Accounts & Finance

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Nov 20, 2013 (3 years and 10 months ago)

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Accounts & Finance

Working Capital

Learning Objectives


Define working capital and explain the
working capital cycle


Prepare a cash flow forecast from given
information


Evaluate strategies for dealing with liquidity
problems

Working Capital


Every business NEEDS cash to function


Cash is needed for everyday expenses such as
wages and buying stock


Without sufficient working capital (cash) a
business will be illiquid (unable to pay its
immediate or short term debts


these are
their liabilities


creditors, overdrafts)


It may be forced into liquidation

Cash
inflows

and cash
outflows


Cash
inflows



payments

in cash
received

by

a
business


Cash
outflows



payments

in cash
made

by

a
business


Work

with

a
partner

and
list

3 cash
inflows

and 3 cash
outflows

that

a
business

may

experience


Main types of cash inflows and outflows


Cash flow can be described as a cycle:



The business uses cash to acquire resources (assets such as stocks)


The resources are put to work and goods and services produced. These
are then sold to customers


Some customers pay in cash (great), but others ask for time to pay.
Eventually they pay and these funds are used to settle any liabilities of the
business (e.g. pay suppliers)


And so the cycle repeats


Hopefully, each time through the cash flow cycle, a little more money is
put back into the business than flows out. But not necessarily, and if
management don’t carefully monitor cash flow and take corrective action
when necessary, a business may find itself sinking into trouble.



The cash needed to make the cycle above work effectively is known as
working capital


Where does Working Capital come from?


Simple calculation



Current assets


current liabilities

Current assets are?


Current assets = Cash + Stock + Debtors


Current Liabilities are?


Current liabilities refers to the money a business
owes that needs to be repaid within the next 12
months. E.g. Overdrafts, Creditors, Tax

Calculating Working Capital


If you’re showing current assets of £100,000
and current liabilities of £80,000, your
working capital is……?


£
20,000



While any current assets are great, cash is
better
-

especially now!

Why?

Managing working capital


The objective of managing working capital is
to ensure there is always enough cash on
hand:



to pay bills as they become due,


to purchase enough inventory and stock to meet
demand


and to have enough sales to support expenses.

Cash management


Cash management is an essential, yet often
neglected, component of business
management



We have all heard the statement that "most
companies do not fail from lack of profit, but from
lack of cash
"



It is also true that a period of dramatic sales
increases will most likely be a company's most
profitable, but will also likely be the period of
greatest cash flow
needs


Remember


Current

assets



Current

liabilities

How much working capital should a business
have?


It depends on:


Volume of sales


Size of trade credit offered to it


Whether the business is expanding or not


Length of operating cycle (from paying for raw materials
to receiving payment from customers)


The rate of inflation

Factors affecting level of working
capital

Factor

Explanation

Need to hold
inventories (stock)

Some businesses need to hold substantial inventories to meet customer needs


e.g.
retailers and distributors

Production lead time

A product that is made and sold within a short time (e.g. fresh food) requires much less
inventory than one where the production process takes a long time (e.g. production of
mature cheese!)

Lean production

Businesses that successfully implement lean production techniques find that they need to
hold significantly less inventory

Customer credit
period

In some industries it is expected that a long credit period can be taken before trade
debtors need to settle their invoices


which means that higher working capital is required

Effectiveness of
credit control

A poorly managed credit control department will allow customers to take too much credit
and take too long to settle their bills


which will mean higher trade debtors and higher
working capital

Supplier credit period

The longer the credit offered by suppliers, the better for cash flow and working capital.

WORKING CAPITAL

THE LIFEBLOOD OF A BUSINESS

Capital & Revenue Expenditure


Capital expenditure


on items that will be
used time & time again, that will continue to
help the business in the following years


is
known as capital expenditure



Revenue expenditure


spending on day to
day items for the running of the business.

Need Working capital for this


REVENUE
expenditure


Or



CAPITAL
expenditure ?

Is this Capital or Revenue Expenditure?


Marketing expenditure

Revenue

Expenditure

Is this Capital or Revenue Expenditure?


New fleet of company cars

Capital

Expenditure

Is this Capital or Revenue Expenditure?


Ink cartridges

Revenue

Expenditure

Is this Capital or Revenue Expenditure?


Inventories

Revenue

Expenditure

Is this Capital or Revenue Expenditure?


Office Equipment

Capital

Expenditure

Is this Capital or Revenue Expenditure?


Salaries

Revenue

Expenditure

Is this Capital or Revenue Expenditure?


New factory

Capital

Expenditure