Management of Working Capital

1. Management of Working Capital

2. learning objectivesworking capital and working capital requirementthe operating cycleFlatco plc balance sheet as at 31 December 2005Flatco plc profit and loss account for the year ended 31 December 2005working capital policy stocks management just in time (JIT), materials requirement planning (MRP), and optimised production technology (OPT) Session Summary (1)

3. debtors and credit managementexample of an aged debtors reportcreditors managementexample of an aged creditors reportoperating cycle performancebalance sheet items that impact on short-term andlong-term cash flowcash management Session Summary (2)

4. explain what is meant by working capital and theoperating cycledescribe the management and control of the working capital requirementoutline some of the working capital policies that may be adopted by companiesimplement the systems and techniques that may be used for the management and control of stocks, and optimisation of stock levels Learning Objectives (1)

5. outline a system of credit management and the controlof debtorsconsider the management of creditors as an additional source of financeuse the operating cycle to evaluate a company’s working capital requirement performanceconsider the actions and techniques to achieve short-term and long-term cash flow improvement Learning Objectives (2)

6. working capital requirement, WCR= stocks + debtors – creditors – accruals + prepaymentsthe difference between working capital (WC) and working capital requirement (WCR) is cash less short-term financial debt (bank overdraft) WC = WCR - short-term debt + cash Working Capital and Working Capital Requirement

7. the operating cycle relates to working capital (WC), thenet of current assets less current liabilitiesthe operating cycle is the period of time, which elapses between the point at which cash begins to be expendedon the production of a product, and the collection ofcash from the customer The Operating Cycle (1)

8. The Operating Cycle (2)

9. Flatco plc Balance Sheet as at 31 December 2005

10. Flatco plc Profit and Loss Account for the Year Ended 31 December 2005

11. the working capital requirement is normally financed by bank overdraft because of its flexibility in accommodating the fluctuating nature of net current assets the general lower cost of short-term financing the working capital policy adopted depends on individual company objectives and there is inevitably a conflict between the goals of profitability and liquidity Working Capital Policy (1)

12. aggressive policies may involve holding low levels ofcash and stocks, with the risk of potential cashshortages and stock-outsconservative policies may be more flexible with higher levels of cash and stock, giving lower risk at the expenseof reduced profitability Working Capital Policy (2)

13. Effective management and control of stocks requiresits appropriate location and storageestablishment of robust stock purchase procedures and reorder systemsaccurate and timely systems for the recording, controland physical checks of stocks Stocks Management (1)

14. Stock levels may be monitored using the following ratios:stock days = stock value_________or stock average daily cost of sales in periodturnover stock weeks = total stock units_____ average weekly units cost of sales Internal stock utilisation efficiency may be measured usingfinished goodsraw materialswork in progressaverage weekly average weekly raw average weekly despatches material usage production Stocks Management (2)

15. JIT is a management philosophy that incorporates a ‘pull’ system of producing or purchasing componentsand products in response to customer demandin a JIT system products are pulled through the system from customer demand back down through the supply chain to the level of materials and componentsthe consumer buys, and the processes manufacture the products to meet this demand - the consumer therefore determines the schedule Just in Time (JIT)

16. Materials requirement planning MRP (or MRPI) isa system that converts a production schedule into alisting of the materials and components, required tomeet that schedulea system that ensures that adequate stock levels are maintained and items are available when needed Materials Requirement Planning (MRP)

17. Manufacturing resource planning (MRPII) is an expansion of material requirements planning (MRPI) to give a broader approach than MRPI to the planning and scheduling of resources, embracing areas such asfinancelogisticsengineeringmarketing Manufacturing Resource Planning (MRPII)

18. OPT is a philosophy, combined with a computerised system of shopfloor scheduling and capacity planningOPT differs from a traditional approach of balancing capacity as near to 100% as possible and then maintaining flow Optimised Production Technology (OPT) (1)

19. OPT aims to balance flow rather than capacity, and like JIT, it aims at improvement of the production process and focuses on factors such asmanufacture to orderqualitylead timesbatch sizessetup times Optimised Production Technology (OPT) (2)

20. Effective management and control of debtors requires the establishment of appropriate policies coveringthe choice of customersthe way in which sales are madethe sales invoicing systemthe means of settlementthe implementation of a credit management and overdue accounts collection system Debtors and Credit Management (1)

21. Debtor levels may be monitored using the following ratiodebtor days = accounts receivable x 365 sales Debtors and Credit Management (2)

22. Example of an Aged Debtors Report

23. although not free, trade creditors provide the company with an additional source of financeeffective management and control of creditors requires the establishment of appropriate policies covering the choice of suppliers the way in which purchases are made the purchase invoicing system the means of settlement Creditors Management (1)

24. Creditor levels may be monitored using the following ratiocreditor days = accounts payable x 365 cost of sales (or purchases) Creditors Management (2)

25. Example of an Aged Creditors Report

26. regular measurement of the operating cycle, which determines the short-term financing requirements of the business, enables the company to monitor its working capital performance against targets and identify areas for improvement operating cycle (days) = stock days + debtor days - creditor daysOr alternatively as a percentageoperating cycle % =working capital requirement (stocks + debtors - creditors) sales Operating Cycle Performance

27. Balance Sheet Items that Impact on Short-term and Long-term Cash Flow

28. The short-term cash position of an organisation maybe improved by reducing current liabilities, and/orincreasing current liabilitiesstock levelsdebtorscash at bankcreditorsoverdraftstaxationVATPAYE/NIdividends payable Cash Management (1)

29. The long-term cash position of an organisation may be improved by increasing equity, and increasing long-term liabilities, and reducing the net outflow on fixed assets:shareholders’ capitalloansleasing and hire purchasepurchases of fixed assetssales of fixed assets Cash Management (2)