Peculiarities of Working Capital Management - Coursework Example

Working Capital Management Table of Contents Table of Contents 1 1. The necessity of Working Capital Management 3 2. Methods of Working Capital Management 4 Inventory Management 4 Receivables Management 5 Cash Management 5 Short term financing 6 3. Working Capital Management in a UK company 6 4. Working capital management in a manufacturing company 8 Reference 10 Appendix 11 1. The necessity of Working Capital Management A firm has to sustain synchronisation amid liquidity and profitability while going through its day to day business activities (Padachi, 2006). Liquidity is quite necessary for a firm to ensure its ability to meet short term obligations and its operations can have a smooth journey. Working capital management is much needed to make the business run both productively and profitably. In due time a company can have asset liability mismatch which can fetch them a good profit in short term with a risk of insolvency. This can be a tricky situation in long run. On the other end, excessive liquidity can come at a cost of profitability, which is surely not desirable. The working capital management takes the concept of managing inventories, cash, receivables and payables and the short term funding. Inventory management is quite important for an organisation. Maintaining a high level of inventory can incur higher cost for the firm, while a low inventory level can put a hindrance on the way to meet the customer needs. So it is very much necessary to have ideal inventory level to meet the customer demands at a minimum possible cost. In a similar way, the receivables would indicate about the willingness of the organisation to offer products or services on credit based. This credit sale is quite risky if not managed well. On the other hand sometimes firms have to offer their products or services on credit basis, as that would fetch more customers to increase the business volume. This again is a risk return trade-off for the organisation. Cash is an important component of the current assets on balance sheet. This is the most liquid asset that a company can avail in troubled situation. On the other end, having an excess level of cash can block to use that as operating capital. So having an optimum cash level is necessary for proper business functioning. Cash and short term securities management is very much needed from liquidity point of view. In all, a proper management of working capital is very much necessary to generate cash and improve profits at a reduced risk level. The allocation can be changed with due change in the financial and operational environment. For an instance in recession time, firms would like to cut down their inventory levels, delay the debt payment and at the same time would like to accelerate the payments from debtors. So different periods can have different working capital needs. Even this can vary depending upon the industry or depending upon the size of the organisation. For an instance retail industry would need to have higher inventory level. Working capital management is needed to meet the different necessitates aligned with the variation in organisational strategies and business environments. 2. Methods of Working Capital Management Working capital management involves the management of cash, inventory, receivables and short term securities. Inventory Management Maintaining an optimal inventory level is known as inventory management. This means maintain adequate stock with a minimum possible investment (Doshi, 2009). Inventory management is necessary to have a striking balance among the inventory level and the cost incurred with it. While managing the inventory it is very much needed to minimise the wastage of materials while providing a better service to the customers. This can also be good to have a control over the production level and match that with the inventory requirement; hence the operational productivity would increase. In a seasonal business, it is of utmost importance to match between the demand and supply and decide on the optimal stock level. There are a number of tools available which would be of great help in managing the inventories. Economic order quantity analysis, ABC analysis, periodical inventory calculation are few of them. Receivables Management The objectives of receivable management are to increase the sales volume and increase in profit. It can be a tactical decision to move ahead of the competitors by offering credit to the customers. However, the default risk is surely there in the whole process. A number of costs must be taken into account before deciding on the level of receivables, the company is willing to take in its accounting book. There would be a cost involved in financing while going through the credit extension. Apart from that during the collection period of the same, the collection cost has to be taken into consideration. If the debtor default on the receivable payment, the company has to consider the default cost attached to it. The organisation must have to decide on their credit and collection policy to properly manage the receivable level. This would surely depend on the nature of the business and the availability of fund to finance credit extension. Again, management of receivable means establishing a match between the anticipated sales volume and the cost incurred with the credit offerings. Cash Management Managing the level of working capital in a firm includes the cash management procedures. It is quite necessary for a company to meet its regular expenditure and obligations. The objective of cash management would include meeting regular cash disbursements in accordance with the payment schedule and collecting cash in conformity with the repayment schedule. Some methods to accelerate the cash inflow include decentralised collection and lock box system. Cash management is all about maintaining the proper liquidity position of the firm and at the same time it is important to take care of the fact that excessive cash balance must not be locked up and therefore free to use in production and operation. Short term financing Consideration of the business cycle is quite necessary to decide on the short term financing avenues. It is important to have the required liquidity in the business and at the same time to attain the optimal profitability at minimum investment expenses. The working capital management procedures in a company should be focused on to have a stable liquidity position while striving for higher productivity and profitability. 3. Working Capital Management in a UK company Kingfisher Plc is Europe’s leading home improvement retailer with operation spread worldwide (Kingfisher, 2010). Financials of the company has been taken for two periods to have an idea of the work capital management in the company. The current ratio of this company has been 1.1739 and 1.026 for the year 2009 and 2008, respectively. These ratios, with values more than one, mean that the company has enough current assets to meet its current obligations. Although, conventionally a value of 2 is considered to be good, still having necessary assets to cover up current obligations can be considered good in retail industry. In quick ratio the company had a very low one in 2008, although in 2009 they have improved over that with a value of 0.538. The company is on its spree to enhance the most liquid assets in its portfolio, which is quite a good sign for this company. Being in retail industry, the company needs to have a higher inventory level in its portfolio. Supporting this fact, among all the current assets the company has the highest allocation in their inventories. That is the reason behind a high current ratio but a low quick ratio, as most of the value amount is allocated in inventory. Over this period the company has seen a drastic growth in short term investment value. In this economic downturn the demand of the customers has decreased to a certain amount. The company, too, has decreased on their inventory level and most probably on their production capacity which left them with excess cash. This could be the reason that the company has invested its excess cash in short term securities. Profitability ratio has been quite low for this company. The reason might be a decrease in business volume and an increase in the expenses. The company should try to decrease its cost of goods sold and administrative expenses. In a retail industry the companies are expected to have a low inventory turnover ratio. . The inventory turnover ratio has been quite high for this company as compared to the industry. This happened because of a hike in cost of goods sold, which needs to be taken care of to have an effective working capital management in place. The company does not prefer to have more receivables on their accounting book. Although 2009 has seen a slight increase in the receivables value. It seems that they have extended more credit to increase the business volume. The company has increased on their working capital value in 2009 with a drastic growth in the value of short term investments. The company should be more focused on their working capital management processes. 4. Working capital management in a manufacturing company The current assets of a manufacturing company would mostly come from the inventory level, it has. The inventory of a manufacturing company would have raw material inventory, work in progress and finished products inventory. So necessarily they have to invest more in inventory management. Another asset which is supposed to be high for some manufacturing companies, as the automobile manufacturing companies, is the receivables. These companies prefer to offer their products on credit basis which would make their receivables position high. They also have the same relationship with their suppliers and that is the reason why the payables keep remaining on a bit higher side. These are the three main areas which are needed to be taken care of by these companies while going through the production procedures. Inventory is of utmost importance among these three. Keeping an excessive inventory would block the working capital in it and that cannot be used in the areas, which are in need of that. So attaining an, optimal inventory level, while keeping the inventory cost low, is very much preferable to the manufacturing organisations. Now a day, many large manufacturing companies are working on just in time basis. In this way all the components which need to be assembled come to the factory on the delivery day. This helps the companies to incur lower cost as stocks would take little space; hence would minimise the holding cost for inventory. Adding to it there would be almost no risk that the stocks would get damaged. In this way it would be possible for the company to conserve a substantial amount of cash. A manufacturing company can strive for this process, as this has almost all the properties of effective inventory management system (PlanWare, n.d.). In case of receivables management, the company must place their credit and collection policy in place. Verification of client credit history and other useful information is an integral part of the credit policy. No doubt, some companies have to offer their products on credit to increase business volume and to be in competition. That is why these companies need to have proper receivables management procedures in place. These heavy manufacturing companies are prone to have a large number of current obligations, which also includes the payables, on their accounting book. So, these companies must manage their obligations in such a way that their liquidity and profitability positions do not get affected. The manufacturing companies must match the receivables and payable conversion cycles in such a way that they got enough cash from their receivables to pay off their obligations. In all, they need to be focused on their liquidity, productivity and profitability. Reference Doshi, N., P. December 1, 2009. Management of Working Capital. [Pdf]. Available at: http://www.caalley.com/art/WorkingCapitalManagement.pdf [Accessed on February 22, 2010]. Kingfisher Plc. 2010. About Us. [Online]. Available at: http://www.kingfisher.co.uk/index.asp?pageid=2 [Accessed on February 22, 2010]. Padachi, K. Trend in Working Capital Management and Its Impact on Firm’s Performance. [Pdf]. Available at: http://www.bizresearchpapers.com/Kesseven.pdf [Accessed on February 22, 2010]. PlanWare. No Date. Business Planning Papers. [Online]. Available at: http://www.planware.org/workingcapital.htm [Accessed on February 22, 2010]. Reuters. 2010. Financial Statements For Kingfisher PLC. [Online]. Available at: http://uk.reuters.com/business/quotes/incomeStatement?stmtType=CAS&perType=ANN&symbol=KGF.L [Accessed on February 21, 2010]. Appendix (Source: Reuters, 2010) Read More