Showing posts with label sources of additional working capital. Show all posts
Showing posts with label sources of additional working capital. Show all posts

Wednesday 12 April 2017

The Working Capital Management: Success in managing debtors, stock and creditors affect cash.

The four largest elements affecting working capital are usually

  • debtors, 
  • stock, 
  • creditors and 
  • cash.


Success in managing the first three affect cash, which can be reinvested in the business or distributed.



Debtors

Many local businesses are plaqued by slow payment of invoices and it is a problem in many other countries too.

A statutory right to interest has been in place for a number of years but nothing seems to make much difference.

An improvement can significantly affect working capital.

It is a great problem for managers, who sometimes are frightened of upsetting customers and feel that there is little that they can do.

This is  completely the wrong attitude.

Customer relations must always be considered, but a great deal can be done.

Some practical steps for credit control are summarized below:


  • Have the right attitude; ask early and ask often.
  • Make sure that payment terms are agreed in advance.
  • Do not underestimate the strength of your position.
  • Give credit control realistic status and priority.
  • Have well-thought out credit policies.
  • Concentrate on the biggest and most worrying debts first.
  • Be efficient; send out invoices and statements promptly.
  • Deal with queries quickly and efficiently.
  • Make full use of the telephone, your best aid.
  • Use legal action if necessary.

This may sound obvious but it usually works.

Be efficient, ask and be tough if necessary.



Stock

The aim should be 
  • to keep stock as low as is realistically feasible and 
  • to achieve as high a rate of stock turnover as is realistically feasible.

In practice, it is usually necessary to compromise between 
  • the wish to have stock as low as possible, and 
  • the need to keep production and sales going with a reasonable margin of safety.

Exactly how the compromise is struck will vary from case to case.  

Purchasing and production control are highly skilled functions and great effort may be expended on getting it right.

"Just in time deliveries" is the technique of arranging deliveries of supplies frequently and in small quantities.  In fact, just in time to keep production going.

It is particularly successful in japan where, for example, car manufacturers keep some parts for production measured only in hours.

It is not easy to achieve and suppliers would probably like to make large deliveries at irregular intervals.  

It may pay to approach the problem with an attitude of partnership with key suppliers, and to reward them with fair prices and continuity of business.

Finished goods should be sold, delivered and invoiced as quickly as possible.



Creditors

It is not ethical advice, but there is an obvious advantage in paying suppliers slowly.

This is why slow payment is such a problem and, as has already been stated, the control of debtors is so important.

Slow payment is often imposed by large and strong companies on small and weak suppliers.

Slow payment does not affect the net balance of working capital,but it does mean that both cash and creditors are higher than would otherwise be the case.

Apart from moral considerations, there are some definite disadvantages in a policy of slow payment:
  • Suppliers will try to compensate with higher prices or lower service.
  • Best long-term results are often obtained by fostering mutual loyalty with key suppliers; it pays to consider their interests.
  • If payments are already slow, there will be less scope for taking longer to pay in response to a crisis.
For these reasons it is probably not wise to adopt a consistent policy of slow payment, at least with important suppliers.

It is better to be hard but fair and to ensure that this fair play is rewarded with 
  • keen prices, 
  • good service and 
  • perhaps prompt payment discounts.

There may be scope for timing deliveries to take advantage of payment terms.  

For example, if the terms are 'net monthly account', a 30 June delivery will be due for payment on 31 July.  At 1 July delivery will be due for payment on 31 August.


Tuesday 11 April 2017

Working Capital

This is the difference between current assets and current liabilities.

It is extremely important.

  • A business without sufficient working capital cannot pay its debts as they fall due. 
  • In this situation it might have to stop trading even if it is profitable.


Possible alternatives might include:

  • raising more capital,
  • taking out a long-term loan, or
  • selling some fixed assets.

Monday 10 April 2017

Never forget the importance of working capital

Working capital is the difference between assets realizable in the short term and liabilities payable in the short term.

It includes cash held and money owed.

Quickly realizable assets are the next best thing to cash.

If you can get the working capital right, you should be safe.

Try hard to achieve this.

Sunday 21 June 2009

Key Working Capital Ratios & Sources of Additional Working Capital

Stock Turnover(in days)
Average Stock * 365/Cost of Goods Sold
= x days
On average, you turn over the value of your entire stock every x days. You may need to break this down into product groups for effective stock management.Obsolete stock, slow moving lines will extend overall stock turnover days. Faster production, fewer product lines, just in time ordering will reduce average days.


Receivables Ratio(in days)
Debtors * 365/Sales
= x days
It take you on average x days to collect monies due to you. If your official credit terms are 45 day and it takes you 65 days... why ?One or more large or slow debts can drag out the average days. Effective debtor management will minimize the days.


Payables Ratio(in days)
Creditors * 365/Cost of Sales (or Purchases)
= x days
On average, you pay your suppliers every x days. If you negotiate better credit terms this will increase. If you pay earlier, say, to get a discount this will decline. If you simply defer paying your suppliers (without agreement) this will also increase - but your reputation, the quality of service and any flexibility provided by your suppliers may suffer.


Current Ratio
Total Current Assets/Total Current Liabilities
= x times
Current Assets are assets that you can readily turn in to cash or will do so within 12 months in the course of business. Current Liabilities are amount you are due to pay within the coming 12 months. For example, 1.5 times means that you should be able to lay your hands on $1.50 for every $1.00 you owe. Less than 1 times e.g. 0.75 means that you could have liquidity problems and be under pressure to generate sufficient cash to meet oncoming demands.


Quick Ratio
(Total Current Assets - Inventory)/Total Current Liabilities
= x times
Similar to the Current Ratio but takes account of the fact that it may take time to convert inventory into cash.


Working Capital Ratio
(Inventory + Receivables - Payables)/Sales
As % Sales
A high percentage means that working capital needs are high relative to your sales.


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An example:

Company A monthly inventory = $30
Company A annual purchases = $360
Inventory turnover = $30 x12 / $360 = 1 month = 30 days

The bank gives a interest free facility for the first 15 days; after then, interests will be charged on a daily basis from the first day of purchase.

The company presently uses the bank facility of $30.

How can this company manages its cash flow better? How can this company saves on its interest payment?

Company A can continues to enjoy the bank's interest free facility if it can get its inventory turnover to be less than 15 days. This will free up working capital that can be used for other parts of its business.

To save on interest, company can increase its own working capital by injecting cash in the form of equity or a loan from owners. This cash can be used to settle the bank facility at the time period of 15 days, that is, before the facility incurs interest charges. How much cash should be injected into its working capital for this? To do so, would require (15 days/30 days ) x $30 = $15 cash to be injected in the form of equity or loan by the owners, for extra working capital.

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Sources of Additional Working Capital


Sources of additional working capital include the following:

  • Existing cash reserves
  • Profits (when you secure it as cash !)
  • Payables (credit from suppliers)
  • New equity or loans from shareholders
  • Bank overdrafts or lines of credit
  • Long-term loans

If you have insufficient working capital and try to increase sales, you can easily over-stretch the financial resources of the business. This is called overtrading.

Early warning signs include:

  • Pressure on existing cash
  • Exceptional cash generating activities e.g. offering high discounts for early cash payment
  • Bank overdraft exceeds authorized limit
  • Seeking greater overdrafts or lines of credit
  • Part-paying suppliers or other creditors
  • Paying bills in cash to secure additional supplies
  • Management pre-occupation with surviving rather than managing
  • Frequent short-term emergency requests to the bank (to help pay wages, pending receipt of a cheque).
For information on cash flow planning, see Making Cash Flow Forecasts, Cashflow Plan software and Checklist for Improving Cash Flow.

http://www.planware.org/workingcapital.htm