WORKING CAPITAL MANAGEMENT

Working capital is the excess of current assets over current liabilities

Elements of working capital are:

1) current assets- receivables, bank and cash, inventory

2) current liabilities- payables, overdraft, accruals

WORKING CAPITAL RATIOS

CURRENT RATIOS = current assets

current liabilities

ACID TEST/ QUICK = current assets - inventory

RATIO current liabilities

RECEIVABLE DAYS = average receivable days x 365

credit sales/ sales

INVENTORY DAYS = average inventory x 365

cost of sales

PAYABLE DAYS = average payables x 365

credit purchases /COS

OPERATING CYCLE

Also known as cash cycle or trading cycle is the length of time between the
company’s initial outlay on raw materials, wages and other expenditures and the
inflow of cash from the sale of goods.

The length of the cycle = inventory days receivable days payable days

If the creditors are paid before cash is received, the cycle is positive.

If the creditors are paid after cash is paid, the cycle is negative.

OVERTRADING

Overtrading is trading by an organisation beyond the resources provided by the

existing capital. It is caused by rapid growth.
INDICATORS OF OVERTRADING

1. Rapid growth or increase in turnover

2. Increase in working capital figures especially stock and debtors/

receivables

3. Increase in trade payable days as payments are delayed

4. Decrease in cash or increase in overdraft

5. No matching increase in permanent capital (overtrading is sometimes

under capitalisation )

6. Increase in operating cycle

7. Deteriorating current and quick ratios

REMEDIES FOR OVERTRADING

1. Cut back trading

2. Raise further permanent capital

3. Improve working capital management.

MANAGING DEBTORS OR RECEIVABLES

a. CREDIT CONTROL

Assessing customer’s credit risk

1. Bank

2. Published information

3. . Credit agencies

4. . Trade references

5 Company’s own sale record

AGREEING TERMS

Set limits for both the amount of credit offered and time taken to repay.

COLLECTING PAYMENT

An effective administration system for debtors must be established

FINANCIAL IMPLICATION

Cost of financing debtors is the interest cost

Interest cost = Debtors x interest (overdraft) rate

where the debtor balance = sales x debtor days

365

DISCOUNTS

Cash discounts are given to encourage early payments by customers. The cost of
discount is balanced against the savings the company receives from a lower
balance and a shorter average collecting period

Discounts may also reduce the number of bad debts.

MANAGING CREDITORS

By delaying payments to creditors, companies face possible problems:

:
1. Supplier may refuse to supply in future

2. Supplier may only supply on cash basis

3. Loss of reputation

4. Supplier may increase price in future

5. Loss of discount or economies of scale

BY : EMMANUEL LECTURER , LTC COLLEGE LONDON