Chapter12ManagingworkingcapitalManagementAccountingforDecisionMakersTenthEditionLEARNINGOUTCOMESYoushouldbeableto:Discussthepurposeofworkingcapital,it’sscaleandthenatureoftheworkingcapitalcycleIdentifythemainelementsofworkingcapitalExplainthefactorsthathavetobetakenintoaccountwhenmanagingeachelementofworkingcapitalExplaintheimportanceofestablishingpoliciesforthecontrolofworkingcapitalThenatureandpurposeofworkingcapitalMajorelementsMajorelementInventoriesTradereceivablesCash(inhandandatbank)TradepayableslessequalsCurrentliabilitiesWorkingcapitalCurrentassetsFigure12.1TheworkingcapitalcycleTradepayablesTrade

receivablesFinishedgoodsCash/

bankoverdraftWorkinprogressRawmaterialsCashsalesCreditsalesCashFigure12.2Averageinvestment(indays)forthemainworkingcapitalelementsSource:Compiledfrominformationin‘Navigatinguncertainty:PwC’sannualglobalworkingcapitalstudy’,2018/19,.TradereceivablessettlementperiodInventoriesturnoverperiodTradepayablessettlementperiodDays040206050301047.948.141.051.92013201420152016201751.854.056.458.953.12013201420152016201758.258.860.462.968.02013201420152016201767.77080InventoriesfinancingcostSource:Annualreportsofthebusinessesfortheyearsendedduring2018.BusinessTypeofoperationsCostofcapitalAverageinventoriesheldFinancingcostofholdinginventoriesOperatingprofit/(loss)Financingcostas%ofoperatingprofit/(loss)(a)(b)(a)×(b)%%AssociatedBritishFoodsFoodproducer9.2￡2,386m￡220m￡1,282m17BTGroupTelecoms8.9￡369m￡30m￡3,421m0Go-AheadTransport5.5￡17m￡1m￡121m1KingfisherDIY8.7￡2,574m￡224m￡580m39TescoSupermarket9.5￡2,617m￡249m￡2,606m10ManaginginventoriesBudgetingfuturedemandFinancialratiosRecordingandreorderingsystemsInventorymanagementmodelsEnterpriseresourceplanning(ERP)systemsLevelsofcontrolJust-in-time(JIT)stockmanagementProceduresandtechniques

thatcanbe

usedtoensurethepropermanagementofinventoriesFinancialratiosAverageinventoriesturnoverperiod

AverageinventoriesheldCostofsales

=×365Figure12.3ABCmethodofanalysingandcontrollinginventoriesCumulativevalueofinventoriesitems

(%)Volumeofinventoriesitemsheld(%)ABC100100InventorieslevelTimeFigure12.4PatternsofinventoriesmovementsovertimeAnnualcosts(￡)Averageinventorieslevel(units)ETotalcostsHoldingcosts0OrderingcostsFigure12.5InventoriesholdingandordercostsTheeconomicorderquantity(EOQ)modelWhere:D=theannualdemandforthe

inventoriesitem(expressedin

unitsoftheinventoryitem)C=thecostofplacinganorderH=thecostofholdingoneunitof

theinventoriesitemforoneyearEOQ

=2DC

H

Just-in-timeinventoriesmanagementMayresultinhiddencosts(takingadvantageofcheapsourcesofsupply)RequirescloserelationshipwithsuppliersMayrequirere-engineeringproductionprocessCanbeseenaspartofTQMapproachFigure12.6PatternsofinventoriesdemandDemand(units)JanFebMarAprMayJuneJulyAugSeptOctNovDecCategoryZCategoryYCategoryXManagingtradereceivablesWhichcustomersshouldreceivecreditQuestionstoaskHowmuchcreditshouldbeofferedWhatlengthofcredititispreparedtoofferWhetherdiscountswillbeofferedforpromptpaymentWhatcollectionpoliciesshouldbeadoptedHowtheriskofnon-paymentcanbereducedThefiveCsofcreditCapitalCapacityCollateralConditionsCharacterWhichcustomersshouldreceivecredit?SourcesofcreditinformationBankreferencesPublishedfinancialstatementsTradereferencesCreditagenciesRegisterofcountycourtjudgementsThecustomerLengthofcreditperiodThetypicalcredittermsoperatingwithintheindustryThedegreeofcompetitionwithintheindustryThebargainingpowerofparticularcustomersTheriskofnon-paymentThecapacityofthebusinesstooffercreditThemarketingstrategyofthebusinessMaybeinfluencedby:Ageingscheduleoftradereceivablesat31DecemberCustomerDaysoutstandingTotal1to30

days31to60

days61to90daysMorethan90days￡￡￡￡￡ALtd12,00013,00014,00018,00057,000BLtd20,00010,000––30,000CLtd–24,000––24,000Total32,00047,00014,00018,000111,000CollectionpoliciesPublicisecredittermsIssueinvoicespromptlyDevelopcustomerrelationshipsProduceanageingscheduleofreceivablesAnswerqueriesquicklyMonitoroutstandingdebtsDealwithslowpayersFigure12.8UKlargebusinesses–averagetimeto

paysuppliersSource:ExtractsfromElmes,S.(2018)paymentpracticesoflargecompanies,12March,www.mycreditcontrollers.co.uk/research/payment-practices-18-03.html.ControllingtradereceivablesAveragesettlementperiodfortradereceivables

Averagetradereceivables×365 Creditsales=

Ratios=Tradereceivablestosales

Tradereceivablesatendofperiod CreditsalesforperiodFigure12.9Comparisonofactualandexpected(target)receiptsovertimeforExample12.5%Time10203040JuneJulyAugustSeptemberActualBudgetedWhyholdcash?Therearethreereasons:Tomeetday-to-daycommitmentsTodealwithuncertaincashflowsToexploitprofitableopportunitiesFactorsinfluencingtheamountofcashheldTheopportunitycostofholdingcashThelevelofinflationThenatureofthebusinessThecostofborrowingEconomicconditionsTheavailabilityofnear-liquidassetsRelationshipswithsuppliersPossiblefactorsmayinclude:ManagingcashMaintechniquesPreparingcashbudgetsControllingthecashbalance(usingcontrollimits)ManagingtheoperatingcashcycleInnerlimitOuterlimitTargetcashbalanceInnerlimitCashbalance(￡)Outerlimit

Time(days)2864953171112100Figure12.10ControllingthecashbalanceFigure12.11TheoperatingcashcyclePurchaseofgoodsoncreditPaymentforgoodsSaleofgoodsoncreditCashreceiv