De Lasalle University - Dasmarinas

  
 

Topics
Inventory Management
Working Capital Management
 INVENTORY MANAGEMENT

 
Inventory management refers to the process of ordering, storing, and using a
company's inventory. This includes the management of raw materials, components,
and finished products, as well as warehousing and processing such items.

For companies with complex supply chains and manufacturing processes, balancing
the risks of inventory gluts and shortages is especially difficult. To achieve these
balances, firms have developed two major methods for inventory management: 
just-in-time (JIT) and materials requirement planning (MRP)
Inventory Management….

How Inventory Management Works

 
A company's inventory is one of its most valuable assets. In retail, manufacturing, food service and other
inventory-intensive sectors, a company's inputs and finished products are the core of its business. A
shortage of inventory when and where it's needed can be extremely detrimental.
At the same time, inventory can be thought of as a liability (if not in an accounting sense). A large
inventory carries the risk of spoilage, theft, damage or shifts in demand. Inventory must be insured, and if
it is not sold in time it may have to be disposed of at clearance prices—or simply destroyed.
 
For these reasons, inventory management is important for businesses of any size. Knowing when to
restock inventory, what amounts to purchase or produce, what price to pay—as well as when to sell and at
what price—can easily become complex decisions. Small businesses will often keep track of stock manually
and determine the reorder points and quantities using Excel formulas. Larger businesses will use
specialized enterprise resource planning (ERP) software. The largest corporations use highly customized 
software as a service (SaaS) applications.
 Inventory Management….

An inventory account typically consists of four separate categories: 

1. Raw materials
2. Work in process
3. Finished goods
 
Raw materials represent various materials a company purchases for its production process. These materials
must undergo significant work before a company can transform them into a finished good ready for sale.
 
Works-in-process represent raw materials in the process of being transformed into a finished product.
 
Finished goods are the final products obtained after the application of the manufacturing processes on the
raw materials and the semi-finished goods discussed above in the article. They are saleable, and their sale
contributes fully to the revenue from the core operations of the company.
Inventory Management….

Traditional Reasons for Carrying Inventory:

 
1. To balance ordering or setup costs and carrying costs.
2. To satisfy customer demand (for example, meet delivery dates).
3. To avoid shutting down manufacturing facilities because of
a) machine failure
b) defective parts
c) unavailable parts
d) late delivery of parts
1. To buffer against unreliable production processes.
2. To take advantage of discounts.
3. To hedge against future price increases.
Inventory Management….

Why Is Inventory Management Important

 
Inventory management is the fundamental building block to longevity. When your inventory is properly
organized, the rest of your supply-chain management will fall into place. Without it, you risk a litany of
mistakes like mis-shipments, out of stocks, overstocks, mis-picks, and so on.
 
Proper warehouse management is key. Mis-picks result from incorrect paper pick lists, disorganized shelf
labels, or just a messy warehouse in general. Mis-shipments are a direct result of mis-picks at the beginning
of the inventory process, and are also a result of a lack in quality control procedures.
 
Out of stocks and overstocks occur when a company uses manual methods to place orders without having a
full grasp on the state of their inventory. This is a not a good predictor for inventory forecasting and results
in too much stock or too little.
 
All of these mistakes will not only cost you money, but also cost you in wasted labor spent correcting the
mistakes later. When you don’t implement management tools, your risk of human error mistakes goes up
by the minute. And your customer reviews and loyalty take a negative hit as well.
Inventory Management….
Inventory Management Techniques
 
Depending on the type of business or product being analyzed, a company will use various inventory
management methods. That being said, inventory management is only as powerful as the way you
use it.
 
It’s well worth the extra time and money to have inventory management set up by the experts who
made the software. Here are some inventory-control techniques that businesses utilize:
 
Economic order quantity
 
Economic order quantity, or EOQ, is a formula for the ideal order quantity a company needs to
purchase for its inventory with a set of variables like total costs of production, demand rate, and
other factors.
 
The overall goal of EOQ is to minimize related costs. The formula is used to identify the greatest
number of product units to order to minimize buying. The formula also takes the number of units in
the delivery of and storing of inventory unit costs. This helps free up tied cash in inventory for most
companies.
Inventory Management….

Minimum order quantity

 
On the supplier side, minimum order quantity (MOQ) is the smallest amount of set stock a supplier is
willing to sell. If retailers are unable to purchase the MOQ of a product, the supplier won’t sell it to you.
 
For example, inventory items that cost more to produce typically have a smaller MOQ as opposed to
cheaper items that are easier and more cost effective to make.
 
ABC analysis
 
This inventory categorization technique splits subjects into three categories to identify items that have a
heavy impact on overall inventory cost.
 
Category A serves as your most valuable products that contribute the most to overall profit.
 
Category B is the products that fall somewhere in between the most and least valuable.
 
Category C is for the small transactions that are vital for overall profit but don’t matter much individually
to the company altogether.
Inventory Management….

Just-in-time inventory management

 
Just-in-time (JIT) inventory management is a technique that arranges raw material orders from suppliers in direct
connection with production schedules.
 
JIT is a great way to reduce inventory costs. Companies receive inventory on an as-needed basis instead of ordering too
much and risking dead stock. Dead stock is inventory that was never sold or used by customers before being removed from
sale status.
 
Safety stock inventory
 
Safety stock inventory management is extra inventory being ordered beyond expected demand. This technique is used to
prevent stockouts typically caused by incorrect forecasting or unforeseen changes in customer demand.
 
FIFO and LIFO
 
LIFO and FIFO are methods to determine the cost of inventory. FIFO, or First in, First out, assumes the older inventory is
sold first. FIFO is a great way to keep inventory fresh.
 
LIFO, or Last-in, First-out, assumes the newer inventory is typically sold first. LIFO helps prevent inventory from going bad.
Inventory Management….

Reorder point formula.

 
The reorder point formula is an inventory management technique that’s based on a business’s own
purchase and sales cycles that varies on a per-product basis. A reorder point is usually higher than a
safety stock number to factor in lead time.
 
Batch tracking
 
Batch tracking is a quality control inventory management technique wherein users can group and
monitor a set of stock with similar traits. This method helps to track the expiration of inventory or
trace defective items back to their original batch.
 
Consignment inventory
 
If you’re thinking about your local consignment store here, you’re exactly right. Consignment
inventory is a business deal when a consigner (vendor or wholesaler) agrees to give a consignee
(retailer like your favorite consignment store) their goods without the consignee paying for the
inventory upfront. The consigner offering the inventory still owns the goods and the consignee pays
for them only when they sell.
Inventory Management….

Perpetual inventory management

 
Perpetual inventory management is simply counting inventory as soon as it arrives. It’s the most basic inventory
management technique and can be recorded manually on pen and paper or a spreadsheet.
 
Dropshipping
 
Dropshipping is an inventory management fulfillment method in which a store doesn’t actually keep the products it
sells in stock. When a store makes a sale, instead of picking it from their own inventory, they purchase the item from
a third party and have it shipped to the consumer. The seller never sees our touches the product itself.
 
Lean Manufacturing
 
Lean is a broad set of management practices that can be applied to any business practice. It’s goal is to improve
efficiency by eliminating waste and any non value-adding activities from daily business.
 
Six Sigma
 
Six Sigma is a brand of teaching that gives companies tools to improve the performance of their business (increase
profits) and decrease the growth of excess inventory.
 
Inventory Management….
Lean Six Sigma
 
Lean Six Sigma enhances the tools of Six Sigma, but instead focuses more on increasing word standardization
and the flow of business.
 
Demand forecasting
 
Demand forecasting should become a familiar inventory management technique to retailers. Demand
forecasting is based on historical sales data to formulate an estimate of the expected forecast of customer
demand. Essentially, it’s an estimate of the goods and services a company expects customers to purchase in
the future.
 
Cross-docking
 
Cross-docking is an inventory management technique whereby an incoming truck unloads materials directly
into outbound trucks to create a JIT shipping process. There is little or no storage in between deliveries.
 
Bulk shipments
 
Bulk shipments is a cost efficient method of shipping when you palletize inventory to ship more at once.
Inventory Management….

Inventory Management System

 
Every business uses at least some level of inventory management system. The best inventory management
systems will not only keep count of products but also provide actionable business intelligence such as
identifying low and high performing products and sending re-order notifications when stocks are low.
 
An inventory management system helps tackle the challenge of assuring the right level of inventory is in the
right place at the right time. The explosion of e-commerce, omnichannel fulfillment and expanding
relationships with national and global trading partners have created new challenges to accurately managing
inventory.
 
The spectrum of inventory management techniques ranges from the fully analog manual paper ledger that's
been used for hundreds of years all the way to the latest smart system that tracks products autonomously.
There are still a surprising number of larger companies that manage inventory through an ad hoc collection of
spreadsheets and legacy applications that simply don't communicate with each other.
 
The inventory management process can be based on a variety of formats and technologies. We'll explore
some of the common options and discuss the pros and cons of each type.
 
Inventory Management….
Common Inventory Management Systems:
 
Inventory vs. Cycle Counting
 
Choosing which of these strategies to follow will set parameters for your entire approach, from infrastructure to
technology. Full inventory counts are completed on a regular basis, often annually as part of a financial audit. You'll
see a retail store is conducting an audit when items on shelves are tagged with slips of paper, and some display items
like furniture are tagged "Do Not Inventory." An inventory team from a vendor is counting items when the store is
closed. The same process occurs in a warehouse. This process is time and labor intensive and only provides a snapshot
of the inventory.
 
By contrast, cycle counting is used to count only a portion of inventory on a regular basis. In a retail store, one area is
counted on a particular day of the week or month, and the next day the team counts stock in a different area. In a
large warehouse, the most active or most valuable items could be counted more frequently. Smaller, more frequent
counts can provide better insights into the state of the inventory. However, inaccuracies can occur as well, especially if
the same product is stored in multiple locations.
 
Of course, human error can creep into both of these processes, with inaccurate data causing a problem across the
company. Both processes can be completed manually or aided by using inventory management technology.
Inventory Management….

Manual
 
Depending on the size and scope of your inventory problem the manual approach may be the most
efficient. It may make sense to hire a vendor or complete it with internal resources. Many small
businesses close a day or two per year for inventory.
 
Each manual step is rife with possibilities for human error, from counting on the warehouse floor to data
entry to manipulating the data. Each mistake-filled action can exacerbate the problem, and only a
manual re-do could restore any sense of accuracy.
 
One of the big negatives to manual counting is the difficulties in turning paper-based information into
useful data. Making marks on a checklist is one thing -- typing those results into a spreadsheet can be a
daunting task.
 
Inventory Management….

Barcode
 
This system uses the familiar label of black stripes that are already affixed to the product, packaging
or pallet. Wearable barcode readers can speed up this process, allowing workers to shave scanning
time a few seconds per item.

One of the main advantages of the bar code system is the data is input in a useful digital format at
the same time, so the count is more real-time. With the accuracy they get with barcodes, managers
have more confidence to make purchasing and sales decisions based on the inventory levels.
Inventory Management….

Radio Frequency Identification (RFID)

 
Radio frequency identification tags are found in two configurations: active and passive. Active systems
use tag readers located throughout a warehouse. Active systems provide real-time updates of inventory
count and location. An active tag simply means it is battery operated and is used when more signal
strength is required to communicate with a reader.
 
Passive systems are read-only when someone activates the readers, such as hand-held devices rather
than fixed readers. In either case, when the tag is read, the inventory is automatically recorded in the
system. Passive technology can be read at up to 40 feet, while active readers are effective up to 300 feet.
 
Fixed readers can run continuously, like the Warehouse Anywhere RFID scanner chandeliers in our
storage locations. In this case, passive tags are read continuously.
Inventory Management….

Warehouse Robots
 
The next level of warehouse inventory systems will be optical systems mounted on autonomous
ground-based or aerial platforms. These systems use machine learning to read existing labels without
barcodes or RFID and maintain an up-to-the-minute inventory.
 
 
 
 WORKING CAPITAL
MANAGEMENT
Working capital management is a business strategy
designed to ensure that a company operates efficiently by
monitoring and using its current assets and liabilities to the
best effect. It refers to the set of activities performed by a
company to make sure it got enough resources for day-to-day
operating expenses while keeping resources invested in a
productive way.
 WORKING CAPITAL
MANAGEMENT
Decisions relating to working capital and short term financing are referred to as
working capital management
Short term financial management concerned with decisions regarding to CA (current assets) and
CL (current liabilities).
Management of Working capital refers to management of CA as well as CL.
If current assets are less than current liabilities, an entity has a working capital deficiency, also
called a working capital deficit.
These involve managing the relationship between a firm's short-termassets and its short-term
liabilities.
 WORKING CAPITAL
Typically means the available current or short-term assets of a
firm such as cash, receivables, inventory and marketable
securities that are used to finance its day-to-day operations.
Working capital typically means the available current or short-
term assets of a firm such as cash, receivables, inventory and
marketable securities that are used to finance its day-to-day
operations. These items are also referred to as «circulating
capital».
 WORKING CAPITAL
Corporate executives devote a considerable amount of attention to the
management of working capital. Positive working capital is required to ensure that
a firm is able to continue its operations and that it has sufficient funds to satisfy
both maturing short-term debt and upcoming operational expenses.
Decisions relating to working capital and short term financing are referred
to as working capital management. Short term financial management concerned
with decisions regarding to current asset and current liability.
 OVERVIEW OF WORKING
CAPITAL MANAGEMENT
Working capital management represents the relationship between a firm's short-term assets and its
short-term liabilities. The goal of working capital management is to ensure that a company can afford
its day-to-day operating expenses while, at the same time, investing the company's assets in the most
productive way. A well-run firm manages its short-term debt and current and future operational
expenses through its management of working capital, the components of which are inventories,
accounts receivable, accounts payable, and cash.
Active working capital management is an extremely effective way to increase enterprise value.
Optimizing working capital results in a rapid release of liquid resources and contributes to an
improvement in free cash flow and to a permanent reduction in inventory and capital costs, thereby
increasing liquidity for strategic investment and debt reduction. Process optimization then helps
increase profitability.
The fundamental principles of working capital management are reducing the capital employed and
improving efficiency in the areas of receivables, inventories, and payables.
 OBJECTIVE OF WORKING
CAPITAL MANAGEMENT
The objectives of working capital management, in addition to ensuring that the company has enough cash
to cover its expenses and debt, are minimizing the cost of money spent on working capital, and maximizing
the return on asset investments. The primary purpose of working capital management is to enable the
company to maintain sufficient cash flow to meet its short-term operating costs and short-term debt
obligations. Another is to ensure that the firm is able to continue its operations and that it has sufficient cash
flow to satisfy both maturing short-term debt and upcoming operational expenses. Businesses face ever
increasing pressure on costs and financing requirements as a result of intensified competition on globalized
markets. When trying to attain greater efficiency, it is important not to focus exclusively on income and
expense items, but to also take into account the capital structure, whose improvement can free up valuable
financial resources.
 OBJECTIVE OF WORKING
CAPITAL MANAGEMENT
The goal of working capital management is to manage the firm’s current assets and
liabilities in such a way that a satisfactory level working capital is maintained. To run firm
efficiently with as little money as possible tied up in Working Capital. Involves trade-offs
between easier operation and cost of carrying short-term assets. Therefore, the main
objectives of working capital management include maintaining the working capital
operating cycle and ensuring its ordered operation, minimizing the cost of capital spent on
the working capital, and maximizing the return on current asset investments. The
interaction of between current assets and current liabilities is, therefore the main theme of
the theory of the working capital management.
 IMPORTANCE OF WORKING
CAPITAL MANAGEMENT
Working capital management can improve a company's earnings and
profitability through efficient use of its resources. Management of working
capital includes inventory management as well as management of accounts
receivables and accounts payables.
Ensuring that the company possesses appropriate resources for its daily
activities means protecting the company’s existence and ensuring it can keep
operating as a going concern.
 WORKING CAPITAL
MANAGEMENT DECONSTRUCTED
Efficient working capital management helps maintain smooth operations and
can also help to improve the company's earnings and profitability. Management
of working capital includes inventory management and management of
accounts receivables and accounts payables.
If a company has insufficient cash to pay for its current expenses, it may
have to file for bankruptcy, undergo restructuring by selling off assets,
reorganize, or liquidate. Conversely, if a company invests excessively in cash
and liquid assets, this may be a poor use of company resources.
 WORKING CAPITAL MANAGEMENT: THREE
MAIN COMPONENTS ASSOCIATED WITH
WORKING CAPITAL MANAGEMENT

1. Accounts Receivable. Accounts receivable are revenues due—what

customers and debtors owe to a company for past sales. A company must
collect its receivables in a timely manner so that it can use those funds to meet
its own debts and operational costs. Accounts receivable appear as assets on a
company's balance sheet, but they do not become assets until they are
collected. Days sales outstanding is a metric used by analysts to assess a
company's handling of accounts receivables. The metric reveals the average
number of days a company takes to collect sales revenues.
 WORKING CAPITAL MANAGEMENT: THREE
MAIN COMPONENTS ASSOCIATED WITH
WORKING CAPITAL MANAGEMENT

2. Accounts Payable. Accounts payable is the amount that a company must pay
out over the short term and is a key component of working capital
management. Companies endeavor to balance payments with receivables to
maintain maximum cash flow. Companies may delay payments as long as is
reasonably possible with the goal of maintaining positive credit ratings while
sustaining good relationships with suppliers and creditors. Ideally, a company's
average time to collect receivables is significantly shorter than its average time
to settle payables.
WORKING CAPITAL MANAGEMENT: THREE MAIN
COMPONENTS ASSOCIATED WITH WORKING
CAPITAL MANAGEMENT

3. Inventory. Inventory is a company's primary asset that it converts into sales

revenues. The rate at which a company sells and replenishes its inventory is a
measure of its success. Investors also consider the inventory turnover rate to be
an indication of the strength of sales and how efficient the company is in its
purchasing and manufacturing. Low inventory means that the company is in
danger of losing out on sales, but excessively high inventory levels could be a
sign of wasteful use of working capital.
 TYPES OF WORKING CAPITAL
MANAGEMENT RATIOS
A. The Working Capital Ratio or Current Ratio is calculated as current assets divided
by current liabilities. It is a key indicator of a company's financial health as it
demonstrates its ability to meet its short-term financial obligations.
Although numbers vary by industry, a working capital ratio below 1.0 generally
indicates that a company is having trouble meeting its short-term obligations. That is,
the company's debts due in the upcoming year would not be covered by its liquid
assets. In this case, the company may have to resort to selling off assets, securing
long-term debt, or using other financing options to cover its short-term debt
obligations.
 TYPES OF WORKING CAPITAL
MANAGEMENT RATIOS
B. The Collection Ratio is a measure of how efficiently a company manages its
accounts receivables. The collection ratio is calculated as the product of the number
of days in an accounting period multiplied by the average amount of outstanding
accounts receivables divided by the total amount of net credit sales during the
accounting period.
The collection ratio calculation provides the average number of days it takes a
company to receive payment after a sales transaction on credit. If a company's billing
department is effective at collections attempts and customers pay their bills on time,
the collection ratio will be lower. The lower a company's collection ratio, the more
efficient its cash flow.
 TYPES OF WORKING CAPITAL
MANAGEMENT RATIOS
C. The Inventory Turnover Ratio the final element of working capital management is
inventory management. To operate with maximum efficiency and maintain a comfortably
high level of working capital, a company must keep sufficient inventory on hand to meet
customers' needs while avoiding unnecessary inventory that ties up working capital.
Companies typically measure how efficiently that balance is maintained by monitoring the
inventory turnover ratio. The inventory turnover ratio, calculated as revenues divided by
inventory cost, reveals how rapidly a company's inventory is being sold and replenished. A
relatively low ratio compared to industry peers indicates inventory levels are excessively
high, while a relatively high ratio may indicate inadequate inventory levels.
 UNDERSTANDING WORKING CAPITAL

Working capital is the difference between a company’s current assets

and its current liabilities. Current assets include cash, accounts
receivable, and inventories. Current liabilities include accounts
payable, short-term borrowings, and accrued liabilities. Some
approaches may subtract cash from current assets and financial debt
from current liabilities.
 WHY WORKING CAPITAL MANAGEMENT IS
IMPORTANT?
Ensuring that the company possesses appropriate resources for its daily
activities means protecting the company’s existence and ensuring it can keep
operating as a going concern. Scarce availability of cash, uncontrolled
commercial credit policies, or limited access to short-term financing can lead
to the need for restructuring, asset sales, and even liquidation of the company.
Investment in current asset represents a substantial portion of total investment.
Investment in current asset and level of current liabilities have to be geared
quickly to changes in sales..
WHY WORKING CAPITAL MANAGEMENT IS
IMPORTANT?
 CONCEPTS OF WORKING CAPITAL
Gross Working Capital Referred as “Economics Concept” since assets are
employed to derive a rate of return. It is the total current assets where current
assets are the assets that can be converted into cash within an accounting year
& include cash ,debtors etc.
Net Working Capital Referred as “point of view of an Accountant‟. It indicates
liquidity position of a firm &suggests the extent to which working capital
needs may be financed by permanent sources of funds. CA– CL
COMPONENTS OF WORKING
CAPITAL
CURRENT ASSETS CURRENT
LIABILITIES
Inventory Sundry creditors
Sundry Debtors Short term loans
Cash and Bank Balances Provisions
Loans and advances  
 COMPONENTS OF WORKING
CAPITAL
Characteristics of Current Assets:
Short Life Span that is cash balances may be held idle for a week or
two, thus a/c may have a life span of 30-60 days etc. Swift
transformation into other asset forms that is each current asset is
swiftly transformed into other asset forms like cash is used for
acquiring raw materials , raw materials are transformed into finished
goods and these sold on credit are convertible into A/R & finally into
cash.
 COMPONENTS OF WORKING
CAPITAL
Matching Principle:
If a firm finances a long term asset (like machinery) with S-T (short term) Debt
then it will have to be periodically finance the asset which will be risky as well
as inconvenient. That is maturity of sources of financing should be properly
matched with maturity of assets being financed. Thus Fixed Assets &
permanent CA should be supported with L-T (long term) sources of finance &
fluctuating CA by S-T sources.
WORKING CAPITAL
 COMPONENTS OF WORKING
CAPITAL
Matching Principle:
If a firm finances a long term asset (like machinery) with S-T (short term) Debt
then it will have to be periodically finance the asset which will be risky as well
as inconvenient. That is maturity of sources of financing should be properly
matched with maturity of assets being financed. Thus Fixed Assets &
permanent CA should be supported with L-T (long term) sources of finance &
fluctuating CA by S-T sources.
 FACTORS THAT AFFECT WORKING CAPITAL
NEEDS
Working capital needs are not the same for every company. The factors that
can affect working capital needs can be endogenous or exogenous.
Endogenous factors include a company’s size, structure, and strategy.
Exogenous factors include the access and availability of banking services, level
of interest rates, type of industry and products or services sold, macroeconomic
conditions, and the size, number, and strategy of the company’s competitors.
FACTORS THAT AFFECT WORKING CAPITAL
NEEDS
Managing Liquidity Properly managing liquidity ensures that the company
possesses enough cash resources for its ordinary business needs and
unexpected needs of a reasonable amount. It’s also important because it affects
a company’s creditworthiness, which can contribute to determining a
business’s success or failure.
The lower a company’s liquidity, the more likely it is going to face financial
distress, other conditions being equal. However, too much cash parked in low-
or non-earning assets may reflect a poor allocation of resources.
FACTORS THAT AFFECT WORKING CAPITAL
NEEDS
Managing Accounts Receivables A company should grant its
customers the proper flexibility or level of commercial credit
while making sure that the right amounts of cash flow in via
operations.
A company will determine the credit terms to offer based on
the financial strength of the customer, the industry’s policies,
and the competitors’ actual policies.
FACTORS THAT AFFECT WORKING CAPITAL
NEEDS
Managing Inventory Inventory management aims to make sure that the
company keeps an adequate level of inventory to deal with ordinary operations
and fluctuations in demand without investing too much capital in the asset.
An excessive level of inventory means that an excessive amount of
capital is tied to it. It also increases the risk of unsold inventory and potential
obsolescence eroding the value of inventory.
A shortage of inventory should also be avoided, as it would determine
lost sales for the company.
FACTORS THAT AFFECT WORKING CAPITAL
NEEDS
Managing Short-Term Debt Like liquidity management, managing short-
term financing should also focus on making sure that the company
possesses enough liquidity to finance short-term operations without
taking on excessive risk.
The proper management of short-term financing involves the selection of
the right financing instruments and the sizing of the funds accessed via
each instrument. Popular sources of financing include regular credit lines,
uncommitted lines, revolving credit agreements, collateralized loans,
discounted receivables, and factoring.
FACTORS THAT AFFECT WORKING CAPITAL
NEEDS
Managing Accounts Payable Accounts payable arises from
trade credit granted by a company’s suppliers, mostly as part
of the normal operations. The right balance between early
payments and commercial debt should be achieved.
Early payments may unnecessarily reduce the liquidity
available, which can be put to use in more productive ways.
FACTORS THAT AFFECT WORKING CAPITAL
NEEDS
Managing Accounts Payable
Late payments may erode the company’s reputation and commercial
relationships, while a high level of commercial debt could reduce its
creditworthiness. Phase 3

Operating or Cash Cycle Phase 2

1. Conversion of cash into inventory Phase 1

2. Conversion of inventory into Receivables

3. Conversion of Receivables into Cash
 TYPES OF WORKING CAPITAL
PERMANENT WORKING CAPITAL - there is always a minimum level of ca
which is continuously required by a firm to carry on its business operations.
Thus , the minimum level of investment in current assets that is required to
continue the business without interruption is referred as permanent working
capital
VARIABLE WORKING CAPITAL - this is the amount of investment required
to take care of fluctuations in business activity or needed to meet fluctuations
in demand consequent upon changes in production & sales as a result of
seasonal changes.
TYPES OF WORKING CAPITAL
 TYPES OF WORKING CAPITAL

DISTINCTION:
Permanent is stable over time whereas variable is fluctuating according to seasonal demands.
Investment in permanent portion can be predicted with some profitability whereas investment in variable
cannot be predicted easily.
While permanent is minimum investment in various case, variable is expected to take care for peak in business
activity.
While permanent component reflects the need for a certain irreducible level of current assets on a
continuous and uninterrupted basis, the temporary portion is needed to meet seasonal & other temporary
requirements. Also permanent capital requirements should be financed from l-t sources, s-t funds should be
used to finance temporary working capital needs of a firm
TIPS FOR EFFECTIVELY MANAGING WORKING
CAPITAL
1. Manage procurement and inventory
Prudent inventory management is an important factor in making the most of your
working capital. Excessive stocks can place a heavy burden on the cash resources of any
business. On the other hand, insufficient stock can result in lost sales and damage to
customer relations. When looking at inventory, it’s important to monitor what you buy, just
as much as what you sell. The key challenge for companies is to establish optimum stock
levels: promoting better communication between departments and forecasting demand are
steps to take in order to prevent your company from holding unnecessary levels of stock.
As well as driving up costs for physical storage and insurance, the stock may be wasted if it
is time-sensitive
TIPS FOR EFFECTIVELY MANAGING WORKING
CAPITAL
2. Pay vendors on time
Enforcing payment discipline should be a key part of your payables process.
Analysis of working capital levels shows that the biggest improvement comes from
improved payables performance and reduced days payable outstanding (DPO). Companies
that pay on time develop better relationships with their suppliers and are in a stronger
position to negotiate better deals, payment terms and discounts. It seems like a counter-
intuitive way of maintaining a steady working capital, but if you keep your suppliers happy,
it could save you money in the long run when it comes to getting larger discounts for bulk
buying, recurring orders and maximizing the credit period.
TIPS FOR EFFECTIVELY MANAGING WORKING
CAPITAL
3. Improve the receivables process
In order to shorten the receivables period, the company needs to have a good collections system in
place. One important aspect of working capital is to send out invoices as soon as possible. Companies should
reassess invoicing processes to eliminate inefficiencies that may be causing delays in sending invoices to your
debtors (manual processing, lost invoices, high volume of invoices to manage etc.). Professional services firm,
Deloitte recommends using technology to deliver invoices electronically in order to speed up billing and
collection, and ultimately shorten the cash conversion cycle. It’s also vital to ensure that invoices are accurate
before they are sent to your debtors to avoid delays in getting paid. Maintaining an accurate debtors ledger
ensures that you are on top of debtor collection dates and can send timely reminders to your customers
regarding payment.
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CAPITAL
4. Manage debtors effectively
The best way to ensure you have working capital is to make sure money is coming in
on time. Reassessing your contracts and credit terms with debtors may be necessary to make
sure you are not giving debtors too big a window to pay for goods and services – as this may
be impacting negatively on your own company’s cash flow. CFOs should review credit terms
with company management to ensure that the level of credit being offered to debtors is
appropriate for your company’s cash flow needs. To reduce bad debts, you should implement
more rigorous credit checks and ensure that effective credit control procedures are in place to
chase late-paying customers.
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CAPITAL
5. Make informed financing decisions
Working capital is interest-free with no conditions, making it the cheapest
and fastest source of cash for a company. As both PWC and The Hackett Group
present in their working capital studies, most firms have no need to rely on debt
financing and instead should look for working capital opportunities within their
balance sheets.
Prioritizing working capital allows companies to make strategic investment
decision, which drives operational performance and efficiencies. Conversely, not
having enough operating liquidity because assets are tied up in inventory or
unpaid invoices can have a huge effect on cash flow.
 SUMMARY
 Working capital management involves balancing movements related to five
main items – cash, trade receivables, trade payables, short-term financing, and
inventory – to make sure a business possesses adequate resources to operate
efficiently.
 The levels of cash should be enough to deal with ordinary or small unexpected
needs, but not so high to determine an inefficient allocation of capital.
 Commercial credit should be used properly to balance the need to maintain
sales and healthy business relationships with the need to limit exposure to
customers with low creditworthiness.
 SUMMARY

 Managing short-term debt and accounts payable should allow the company to achieve
enough liquidity for ordinary operations and unexpected needs, without an excessive increase
in financial risk.
 Inventory management should make sure there are enough products to sell and materials
for its production processes while avoiding excessive accumulation and obsolescence.
 Working capital management is crucial to ensure that a company maintains sufficient cash
flow to meet its short-term operating costs and obligations.
 The elements of working capital are money coming in, money going out, and the
management of inventory.
 SUMMARY
 Companies must also prepare reliable cash forecasts and maintain accurate data on
transactions and bank balances.
 If a company cannot meet its short-term obligations, it may face bankruptcy while holding
excessive liquid assets or cash may not be the best use of its resources.
 The goal of working capital management is to maximize operational efficiency.
 Efficient working capital management helps maintain smooth operations and can also help
to improve the company's earnings and profitability.
 Management of working capital includes inventory management and management of
accounts receivables and accounts payables.