ACCT 430 – Advanced Financial Management
In class notes 1 & 2
Working capital management
Elements of working capital
Inventory
o Types of inventory – Raw materials, WIP (RM cost + WIP % Conversion costs i.e.
Labour and Overheads), finished goods (RM cost + Completed Conversion costs i.e.
Labour and Overheads)
o Accounting for inventory – FIFO (Raw Materials or FG bought for resale), AVCO (Raw
Materials or FG bought for resale), Standard cost (for manufactured goods)
o Cost of inventory = Purchase Price or FG Standard cost + Ordering Cost (Co) + Holding
√
2 Co D cost (Ch)
EOQ= EOQ EOQ
Ch o Cost of holding stock = (Ch x ) or ACCA (Ch x( + Buffer))
2 2
Demand
o Cost of ordering stock = ( ×C o ¿
EOQ
o Production requirements and/or demand
o Inventory levels – minimum, maximum, average, re-order, buffer stock
Average Inventory
o Inventory days/turnover = x 365 days
Cost of sales
o Calculate current cost of inventory vs Considering quantity discounts
PRODUCTION 1ST LEVEL COUNTRY
MATTEL (USA) WHOLESALER RETAILER CUSTOMER
(CHINA) DISTRIBUTOR DISTRIBUTOR
Receivables
o Receivables exist because we give customers credit
o Why? Quick turnover; some businesses don’t get cash from the final customer until
it reaches the final customer, which may be a few companies down the supply chain
line, therefore by nature of the revenue collection of the business, the company has
to sell on credit; to competitive edge and market share; to increase revenue
generation ability.
o How to determine who to give credit? Obtain credit rating information/scores,
evaluate past financial statements, obtain trade references, business type, barter
o Problems with receivables?
Late payments
No payments i.e. bad debts
Loss of customers
o Solutions to problems
Interest penalty on late payments, and fines
Early settlement discounts
How to calculate the discount (cost)
The reduction in finance cost because of the reduction in receivables
The potential reduction in bad debts
Hiring a debt factor
Cost of the factor
The reduction in finance cost because of the reduction in receivables
The potential reduction in bad debts
Proper collection personnel and procedures
o Costs of Receivables
Bad debts
Finance cost
Administrative fee
Discount cost if there are discounts
Factor fee if there is a factor
Receivables
o Receivables days = ×365
Credit Sales
Cash
o Cash includes – cash at bank, cash in hand, bank overdraft, short-term fixed
deposits, cheques in hand, anything that can be traded as cash
o Key elements of managing cash – positive cash is better than an overdraft, cash
should only be held to meet short term obligations, excess cash should be invested
o Cash in hand does not attract high interest or returns, however an overdraft costs
the company high interest
Payables
o Payables exist because we buy goods on credit
o To maintain good standing and favour with our suppliers we need to pay our
obligations within the given credit period.
o We can negotiate with suppliers to extend credit payment period, credit limits, bulk
discounts and early settlement discounts.
Early settlement discounts
Calculate savings from discount (benefit)
Calculate increase in finance cost because of the reduction in
payables (cost)
Payables
o Payables days = × 365
Credit Purchase(cos)
Working Capital Ratios
Current assets
Current ratio =
Current liabities
Current assets−Inventory
Quick ratio =
Current liabities
Working capital /Cash operating cycle = Receivable days + Inventory days – Payables days
Examples
WCC = 10 + 10 – 15 = 5 days : this means that the company is due to pay the supplier 5 days before
cash is collected from the customer
WCC = 10 + 10 – 30 = -10 days : this means that the company has 10 days grace period from when
cash is collected from customers to when cash is required to be paid to the supplier.
