This document discusses working capital management. It covers elements of working capital like current assets and current liabilities. The objectives of working capital management are maintaining liquidity and maximizing profitability. It also discusses shortening the working capital cycle by reducing inventory holding periods and collection periods. The document defines overtrading and provides indicators and solutions. Finally, it discusses various working capital ratios like current ratio, quick ratio, inventory turnover ratio, debtor days, and creditor days that are used to analyze working capital.

1. PERFORMANCE
MANAGEMENT
Session 3-Working Capital Management

2. Topics Covered
Elements of working capital
Objectives of working capital management
Shortening working capital cycle
Overtrading
Working capital Ratios
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3. Elements of working capital
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4. Objectives of working capital management
• Liquidity-Maintenance of working capital at appropriate level.
• Profitability-maximising the return on capital employed hence minimizing
the investment in working capital.
In the accomplishment of these two objectives, the management has to
consider the composition of current assets pool. The working capital position
sets the various policies in the business with respect to general operations
like purchasing, financing, expansion and dividend etc.
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5. Cash flow Vs. Profit
• Unprofitable companies can survive if they have liquidity.
• Profitable companies can not survive if they don’t have liquidity
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6. Operating Cycle
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7. Shortening working capital cycle
• Reduce raw material inventory holding
• More finance from suppliers by delaying payments.
• Reducing work in progress by improving production techniques.
• Reducing finished goods inventory by reorganizing the production schedule
and distribution methods.
• Reducing credit given to customers.
• Debt factoring.
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8. Overtrading
• Meaning- when the business is not having access to sufficient capital to fund
the increase.
• Indicators:
Rapid increase in turnover
Rapid increase in current assets
Dramatic drops in liquidity ratios
Most of the increase is financed by credit.
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9. Overtrading-Solutions
Raising of more long term capital
Profit should be more than increase in working capital
Improve working capital management
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10. Working capital Ratios
Current ratio:
• Current asset
• Current liabilities
Quick ratio:
• Current asset-inventory
Current liabilities
Current Assets - Current Liabilities = Working Capital
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11. Working capital Ratios
Inventory Turnover Ratio:
Raw Material
( Average inventory / Material usages) x 365 days
Work in process:
( Average inventory / Production cost) x 365 days
Finished Goods:
• ( Average inventory / Cost of goods sold ) x 365 days
• Significance-this tells us how long on average each unit of stock is in the
shop/warehouse etc. before being sold. Clearly, the shorter this length of time
the better.
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12. Working capital Ratios
Debtor days
• ( Average accounts relievable / Sales ) x 365 days
• Significance- this tells us how long on average each debtor takes to settle
their debt to the business. Clearly, the shorter this length of time the better. A
very large debtor collection period might indicate that the business may be
unable to collect its debts.
Creditor days
• ( Average accounts payable / Cost of sales ) x 365 days
• Significance- this tells us how long on average the business takes to pay its
creditors. The longer this length of time the better. However, a very large
credit period may indicate that the business does not have the cash to pay its
debts.
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13. KAPP EDGE SOLUTIONS
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