1. Chapter 10 Managing working capital
LEARNING OUTCOMES
You should be able to:
Discuss the purpose of working capital and the nature of the working capital cycle
Identify the main elements of working capital
Explain the factors that have to be taken into account when managing each element of the working capital
Explain the importance of establishing policies for the control of working capital

2. The nature and purpose of working capital
Major elements
Major element
Inventories
Trade receivables
Cash (in hand and at bank)
Trade payables
less
equals
Current liabilities
Working capital
Current assets

3. The working capital cycle
Trade payables
Trade receivables
Finished goods
Cash/ bank overdraft
Work in progress
Raw materials
Cash sales
Credit sales
Cash
Source: P. Atrill and E. McLaney, Acounting: An Introduction, 5th edn, Financial Times Prentice Hall, 2009.

4. Excess working capital investment by large European businesses as a percentage of sales revenue5 %
2005
2006
2007
2008
12.6
12.1
12.3
11.7 15 10
2009
12.7
Source: compiled from information in REL Consultancy 2010 Europe Working Capital Survey,

5. Inventories financing cost
Business
Type of operations
Cost of capital
Average inventories held
Cost of holding inventories
Operating profit/ (loss)
Cost as % of operating profit/(loss)
(a)
(b)
(a) × (b) % £m
Associated British Foods
Food producer
9.5
1,152
109
625
17.4
British Airways
Airline
8.9
120 11
(220)
5.0
Kingfisher
Home improvement retailer
7.8
1,669
130
623
20.9
J. Sainsbury
Supermarket
10.0
696 70
710
9.9
Source: Annual Reports for years ending in 2009 and 2010

6. Managing inventories Forecasts of future demands Financial ratios
Recording and reordering systems
Inventories management models
Materials requirements planning (MRP) system
Levels of control
Just-in-time (JIT) stock management
Procedures and techniques that can be used to ensure the proper management of inventories

7. ABC method of analysing and controlling inventories
Cumulative value of inventories items (%)
Volume of inventories items held (%) A B C
100
Source: P. Atrill and E. McLaney, Acounting: An Introduction, 5th edn, Financial Times Prentice Hall, 2009.

8. Patterns of inventories movements over time
Inventories level
Time

9. Inventories holding and order costs
Annual costs (£)
Average inventories level (units) E
Total costs
Holding costs
Ordering costs

10. The economic order quantity (EOQ) model
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
EOQ =
2DC H

11. Managing receivables Questions to ask
Which customers should receive credit
Questions to ask
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

12. Which customers should receive credit?
The five Cs of credit
Capital
Capacity
Collateral
Conditions
Character

13. Collection policies Develop customer relationships
Publicise credit terms
Issue invoices promptly
Develop customer relationships
Produce an ageing schedule of receivables
Answer queries quickly
Monitor outstanding debts
Deal with slow payers

14. Comparison of actual and expected (budgeted) receipts over time for Example 10.5%
Time 10 20 30 40
June
July
August
September
Actual
Budgeted

15. Why hold cash? There are three reasons: To meet day-to-day commitments
To deal with uncertain cash flows
To exploit profitable opportunities

16. Managing cash Main techniques
Preparing projected cash flow statements
Controlling the cash balance (using control limits)
Managing the operating cash cycle

17. Controlling the cash balance
Inner limit
Outer limit
Target cash balance
Cash balance (£)
Time (days) 2 8 6 4 9 5 3 1 7 11 12 10
Source: P. Atrill and E. McLaney, Acounting: An Introduction, 5th edn, Financial Times Prentice Hall, 2009.

18. 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
Source: P. Atrill and E. McLaney, Acounting: An Introduction, 5th edn, Financial Times Prentice Hall, 2009.

19. Calculating the operating cash cycle
equals
minus
plus
Operating cash cycle
Average payment period for payables
Average settlement period for receivables
Average inventories turnover period
Source: P. Atrill and E. McLaney, Accounting and Finance for Non-Specialists, 7th edn, Financial Times Prentice Hall, 2010.

20. The average OCC of large European businesses15
2005
2006
2007
2008
2009
Days
46.9
44.4
45.6
44.1 45 30
Source: compiled from information in REL Consultancy 2010 Europe Working Capital Survey,