The document discusses working capital management. It covers topics such as the cash operating cycle, funding current assets, managing inventory, accounts receivable, accounts payable, and cash. The objectives of working capital management are to maximize profitability while maintaining adequate liquidity and financial stability. Effective working capital management requires balancing current assets, current liabilities, and sources of short-term and long-term financing.

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2. The nature of working capital The cash operating cycle Funding the cash operating cycle The objectives of working capital Inventory management Managing trade receivables Relationship with suppliers Managing Cash Maroof Hussain Sabri

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4. Current Assets less Current Liabilities Maroof Hussain Sabri

5. Sales Inventories Debtors Sustain Maroof Hussain Sabri

6. Despite running at full capacity, steel suppliers in Japan and elsewhere in Asia struggled to satisfy Japan’s booming exporters Nissan had to cut down its production by an estimated 40,000 vehicles to meet demand in March (March is the month where demand for cars in Japan hits a peak) Source FT Dec 2004 Maroof Hussain Sabri

7. The Cheapest way to finance current assets is to use free credit from suppliers This may lead to LIQUIDITY PROBLEMS . This risk can be illustrated using a Cash Operating Cycle Maroof Hussain Sabri

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9. Inventory Turnover Period Raw Materials holding period Production Period Finished Goods holding period Maroof Hussain Sabri

10. The accounts receivable payment period How long our customers take, on average, to settle their bills Maroof Hussain Sabri

11. Accounts payable payment period How long, on average, we take to pay our customers FREE CREDIT DAYS!! Maroof Hussain Sabri

12. Ratios have limitations particularly when comparing P/L items with Balance Sheet Figures Example: In December retailers normally have below average stock levels and therefore an average based on December figures may not reflect the annual average Maroof Hussain Sabri

13. If you are 6 feet tall and you don’t know how to swim, would you wade across a pool with an average depth of 3 feet? Maroof Hussain Sabri

14. Trade Payables Raw Materials W-I-P Finished Goods Debtors Cash Outflow Cash Inflow Financing current assets entirely from trade payables will keep the cost of interest down BUT this may lead to liquidity problems Maroof Hussain Sabri

15. Deferral of Cash Inflows Stock becoming obsolete or out-of-fashion Disruptions in production processes Debtors failing to meet credit deadlines Foregone Cash Inflows Bad Debts Other Cash Outflows - Overheads Maroof Hussain Sabri

16. The duration of the trade payables period is normally dictated by suppliers or the market in general. Therefore it may not match the current asset turnover period In addition the conversion of current assets into cash may be deferred or at worse foregone (Bad Debts) Maroof Hussain Sabri

17. Trade Payables Raw Materials W-I-P Finished Goods Debtors Funding the cash operating cycle Maroof Hussain Sabri

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19. Short-Term Borrowings Bank Overdraft Commercial Paper Invoice or Bills of Exchange Discounting Long-Term Capital Employed Debt / Equity Maroof Hussain Sabri

20. AGRESSIVE CONSERVATIVE SHORT-TERM FUNDING LONG-TERM FUNDING Flexible / Low Cost Liquidity Risk Rigid / High Cost Financially Stable Maroof Hussain Sabri

21. MATCHING Current assets are assets which are either cash or expected to be converted into cash with one year For funding purposes these can be classified into: Permanent Fluctuating Maroof Hussain Sabri

22. Permanent Inventory Inventory required to stock the shops plus to keep some buffer stock in warehouse/s Fluctuating Inventory levels before the Easter, Summer and Christmas holidays will normally be above average Example: Toy Shop Maroof Hussain Sabri

23. Permanent Current Assets financed by Long-term Capital Fluctuating Current Assets financed by Short-Term Funding Maroof Hussain Sabri

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25. A business needs to invest in current assets to sustain its business operations The aim of working capital management is to strike off a balance between FINANCIAL STABILITY and PROFITABILITY Maroof Hussain Sabri

26. Too much working capital will impinge on profitability Higher interest rate burden Opportunity Cost – long-term capital tied in current assets can be used to finance feasible projects Maroof Hussain Sabri

27. Inadequate Working Capital may lead to liquidity problems Overtrading Rapid expansion in business without having adequate working capital. Maroof Hussain Sabri

28. Symptoms of Overtrading Accounts Payable period will increase Development of hard core element in bank overdraft plus encroachments Profit margins will start to decline as raising cash will be given priority to profitability Maroof Hussain Sabri

29. Some textbooks suggest that: However Working Capital needs depend on a number of factors. For example: type of industry accessibility to financial markets Maroof Hussain Sabri

30. Trade Payables (48.7 days) Inventory (13.8 days) J SAINSBURY – FOOD RETAIL INDUSTRY Negative Working Capital Source: Fitch Ratings figures as at 24-Mar-07 Maroof Hussain Sabri

31. Trade Payables (30.7 days) Inventory processing period (31.2 days) Debtors ( 27.4 days) Cash Operating Cycle (27.9 days) SABMILLER – BREWERY Source: Fitch Ratings figures as at 31-Mar-07 Maroof Hussain Sabri

32. Working Capital Needs differ among industries Optimality depends on the management of the constituents of Working Capital Maroof Hussain Sabri

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34. INVENTORY COSTS HOLDING COSTS funding storage insurance PROCUREMENT ordering delivery SHORTAGE COSTS lost contribution from missed sales Maroof Hussain Sabri

35. Where: EOQ (Q) economic order quantity Co Ordering Cost D Annual Demand Ch Cost of holding 1 unit Maroof Hussain Sabri

36. Example: The expected annual demand is 500,000. Purchase price is $100. It costs $ 500 to place an order and the cost of holding one unit in stock is 20%. Maroof Hussain Sabri

37. EOQ Maroof Hussain Sabri

38. Assumptions – Practical Implications Goods are delivered when they are ordered i.e. no lead times Demand is constant Price is constant and no bulk purchases discounts Maroof Hussain Sabri

39. Toyota was the first company to develop JIT Toyota needed to reduce costs of production and JIT was the solution Kanban System – pull system of production i.e. items are only produced when they are needed Maroof Hussain Sabri

40. Companies thinking of introducing JIT will first have to: Find reliable suppliers Train employees to minimize wastages and idle time Improve quality Minimize lead times Maroof Hussain Sabri

41. A company which is selling on credit is actually lending money It must have a debtors policy, composed of a: Credit Analysis System Credit Control System Debt Collection procedure Maroof Hussain Sabri

42. The objective of selling on credit is to increase sales, however: Sales Growth is vanity Profit is sanity Cash is king Ultimate objective should be profitability without jeopardizing liquidity Maroof Hussain Sabri

43. Main benefit – increase in contribution Costs Increase in debtors administration costs Increase in the likelihood of bad debts Increase in funding costs Maroof Hussain Sabri

44. Three-tiered service Administration Credit Protection Invoice or Bills of Exchange Discounting Maroof Hussain Sabri

45. Saving in administration costs Invoice discounting: alternative source of funds Credit protection Can be expensive Loss of goodwill if too aggressive at chasing for payment Can be deemed as a signal of liquidity problems Advantages Disadvantages Maroof Hussain Sabri

46. Factors to consider in choosing Suppliers: Credit Terms Reliability Price Maroof Hussain Sabri

47. 3 reasons for holding cash Transactions motive Precautionary motive Speculative motive (John Maynard Keynes) Maroof Hussain Sabri

48. Simple and Effective Cash Management tool Objective is to estimate future cash shortages cash surpluses Maroof Hussain Sabri

49. Temporary Surpluses Benefit from early settlement discounts Increase current assets Make short-term investments Temporary Deficits Arrange for short-term funding Give early settlement discounts Maroof Hussain Sabri

50. Permanent Deficits Raise long-term finance Permanent Surpluses Look for feasible long-term projects Reduce gearing Expand/Diversify Maroof Hussain Sabri

51. Cash management in large organizations tends to be more complex Most organizations have centralized treasuries and apply more sophisticated models to manage cash Maroof Hussain Sabri

52. The Baumol model is the same one which is used to estimate EOQ Cash is considered as inventory and two related costs are: Money Procurement costs Opportunity cost Maroof Hussain Sabri

53. Treasury Division A Division D Division C Division B Cash flows Cash flows Cash flows Cash flows Maroof Hussain Sabri

54. According to the cash flow forecast, Division B’s annual cash requirement is $ 1 million Procurement Costs - $ 700 Opportunity Cost - 3.5% Maroof Hussain Sabri

55. Using the same formula for inventories, the optimal amount to be raised and transferred is U$ 200,000. Maroof Hussain Sabri

56. Current Assets are essential in sustaining the operations of a business. Working Capital Management deals with how current assets are managed and financed. The objective of working capital management is to maximize profitability without jeopardizing liquidity. Maroof Hussain Sabri

57. QUESTION TIME Maroof Hussain Sabri