Working Capital Cycle Flashcards
(13 cards)
Working capital definition & formula
Working capital is the total amount of capital tied up in current assets and current liabilities, which normally include inventories, trade receivables, cash and cash equivalents (less trade payables)
WCC = Inventory holding period + trade receivables collection period - trade payables payment period
Too much WC: Overcapitalisation (idle funds, unnecessary cost)
Too little WC: Overtrading (cash shortfalls, risk of insolvency)
WCC Influencing Factors
Liquidity vs profitability balance
Efficiency of management
Industry type and trade terms
Current & Quick Ratios
Current
Current Assets ÷ Current Liabilities
2:1
Quick (Acid)
(Current Assets - Inventory) ÷ Current Liabilities
1:1 (or above)
Efficiency Ratios
Asset Turnover
Inventory Turnover
Payables
Receivables
Inventory Holding Period
Economic Order Quantity
Constant demand, lead time, and costs
No buffer stock or demand variation
Order quantity that minimises total inventory cost:
EOQ = √2 × c × d ÷ h
ABC Inventory Control System
A Items: High value, tight control (15-20% of items, 70-80% value)
B Items: Moderate value and control
C Items: Low value, minimal control (bulk of items, 5-10% value)
VED Analysis
Popular with start ups working with limited budget
Vital: Production halts if missing
Essential: Disruption if missing, but recoverable
Desirable: Only minor impact if not available
Just-In-Time
Pros:
1) Low inventory levels
2) Lower storage costs
3) Improved efficiency
Cons:
1) Vulnerable to supply chain issues
2) Costly with demand volatility
3) Requires strong supplier relationships and IT systems
Receivables Management - Objectives & Key Influencing Factors
Objectives:
1) Minimise admin and bad debt costs
2) Optimise receivables and maintain sales levels
Key Influencing Factors:
1) Size of credit sales
2) Terms of trade and pricing
3) Credit and collection policies
4) Expansion efforts
Receivables Management - Effective Credit Policy Factors
Effective Credit Policy Factors:
1) Credit period and terms
2) Market/industry norms
3) Discounts offered
4) Internal efficiency in record keeping
Payables Management - Objectives & Considerations
Objectives:
1) Optimise trade credit usage
2) Support relationships with suppliers
Considerations:
1) Use trade credit as short-term finance
2) Avoid harming supplier relationships
3) Evaluate early settlement discounts vs liquidity needs
Payables Management - Monitoring
Monitor using:
1) Payables period ratio
2) Current and quick ratios
Trade Offs & Strategic Balance
Liquidity vs Profitability: Holding too much WC ensures safety but lowers returns; too little WC raises risk of disruption.
Supplier vs Customer Relations: Prompt payables can improve supplier goodwill, while generous receivables terms attract customers but increase risk.
Control Mechanisms: Effective policies, ratio monitoring, and systems are essential to maintain an optimal balance.
