FM - Lesson 9 - Working Capital Management.pptx

Working Capital Management

1. Working Capital Management Financial Management Lesson 9

2. Lesson Outline

3. Definition of Working Capital Management Working capital management refers to a company's managerial accounting strategy designed to monitor and utilize the two components of working capital, current assets and current liabilities, to ensure the most financially efficient operation of the company .

4. Definition of Working Capital The primary purpose of working capital management is to make sure the company always maintains sufficient cash flow to meet its short-term operating costs and short-term debt obligations .

5. Nature and Purpose of Working Capital Working capital is usually defined as current assets less current liabilities.

6. Nature and Purpose of Working Capital

7. Nature and Purpose of Working Capital The size and composition of working capital can vary between industries . For some types of business, the investment in working capital can be substantial.

8. Nature and Purpose of Working Capital For example, a manufacturing business will typically invest heavily in raw material, work in progress and finished goods, and will normally sell its goods on credit, giving rise to trade receivables .

9. Nature and Purpose of Working Capital A retailer, on the other hand, will hold only one form of inventories (finished goods), and will usually sell goods for cash . Many service businesses hold no inventories.

10. Nature and Purpose of Working Capital Most businesses buy goods and/or services on credit , giving rise to trade payables . Few, if any, businesses operate without a cash balance, though in some cases it is a negative one (a bank overdraft ).

11. Nature and Purpose of Working Capital Working capital represents a net investment in short-term assets . These assets are continually flowing into and out of the business and are essential for day-to-day operations.

12. Nature and Purpose of Working Capital The various elements of working capital are interrelated and can be seen as part of a short-term cycle .

13. Working Capital Cycle (Manufacturing)

14. Working Capital Cycle (Manufacturing)

15. Working Capital Cycle (Manufacturing)

16. Working Capital Cycle For a retailer , the situation would be as in the figure above except that there would be no work in progress and the raw materials, and the finished inventories would be the same.

17. Working Capital Cycle For a purely service business , the working capital cycle would also be like that depicted in figure above except that there would be no inventories of raw materials and finished goods. There may well be work in progress , however, since many services, for example a case handled by a firm of solicitors, will take some time to complete and costs will build up before the client is billed for them.

18. Types of Working Capital

19. Working Capital Financing Policies

20. Disadvantages or Dangers of Inadequate or Short Working Capital

21. Managing Working Capital The management of working capital is an essential part of the business’s short-term planning process . It is necessary for management to decide how much of each element should be held.

22. Managing Working Capital There are costs associated with holding either too much or too little of each element. Management must be aware of these costs, which include opportunity costs, to manage effectively. Hence, the potential benefits must be weighed against the likely costs to achieve the optimum investment .

23. Managing Working Capital The working capital needs of a particular business are likely to change over time because of changes in the business environment. This means that working capital decisions are constantly being made. Managers must try to identify changes to ensure that the level of investment in working capital is appropriate.

24. Managing Working Capital In addition to changes in the external environment, changes arising within the business could alter the required level of investment in working capital. Examples of such internal changes include:

25. The Scale of Working Capital We might imagine that, compared with the scale of investment in non-current assets by the typical business, the amounts involved with working capital are trivial. This would be unrealistic – the scale of the working capital elements for most businesses is vast .

26. Managing Cash Firms hold cash balances in checking accounts. Why?

27. Managing Cash For example: Payroll must be met Supplies and inventory purchases must be paid Other day-to-day expenses of being in business must be met Trade discounts should be taken if financially attractive

28. Managing Cash

29. Managing Cash

30. Managing Cash

31. Managing Cash

32. Managing Cash

33. Three Primary Criteria in Selecting Marketable Securities In order of priority, three primary criteria for selecting appropriate marketable securities to meet firm’s anticipated short-term cash needs (particularly those arising from precautionary and speculative motives):

34. Three Primary Criteria in Selecting Marketable Securities

35. Three Primary Criteria in Selecting Marketable Securities

36. Three Primary Criteria in Selecting Marketable Securities

37. Actions firm may take to improve cash flow pattern:

38. Actions firm may take to improve cash flow pattern:

39. Actions firm may take to improve cash flow pattern:

40. Other Ways to Improve a Firm’s Cash Flows

41. Other Ways to Improve a Firm’s Cash Flows

42. Other Ways to Improve a Firm’s Cash Flows

43. Any Questions?