Managing Working Capital

Slide 12.
Chapter 12
MANAGING
WORKING CAPITAL
Atrill and McLaney, Accounting and Finance for Non-Specialists PowerPoints on the Web, 8th edition Pearson Education Limited 2013
Slide 12.2
LEARNING OUTCOMES
You should be able to:
Identify the main elements of working capital
Discuss the purpose of working capital and

the nature of the working capital cycle
Explain the importance of establishing policies for

the control of working capital
Explain the factors that have to be taken into

account when managing each element of the
working capital
Slide 12.3
The nature and purpose of working capital

Major elements
Major element
Inventories
Trade payables
Trade receivables
Cash (in hand and at bank)
Working
capital
Current assets
equals
Current liabilities
less
Slide 12.4
The working capital cycle
Cash sales
Cash/
bank
overdraft
Finished
goods
Credit sales
Work in
progress
Trade
receivables
Raw
materials
Cash
Trade
payables
Slide 12.5
Average investment (in days) for main working capital elements
60
Trade
receivables
settlement
period
40
52.6
Days
2010
Inventories
Trade payables
turnover period settlement period
46.0
34.2
20
0
2009
Days
60
40
20
53.0
45.5
34.8
0
Source: Compiled from information in All tied up: working capital management report 2011, Ernst and Young, www.ey.com.
Slide 12.6
Inventories financing cost

Business
Type of
operations
Cost of
capital
Average
inventories
held
Cost of
holding
inventories
Operating Cost as %
profit/
of operating
(loss)
profit/(loss)
(a)
(b)
(a) x (b)
Associated
British
Foods
Food
producer
10.0
1,332
133
842
15.8
Kingfisher
Home
improvement
retailer
8.1
1,668
135
698
19.3
J. Sainsbury
Supermarket
10.0
757
76
851
8.9
Source: Annual Reports of the businesses for the year ending in 2011.
Slide 12.7
Managing inventories
Procedures and techniques that can be used to
ensure the proper management of inventories
Budgeting future demand
Financial ratios
Recording and reordering systems
Levels of control
Inventory management models
Materials requirements planning (MRP) system
Just-in-time (JIT) stock management
Slide 12.8
Financial ratios
Average inventories
turnover period
Average inventories held 365

Cost of sales
Slide 12.9
ABC method of analysing and controlling inventories

100
Cumulative
value of
inventories
items
(%)
100
Volume of inventories items held (%)
Slide 12.10
Inventories level
Patterns of inventories movements over time
Time
Slide 12.11
Inventories holding and order costs
Ordering
costs
Annual
costs
()
Total costs
Holding
costs
Average inventories
level (units)
Slide 12.12
The economic order quantity (EOQ) model
EOQ
2DC
H
where:
D = the annual demand for the
inventories item (expressed in
units of the inventory item);
C = the cost of placing an order;
H = the cost of holding one unit of
the inventories item for one year
Slide 12.13
Just-in-time inventories management
Requires close relationship

with suppliers
May require re-engineering
production process
May result in hidden costs (taking
advantage of cheap sources of supply)
Can be seen as part of TQM approach
Slide 12.14
Managing trade receivables

Questions to ask
Which customers should receive credit
How much credit should be offered
What length of credit it is prepared to offer
Whether discounts will be offered for
prompt payment
What collection policies should be
adopted
How the risk of non-payment can be
reduced
Slide 12.15
Which customers should receive credit?

The five Cs of credit
Capital
Capacity
Collateral
Conditions
Character
Slide 12.16
Sources of credit information

Trade references
Bank references
Published financial statements
The customer
Credit agencies
Register of County Court Judgements
Other suppliers
Slide 12.17
Length of credit period

May be influenced by:
The typical credit terms operating
within the industry
The degree of competition within the industry
The bargaining power of particular customers
The risk of non-payment
The capacity of the business to offer credit
The marketing strategy of the business
Slide 12.18
Collection policies
Develop customer relationships
Publicise credit terms
Issue invoices promptly
Monitor outstanding receivables
Produce an ageing schedule of receivables
Answer queries quickly
Deal with slow payers
Identify the pattern of receipts
Slide 12.19
Ageing schedule of trade receivables at 31 December

Customer
Days outstanding
Total
1 to 30
days
31 to 60
days
61 to 90
days
More than
90 days
A Ltd
20,000
10,000
30,000
B Ltd
24,000
24,000
C Ltd
12,000
13,000
14,000
18,000
57,000
Total
32,000
47,000
14,000
18,000
111,000
Slide 12.20
Comparison of actual and expected (budgeted)

receipts over time for Example 12.5
Budgeted
40
Actual
%
30
20
10
June
July
August
September
Time
Slide 12.21
Why hold cash?
There are three reasons:
To meet day-to-day commitments
To deal with uncertain cash flows
To exploit profitable opportunities
Slide 12.22
Factors influencing the amount of cash held

Possible factors may include:
The nature of the business
The opportunity cost of holding cash
The level of inflation
The availability of near-liquid assets
The cost of borrowing
Economic conditions
Relationships with suppliers
The availability of borrowing
Slide 12.23
Managing cash
Main techniques
Controlling the cash balance

(using control limits)
Preparing projected
cash flow statements
Managing the operating
cash cycle
Slide 12.24
The operating cash cycle
Purchase
of goods
on credit
Payment
for
goods
Sale of
goods on
credit
Cash
received
from credit
customer
Inventories
holding period
Operating cash
cycle
Slide 12.25
Calculating the operating cash cycle

Average inventories
turnover period
plus
Average settlement
period for receivables
minus
Average payment
period for payables
equals
Operating cash cycle
Slide 12.26
Days
The average OCC of large European businesses

50
40
42.3
40.8
30
20
10
2009
2010
Source: Adapted from figure in All tied up: working capital management survery 2011 Ernst and young, p.2, www.ey.com

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Slide 12.

Discuss the purpose of working capital and

Explain the importance of establishing policies for

Explain the factors that have to be taken into

The nature and purpose of working capital

The working capital cycle

Average investment (in days) for main working capital elements

Inventories financing cost

Average inventories held 365

ABC method of analysing and controlling inventories

Volume of inventories items held (%)

Patterns of inventories movements over time

Inventories holding and order costs

The economic order quantity (EOQ) model

Just-in-time inventories management

Requires close relationship

Can be seen as part of TQM approach

Managing trade receivables

Which customers should receive credit?

Sources of credit information

Length of credit period

Ageing schedule of trade receivables at 31 December

Comparison of actual and expected (budgeted)

Why hold cash?

There are three reasons:

To meet day-to-day commitments

To deal with uncertain cash flows

To exploit profitable opportunities

Factors influencing the amount of cash held

Controlling the cash balance

The operating cash cycle

Calculating the operating cash cycle

Operating cash cycle

The average OCC of large European businesses

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