This document discusses various aspects of working capital management including: - Definitions of working capital and its key components like cash, receivables, inventory, and payables. - The objectives of working capital management are profitability and liquidity. There is sometimes a conflict between these two objectives when decisions are made. - Key concepts covered include the cash operating cycle, economic order quantity (EOQ) formula, ABC inventory classification, and just-in-time (JIT) techniques. - Materials requirements planning (MRP) is introduced as a production planning technique that maintains low inventory levels by ordering only what is needed based on the bill of materials and production schedule.

1. WORKING CAPITAL MANAGEMENT

2. Introduction
Definition: Working Capital refers to the capital of a
business that is used in its day-to-day trading operations.
It is the difference between the current assets and the
current liabilities. It is also a signal of a company's
operating liquidity.
 The goal of working capital management is to
ensure that a firm is able to continue its operations
and that it has sufficient ability to satisfy both
maturing short-term debt and upcoming operational
expenses. The management of working capital
involves managing inventories, accounts receivable
and payable, and cash.

3. Elements of Working Capital
• Cash inflows and outflows need to be monitored carefully with proper
budgeting and forecasting to achieve the required balance for the firm.
Cash
• These are amounts that are yet to be received from debtors. These
need to be monitored and checked regularly for timely recovery.
Receivable
• This is the stock of finished and unfished goods (work in progress). It
should be maintained at a particular level to meet the firm’s needs.
Inventory
• The accounts payable should be regularly checked not only for working
capital requirements but also for the firm’s goodwill (reputation).
Payable
• These are certain outstanding expenses that the firm has not paid and
will be reflected on the capital e.g. accrued salaries and accrued bills.
Expenses

4. Objectives of Working Capital
Profitability:
means the firm’s ability to generate revenues over and
above all costs associated with and incurred in the
production process. A firm is said to be profitable if its
revenues are consistently higher than the costs it incurs.
Liquidity:
refers to a company's ability to pay (meet claims) its
bills (obligations) as and when they become due.
In the context of an asset, it implies convertibility of the
same ultimately (assets a company has that it can
quickly and easily convert to cash without losing
value). It has two dimensions in it, time and risk

5. Profitability vs Liquidity
Profitability is the ability of a company
to generate profits.
Liquidity is the ability of a company to
convert assets into cash.
Time
Profitability is more important in long-
term.
Liquidity is important in short-term.
Ratios
Key ratios include GP margin, OP
margin, NP margin and ROCE.
Key ratios are current ratio and quick
ratio.
Working Capital …

6. Conflict B’tn Liquidity & Profitability
• Profitability and liquidity are the two terms which are
most widely watched by both the investors and owners
in order to gauge whether the business is doing good or
not. When one increases the other decreases so it is
always the task of a financial manager to solve the
conflicts as he strikes a balance.
• If company focuses on too much profitability then it
runs the risk of not able to pay its creditors, employees
and other parties whereas on the other hand if company
focuses on liquidity and then it runs the risk of going
into loss.

7. Conflict B’tn Liquidity & Profitability
availability
of profits
availability
of cash
Lower risk Vs Higher
return
Goals conflict in
decisions

8. Cash Operating Cycle
Cash operating cycle is gross operating cycle less
creditor’s collection period.
Acquire
Inventory
for Credit
Sell
Inventory
for Credit
Collect on
Accounts
Receivable
Pay
Suppliers
Acquire
Inventory
for Cash
Sell Inventory
for Credit
Collect on
Accounts
Receivable
Operating Cycle Cash Cycle

9. Number of days of inventory =
Inventory
Average day′s
cost of goods sold
=
365
Inventory turnover
Average time it
takes to create
and sell
inventory
Number of days of receivables =
Receivables
Average day′s
revenues
=
365
Receivables turnover
Average time it
takes to collect
on accounts
receivable
Number of days of payables =
Accounts payable
Average day′s
purchases
=
365
Payables turnover
Average time it
takes to pay its
suppliers
Operating cycle =
Number of days
of inventory
+
Number of days
of receivables
Net operating cycle
or
Cash conversion cycle
=
Number of days
of inventory
+
Number of days
of receivables
−
Number of days
of payables
11

10. Economic Order Quantity (EOQ)
Economic order quantity (EOQ) is a decision tool used
in operations management to determine the most cost-
effective purchase quantity. It’s a formula that allows
you to calculate the ideal quantity of inventory to order
for a given product. The calculation is designed to
minimise ordering and carrying costs.
Q is the economic order
quantity (units)
D is demand (units, often
annual)
S is ordering cost (per
purchase order)
H is carrying cost per unit

12. Economic Order Quantity …
Assumptions
• Demand is known and is deterministic, i.e. constant
• The lead time (the time between placement of the order
and the receipt of the order) is known and constant
• The receipt of inventory is instantaneous. I.e. the
inventory from an order arrives in one batch at one point in
time.
• Quantity discounts are not possible, in other words it
does not matter how much we order, the price of the product
will be the same.
• The only cost pertinent to inventory model are costs of
placing an order and holding costs

13. ABC inventory management
The materials are grouped into three categories basing on the
value and relative importance of the materials. The logic
behind this kind of analysis is that the management is to study
each item of stock in terms of its usage, lead time, technical or
other problems and its relative money value in the total
investment in inventories.
Items with high value deserve very close attention, low value
items are given minimum expense, and clerical costs which
result in better planning and improved inventory turnover.
DEFINITION

14. ABC inventory management …
A Goods
• High Value
• Low
Proportion
B Goods
• Intermediate
Materials
C Goods
• Low Value
• High
Proportion
Value
(return)
70% 20% 10%
Proportion
(Volume)
10% 20% 70%

16.  The organisation of stock items using ABC
analysis ensures close attention to high value items
which helps the firm to control inventory.
 The analysis also helps in reducing the clerical
costs, enhance better planning and inventory turnover.
 Minimum storage cost; since the material from
group 'A' are purchase in lower quantities as much as
possible, it reduce the storage cost as well.
 Saving in time; since a signification effort is made
for management of the material from group 'A', it
helps to save time as well.
 Economy; this method is economical, since equal
time and labor is not needed for all types of materials.

17.  ABC analysis will not be effective if the materials
are not classified into the groups properly.
 It is not suitable for the organization where the
costs of materials do not vary significantly.
 There is no any scientific base for the
classification of material under ABC analysis.
 The classification of the materials into different
groups may lead to extra cost. Hence, it may not be
suitable for small organization.

18. Just In Time Techniques (JIT)
This is a purchasing and control of method in which materials
are obtained just in time of production to provide finished
goods just in time for sale. Just in time manufacturing system
requires making goods or service only when the customer,
internal or external requires it (Arinaitwe, 2013).
Just in time requires better coordination with suppliers so that
materials arrive immediately prior to their use. The system is
based on placing smaller and more frequent inventory orders.
The fundamental objective of just in time is to produce and
deliver what is needed, when needed at all stages in the
production process.
DEFINITION

19.  It is an efficient inventory management system.
 Areas that need improvement such as productivity
workspace or working capital can be revealed.
 Increased Working Capital.
 Saves on inventory holding costs by keeping stock levels
low .
 Reduces the setup time since it lessens or eliminates
inventory for “changeover” time.
 Eliminates dead stock.
 Ideal for smaller organizations.
 Reduces the amount of storage an organization needs.
 Production mistakes can be spotted more quickly and
corrected thus fewer defect products.
 Easier to switch to a different products to meet changes in
customer demand.

20.  A simple glitch in the supply system can cause
stock shortages.
 Is risky because it is based on customers’
behavior.
 Heavily relies on the efficient coordination of
the elements of inventory chain.
 Unable to meet unexpected orders.

21. Main Takeaways
• Objectives of working capital
– Profitability
– Liquidity
• Conflict between liquidity and
profitability
• Cash operating cycle
– Operating Cycle
– Cash cycle
• Inventory management
– Economic Order Quantity (EOQ)
– ABC inventory management
– Just In Time Techniques (JIT)

22.  Production technique which provide list of
materials to be produced at different stages.
 It is a flow control system that orders only
what component is required to maintain the
manufacturing flow.

23.  Most of them are software based. Using bar
code scanning.
 MRP integrate data from production schedule
with that from inventory and bill of material
(BOM) to calculate purchasing and shipping
schedules for the parts required to build
product.

24.  Identifying Requirements- Quantity on
Hand, Quantity on Open Purchase Order,
Quantity in/Planned for Manufacturing,
Quantity committed for Existing Orders,
Quantity forecasted
 Drawing the Master Production Schedule-
Creating the Suggestions i.e. list of finished
goods required at different period
 Material Requirement Plan - Manufacturing
Orders, Purchasing Orders, Various
Reports

25. Materials Requirements
Planning
Master
Production
Schedule
Inventory
Master File
Product
Structure
File
Manufacturing
Orders
Purchase
Orders
Various
Reports

26.  Inventory control, bill of material processing
and elementary scheduling.
 MRP helps organizations to maintain low
inventory levels or turnover.
 It is used to plan manufacturing, purchasing
and delivering activities.

27.  If there are errors in inventory, BOM data,
the master production schedule, the output
data will be incorrect (GiGo).
 Mistakes in receiving input and shipping
output. Scrap not reported, waste, damage,
 Box count errors, supplier container count
errors, production reporting errors and
system errors.

28. INVENTORY TURNOVER RATIO
 Inventory Turnover Ratio shows how many times a company’s
inventory is sold and replaced over a given period of time.
 It compares the cost of goods sold (sales) with the average
inventory for a given period.
Inventory Turnover Ratio = Cost of goods sold
Average Inventory
 The ratio measures how many times the average inventory will
be “turned” or sold over a period.
 It measures how well a company is turning its inventory into
sales
12-31

29. INVENTORY TURNOVER RATIO Contd….
 Average Inventory is used instead of ending
inventory because most firm’s/companys
inventory fluctuates across a given period.
 Cost of goods sold /sales can be found in the
income statement, if not given.
 A high turnover ratio implies effective
inventory control while a low ratio depicts
weak inventory control
12-32

30. INVENTORY TURNOVER RATIO
Contd….
 A high turnover ratio implies effectiveness/no
resource wastage (much of what is
bought/produced is sold) thus minimal
storage/holding costs
 If large purchases are made, sales should
also be increased to avoid carrying costs.
12-33

31. Advantages of using Inventory Turnover Ratio
It tries to balance stock purchases with
sales
 it shows company’s inventory liquidity,
i.e. how easily a company converts its
inventory into cash
It acts as a collateral to banks, i.e. banks
are interested on how easy inventory is
converted into cash
 Minimizes understocking costs
12-34

32. TWO BIN SYSTEM OF INVENTORY
MANAGEMENT
 A Two-bin system of inventory management is
an evaluation system used to monitor the quantity of an
item left behind.
 The two-bin inventory control method is mainly used for
small or low value items.
 When items in the first bin have been finished, an order
is placed to refill or replace these items.
 The second bin is supposed to have enough items to last
until the placed order arrives.
 The first bin has a minimum of stock and the second bin
keeps reserve stock or remaining material.
 Bin cards and store ledger cards are used to record the
inventory.

33. HOW IT WORKS
 Two bins of items are created.
 The first bin is stacked on top of, or in front of, the second bin.
 A reorder card is placed on the bottom of each bin.
 Material is drawn from the first (or most accessible) bin only.
 When the first bin is empty, it is exchanged with the second bin.
 The reorder card is used to replace items in the first bin.
 Material is then drawn from the second bin while waiting for receipt
of the material on order.
 When the new material arrives, it is placed in the empty bin, and the
reorder card is returned to its proper place in the bin.
 The procedure is continued, with material being selected from one
bin until it is depleted. The material is then replenished through use
of the reordering card.

34. ADVANTAGES OF A TWO BIN SYSTEM OF
INVENTORY MANAGEMENT
 It prevents stock outs since the reserve bin can be
replaced during the lead-time period to meet the demand
of the customers.
 It reduces the risk of loosing the inventory incase of a
disaster such warehouse fires, water damage or theft.
The business will have the reserve bin to replace the
what is lost.

35. DISADVANTAGES OF A TWO BIN SYSTEM OF
INVENTORY MANAGEMENT
 It requires the inventory level to be high. Therefore the
business needs to maintain a high level of inventory to
be placed on the two bin in order to prevent the stock
out.
 It is costly since it involves extra costs to keep the stock
such as extra insurance, warehouse rental that are
required to cover the two bin system