the
options may be computed as follows:
OPTION
Carrying a cash reserve in this case is more economical to the firm because it carries a
1,000,000
50%
500,000
No reserve
lower penalty
expected value.
Development
800,000
50%
400,000
of Alternative
Sources of
Liquidity
With cash
- Once
the liquidity reserve needs of the firm have been defined and quantified,
reserve
alternative sources of meeting these needs should be identified and evaluated.
One possible alternative is the exploitation of the unused borrowing capacity of the firm.
CONTD
Credit bureaus are institutions organized for the exchange of ledger information
among associated creditors.
1. reports
2. bulletins;
3. credit guides; and
4. special services.
Capital refers to the financial resources of the credit applicant. The balance sheet is a
very useful tool in determining the resources of the applicant.
Capacity refers to the ability of the applicant to operate successfully.
Character refers to the reputation for honesty and fair dealing of the applicant or the
owners of the firm applying for credit.
Conditions refer to the environment required for the extension of credit.
Inventory Management refers to the activity that keeps track of how many of the
procured items needed to create a product or service are on hand, where items is , and
who has responsibility for each item.
A successful inventory management programs main objective is to strike a balance
among three key elements as follows:
1. Customer service
2.Inventory investment
3. Profit
Customer Service
- the period between when the order is made and the date of delivery is very
important to the customer. Shorter periods are preferred.
Inventory Investment
- funds tied up in inventory should ideally be kept to a minimum without
sacrificing customer service. These usually take the form of interests, insurance,
taxes, obsolescence, and storage.
Profit
-the level of inventory carried by the company most often affects the profitability
of the company. The task of the management is to determine the level of which
would bring the highest return of equity.
Functions of Inventory
- Inventories perform certain functions. These are the following:
1. they serve to offset errors contained in the forecast of the demand for
the companys products.
2. they often permit more economical utilization of equipment, buildings,
and manpower when the nature of the business is such that fluctuations in
demand exists; and
Contd
3. it permits the company to purchase or manufacture in
economic lot
sizes.
Forms of Inventory
1.Raw materials
2. Work-in-process; and
3. Finished goods.
LIQUIDITY
MANAGEMENT
Cash
Management
Money
Mobilizati
on
Effective
Cash Flow
Liquidity
Forecasting
Reserve
Definition
and
Quantificati
on
Productive
Use of Surplus
Assets
Accounts
Receivable
Management
Determine
Cost and
Profitability
of Credit
Sales
Projection of
Cash Flows
from
Receivables
Direction and
Control of
Credit
Extension
Inventory
Management
Customer
Service
Inventory
Investment
Profit
Aspects
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