accounts & finance working capital. learning objectives define working capital and explain the...
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Accounts & Finance
Working Capital
Learning Objectives
Define working capital and explain the working capital cycle
Prepare a cash flow forecast from given information
Evaluate strategies for dealing with liquidity problems
Working Capital
• Every business NEEDS cash to function• Cash is needed for everyday expenses such as
wages and buying stock• Without sufficient working capital (cash) a
business will be illiquid (unable to pay its immediate or short term debts – these are their liabilities – creditors, overdrafts)
• It may be forced into liquidation
Cash inflows and cash outflows
• Cash inflows – payments in cash received by a business
• Cash outflows – payments in cash made by a business
• Work with a partner and list 3 cash inflows and 3 cash outflows that a business may experience
Main types of cash inflows and outflows
• Cash flow can be described as a cycle:
• The business uses cash to acquire resources (assets such as stocks)• The resources are put to work and goods and services produced. These are then
sold to customers• Some customers pay in cash (great), but others ask for time to pay. Eventually they
pay and these funds are used to settle any liabilities of the business (e.g. pay suppliers)
• And so the cycle repeats• Hopefully, each time through the cash flow cycle, a little more money is put back
into the business than flows out. But not necessarily, and if management don’t carefully monitor cash flow and take corrective action when necessary, a business may find itself sinking into trouble.
• The cash needed to make the cycle above work effectively is known as working capital
Where does Working Capital come from?
• Simple calculation
Current assets – current liabilities
Current assets are?
Current assets = Cash + Stock + Debtors
Current Liabilities are?
Current liabilities refers to the money a business owes that needs to be repaid within the next 12 months. E.g. Overdrafts, Creditors, Tax
Calculating Working Capital
• If you’re showing current assets of £100,000 and current liabilities of £80,000, your working capital is……?
• £20,000
• While any current assets are great, cash is better - especially now!
Why?
Managing working capital
• The objective of managing working capital is to ensure there is always enough cash on hand:
– to pay bills as they become due, – to purchase enough inventory and stock to meet
demand – and to have enough sales to support expenses.
Cash management
• Cash management is an essential, yet often neglected, component of business management
• We have all heard the statement that "most companies do not fail from lack of profit, but from lack of cash"
• It is also true that a period of dramatic sales increases will most likely be a company's most profitable, but will also likely be the period of greatest cash flow needs
Remember
Current assets – Current liabilities
How much working capital should a business have?
• It depends on:– Volume of sales– Size of trade credit offered to it– Whether the business is expanding or not– Length of operating cycle (from paying for raw materials
to receiving payment from customers)– The rate of inflation
Factors affecting level of working capital
Factor Explanation
Need to hold inventories (stock)
Some businesses need to hold substantial inventories to meet customer needs – e.g. retailers and distributors
Production lead time
A product that is made and sold within a short time (e.g. fresh food) requires much less inventory than one where the production process takes a long time (e.g. production of mature cheese!)
Lean production Businesses that successfully implement lean production techniques find that they need to hold significantly less inventory
Customer credit period
In some industries it is expected that a long credit period can be taken before trade debtors need to settle their invoices – which means that higher working capital is required
Effectiveness of credit control
A poorly managed credit control department will allow customers to take too much credit and take too long to settle their bills – which will mean higher trade debtors and higher working capital
Supplier credit period
The longer the credit offered by suppliers, the better for cash flow and working capital.
WORKING CAPITAL
THE LIFEBLOOD OF A BUSINESS
Capital & Revenue Expenditure
• Capital expenditure – on items that will be used time & time again, that will continue to help the business in the following years – is known as capital expenditure
• Revenue expenditure – spending on day to day items for the running of the business.
Need Working capital for this
• REVENUE expenditure
Or
• CAPITAL expenditure ?
Is this Capital or Revenue Expenditure?
Marketing expenditure
Revenue Expenditure
Is this Capital or Revenue Expenditure?
New fleet of company cars
Capital Expenditure
Is this Capital or Revenue Expenditure?
Ink cartridges
Revenue Expenditure
Is this Capital or Revenue Expenditure?
Inventories
Revenue Expenditure
Is this Capital or Revenue Expenditure?
Office Equipment
Capital Expenditure
Is this Capital or Revenue Expenditure?
Salaries
Revenue Expenditure
Is this Capital or Revenue Expenditure?
New factory
Capital Expenditure