Topic 3: Accounts & finance

3.3 Working Capital

• LO1: Define working capital and explain the working capital cycle.

• LO2: Prepare a cash-flow forecast from given information.

• LO3: Evaluate strategies for dealing with liquidity problems.

3.3 Working Capital

• Working capital cycle

• Cash-flow forecasts

• Management of working capital.

Working Capital

• Measure of ability to meet short-term debts or obligations.

• Needed to pay for raw materials, day-to-day running costs and credit offered to customers.

• Difference between current assets and current liabilities

• Allows use of factors of production

Working Capital

• Meeting day-to-day obligations involves use of assets.

– Resources used in business activity to generate goods or services.

• Assets that are capable of being used within the year, for day-to-day operation of business to generate economic activity are referred to as Current Assets.

Working Capital

Stock

Debtors

Cash

Creditors

Working Capital Cycle

• Period of time between spending cash on production process and receiving cash payments from customers.

Some terms...

• Cash flow

– Sum of cash payments to business (inflows) minus sum of cash payments made by it (outflows).

• Liquidation

– Turning assets into cash (possible punishment for not paying suppliers)

• Insolvent

– When business cannot meet short-term debts

Cash Flow

• Cash Inflows

– Payments in cash received from customers (debtors) or the bank.

• Cash Outflows

– Payments in cash by the business to suppliers and workers.

Cash Flow Forecasts

• Estimating future cash inflows and outflows

• Usually done month-by-month basis

Cash Flow Forecasts

• Centre of business plan

• Lenders able to see possible returns.

• Foresee liquidity problems

• Forecast not omniscient

Key Terms

• Net monthly cash flow

– Estimated difference between inflows and outflows

• Opening cash balance

– Cash held at the beginning of the month

• Closing cash balance

– Cash held at the end of the month.

– Next months opening balance

Possible Inflows

• Cash Received

• Cash Sales

• Credit Sales

• Payments by Debtors

• Sale of Assets

• Capital Injection

• Any other cash inflow?

Possible Outflows

• Rent

• Rates

• Lease

• Interest

• Materials

• Wages / Labour

• Overheads

• Other costs?

Cash Flow Forecasts

Item Jan Feb Mar Apr May Jun

Opening Balance

Cash Inflows

Cash Received

Sale of Assets

Total Cash Inflow

Cash outflows

Rent

Rates

Materials

Wages

Total Cash Outflows

Net Cash Flow

Closing Balance

Over to you...

• S&S Textbook from Pg. 199

• Cash Flow Handout

– Complete and discuss

Increase Cash Flow

• Overdraft

• Short-term loan

• Sale of Assets

• Sale and leaseback

• Reduce credit terms to customers

• Debt factoring

Decrease Cash Flow

• Delay payments to creditors (suppliers)

• Delay spending on capital equipment

• Use leasing not purchase of capital equipment

• Cut overhead spending that does not effect output (reduce promotion)