1. Chapter 12 Management of working capital
Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Business Accounting and Finance in NZ by Clark, Maguire and Davies
Slides prepared by Laura Hopkins

2. Learning objectives Completion of this topic should enable you to
define and explain working capital and the operating cycle
describe the management and control of working capital
outline some working capital policies that businesses may adopt
Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Business Accounting and Finance in NZ by Clark, Maguire and Davies
Slides prepared by Laura Hopkins

3. Learning objectives cont.
Completion of this topic should enable you to
use systems and techniques for the management and control of inventory
outline a system for managing credit and debtors
explain how creditors can be managed to provide a source of finance
Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Business Accounting and Finance in NZ by Clark, Maguire and Davies
Slides prepared by Laura Hopkins

4. Learning objectives cont.
Completion of this topic should enable you to
use the operating cycle to evaluate a company’s working capital management
use techniques to improve short- and long-term cash flow
Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Business Accounting and Finance in NZ by Clark, Maguire and Davies
Slides prepared by Laura Hopkins

5. Working capital and the working capital requirement
A company has two types of investment
investment in operations
investment in fixed assets
Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Business Accounting and Finance in NZ by Clark, Maguire and Davies
Slides prepared by Laura Hopkins

6. Investment in operations
Investment in operations is
inventory + debtors + prepayments + cash  creditors  accruals
i.e. the working capital of the company
The accounting equation
assets = liabilities + equity
can be rewritten as
fixed assets + working capital = equity + debt
Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Business Accounting and Finance in NZ by Clark, Maguire and Davies
Slides prepared by Laura Hopkins

7. The operating cycle
The period of time between the point at which cash begins to be expended on the production of a product or service, and the point at which cash is received from customers
Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Business Accounting and Finance in NZ by Clark, Maguire and Davies
Slides prepared by Laura Hopkins

8. The operating cycle
Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Business Accounting and Finance in NZ by Clark, Maguire and Davies
Slides prepared by Laura Hopkins

9. The working capital requirement
The investment in operations, or the operating cycle, is called the working capital requirement.
WCR = inventory + debtors  creditors  accruals/prepayments
The smaller the WCR
the smaller the total financial resources needed
the stronger the company
In most manufacturing companies the WCR is positive.
WCR will be negative in companies with low inventory and low accounts receivable, e.g. a supermarket.
Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Business Accounting and Finance in NZ by Clark, Maguire and Davies
Slides prepared by Laura Hopkins

10. Working capital WC = current assets  current liabilities
WCR = inventory + debtors  creditors  accruals/prepayments
WC = WCR - short-term debt + cash or
WC = equity + long-term debt fs fixed assets
Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Business Accounting and Finance in NZ by Clark, Maguire and Davies
Slides prepared by Laura Hopkins

11. Working capital policy
Company has a choice between internal and external finance
External financing
usually provided by bank overdraft
flexibility accommodates fluctuating net current assets
but servicing costs are high
Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Business Accounting and Finance in NZ by Clark, Maguire and Davies
Slides prepared by Laura Hopkins

12. Working capital policy cont.
Aggressive policy
holding low levels of cash and inventory
risk is of cash and inventory shortages
Conservative policy
holding high levels of cash and inventory
risk is lower but so is profitability
Policy selected depends on a company’s objectives.
Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Business Accounting and Finance in NZ by Clark, Maguire and Davies
Slides prepared by Laura Hopkins

13. Inventory management
Business needs to effectively manage and control inventory
efficient and effective purchasing procedures and re-ordering systems
accurate and timely inventory recording
turnover regularly reviewed
old/obsolete inventory disposed of
physical check of inventory stocks
Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Business Accounting and Finance in NZ by Clark, Maguire and Davies
Slides prepared by Laura Hopkins

14. 7 main areas of waste Overproduction Waiting Transportation
the most serious of the waste areas
Waiting
Transportation
Inappropriate processes
Unnecessary inventory
Unnecessary motion
Product defects
Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Business Accounting and Finance in NZ by Clark, Maguire and Davies
Slides prepared by Laura Hopkins

15. Inventory ratios
Inventory turnover ratios used to monitor inventory levels
inventory days
inventory value
average daily cost of sales in period
shows number of days inventory could last at current usage
calculated for total inventory or
for finished goods, raw materials, work in progress
inventory weeks
Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Business Accounting and Finance in NZ by Clark, Maguire and Davies
Slides prepared by Laura Hopkins

16. ABC and VIN analysis
The level of inventory control assesses the costs of control against accuracy required and the potential benefits.
ABC method
uses Pareto analysis
VIN method
inventory allocated according to
V = vital
I = important
N = nice to have
Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Business Accounting and Finance in NZ by Clark, Maguire and Davies
Slides prepared by Laura Hopkins

17. Economic order quality
The most economic inventory replenishment order size that minimises the sum of the inventory ordering costs and inventory holding costs
Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Business Accounting and Finance in NZ by Clark, Maguire and Davies
Slides prepared by Laura Hopkins

18. Just in time
A pull system of producing or purchasing components and products in response to customer demand
the consumer determines the schedule
improves inventory management
aims at waste elimination
A push system produces in advance of demand
Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Business Accounting and Finance in NZ by Clark, Maguire and Davies
Slides prepared by Laura Hopkins

19. Other inventory management systems
Materials requirement planning
a push system
forecasts customer demand and calculates and reconciles materials requirements to meet the schedule
Optimised production technology
based on throughput accounting
balances flow rather than capacity
Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Business Accounting and Finance in NZ by Clark, Maguire and Davies
Slides prepared by Laura Hopkins

20. Debtor management
Effective management and control of debtors requires appropriate policies covering
choice of customers
credit check
the way sales are made
sales invoicing system
prompt and timely
implement a control system
Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Business Accounting and Finance in NZ by Clark, Maguire and Davies
Slides prepared by Laura Hopkins

21. Debtor management cont.
 speedy correction of errors and resolving
disputes
 means of settlement
letters of credit
electronic collection popular
 monitoring customer settlement performance
aged debtors report
calculate debtor days ratio
 overdue accounts collection system
Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Business Accounting and Finance in NZ by Clark, Maguire and Davies
Slides prepared by Laura Hopkins

22. Example of an aged debtors report
Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Business Accounting and Finance in NZ by Clark, Maguire and Davies
Slides prepared by Laura Hopkins

23. Debtor ratios Monitor customer settlement performance
debtor days = accounts receivable x 365
sales
Indicates average time taken to receive payment from credit customers
Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Business Accounting and Finance in NZ by Clark, Maguire and Davies
Slides prepared by Laura Hopkins

24. Creditor management
Essential for business effectiveness and improved control over cash flow
Requires appropriate policies covering
choice of suppliers
evaluate quality of product
financial stability
the way of making purchases
used skilled buyers
purchase invoicing system
computerised systems allow an integrated system
Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Business Accounting and Finance in NZ by Clark, Maguire and Davies
Slides prepared by Laura Hopkins

25. Creditor management cont.
speedy correction of errors and resolution of disputes
means of settlement
clarify terms in writing
monitoring of supplier payment performance
aged creditors report
calculate creditor days ratio
Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Business Accounting and Finance in NZ by Clark, Maguire and Davies
Slides prepared by Laura Hopkins

26. Creditor ratios Monitor supplier payment performance
creditor days = accounts payable x 365
cost of sales or purchases
Indicates average time taken to pay for supplies received on credit
Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Business Accounting and Finance in NZ by Clark, Maguire and Davies
Slides prepared by Laura Hopkins

27. Example of an aged creditor report
Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Business Accounting and Finance in NZ by Clark, Maguire and Davies
Slides prepared by Laura Hopkins

28. Operating cycle performance
Operating cycle is the time that elapses between when cash begins to be expended on production and the receipt of cash from the customer.
 operating cycle days =
inventory days + debtor days  creditor days
 operating cycle % =
working capital requirement (inventory + debtors  creditors)
sales
Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Business Accounting and Finance in NZ by Clark, Maguire and Davies
Slides prepared by Laura Hopkins

29. Overtrading
Occurs when a business enters into commitments greater than its available short-term resources
volume of trade too great for the small working capital base
Will require strategies to deal with it
Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Business Accounting and Finance in NZ by Clark, Maguire and Davies
Slides prepared by Laura Hopkins

30. Items that impact on short-term and long-term cash flow
Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Business Accounting and Finance in NZ by Clark, Maguire and Davies
Slides prepared by Laura Hopkins

31. Short-term cash flow improvement
Reduce current assets and/or increase current liabilities.
Optimise inventory levels held.
Turn credit sale into cash in the shortest time.
Invest surplus cleared funds.
Minimise overdraft interest and charges.
Make timely tax and GST payments to avoid penalties.
Plan dividends payable payments to suit cash flow.
Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Business Accounting and Finance in NZ by Clark, Maguire and Davies
Slides prepared by Laura Hopkins

32. Long-term cash flow improvement
Increase equity, increase long-term liabilities and reduce net outflow on fixed assets.
Acquire fixed assets with long-term loans, not overdraft funding.
Acquire fixed assets using hire purchase and leasing.
Consider asset sale and leaseback.
Additional equity improves financial position.
Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Business Accounting and Finance in NZ by Clark, Maguire and Davies
Slides prepared by Laura Hopkins

33. Cash management Cash shortage is a common cause of business failure.
Control cash flow with a plan continually reviewed and updated.
Copyright  2006 McGraw-Hill Australia Pty Ltd PPTs t/a Business Accounting and Finance in NZ by Clark, Maguire and Davies
Slides prepared by Laura Hopkins