INTRODUCTION TO WORKING CAPITAL MANAGEMENT

1.0 INTRODUCTION

This unit, you will be introduced to working capital management. In business, when sales arise not in cash, the immediate outlet is receivables – accounts receivables or trade debtors and current asset cash and receivables (debtors) which assist in the operation of a business enterprise. The management of these receivables is very vital to the business as a going concern. Organisations usually have claims to future inflows of cash. These claims are known as accounts receivables and note receivables expressed in financial statements.

 
Inventories are the balance of goods on hand (part of current assets). In a producing enterprise, they comprise raw materials, work-in-progress and finished products. These inventories need to be managed properly to avoid unnecessary cost. Management of inventory will be explained as part of working capital management.

2.0 OBJECTIVES

At the end of this unit, you should be able to:

1.  Explain working capital management 
2. State the main components of working capital management 
3.  Explain receivable management 
4.  List Steps to Cash Management 
5. Explain the process for managing inventory 

3.0 MAIN CONTENT

3.1 Working capital management

Working capital management refers to the management of current or short-term assets and short-term liabilities. Components of short-term assets include inventories, loans and advances, debtors, investments, and cash and bank balances. Short-term liabilities include creditors, trade advances, borrowings and provisions. The major emphasis is, however, on short-term assets, since short-term liabilities arise in the context of short-term assets.

Working capital management is, therefore, concerned with the ways and means of making working capital adequate to meet the firm’s short-term obligations. The effective working capital management involves the adoption of appropriate management policy.

3.2 The main components of Working capital management

1. Cash management 
2. Receivables management 
3.  Inventory management 

3.2.1Cash management focuses on managing cash flows in and out of an enterprise i.e. cash flows within and cash balances held by an enterprise at a given point in time which is utilised either by financing the deficit gap or investing surplus cash. Note: Sales generate cash disbursed. Surplus cash is invested while deficit is borrowed to make-up.

Cash management attempts to control cash cycle at a minimum cost and tries to achieve liquidity. Cash management places cash as the most significant and at the same time the least productive asset at the disposed of an enterprise. It is a means of settling indebtedness of the enterprise. It is not easy to predict cash flows accurately, that means, it takes time and dexterity to achieve its ideal position. That means the aim of cash management is to maintain adequate control over cash position to be able to keep the enterprise sufficiently liquid and to use excess cash in some profitable way.

Cash management is concerned with the managing of: 

1. Cash flows into and out of the enterprise 
2.  Cash flows within the enterprise 
3. Cash balances held by the enterprise at a point of time by financing deficit or investing surplus cash. 

Self Assessment Exercise 1

What is cash management?

Steps to Cash Management

This involves two paths of action – (i) having the right amount on hand to pay your bills (2) using any excess of that amount wisely. We will now consider an approach for a reliable cash management which involves four steps:

1.  Keeping adequate records on cash book control 
2. Identifying the cash flow pattern 
3.  Estimating future cash balances and 
4. Utilizing excess cash to generate income. 

Cash comes from:

1.  Daily cash sales 
2. Payments made by customers to their accounts 
3. Loans acquired for short-term needs 
4. Additional capital borrowed on long term basis. 

Motives for holding cash

Business need to hold cash to achieve the following three motives: Transactions, Precautionary and Speculative

Transaction Motive

This requires an enterprise to hold cash to perform it ordinary business activities. This cash is to pay for purchase, wages and salaries, other operational expenses, tax dividends etc. With effective management of cash receipts and cash payment will make the holding of cash not necessary as there will be enough cash when payment is to be made.

Precautionary Motive

This is for the enterprise to meet up contingencies as they arise in the future. Cash at this stage is used to provide a cushion or buffer to withstand some unexpected emergency. The precautionary amount of cash will depend upon the predictable nature of the cash flow of the business.

Speculative Motive

This is holding cash for investing in profit-making opportunities as and when the need arises. The opportunity to make profit by an enterprise may arise when the security prices change. This is an opportunity to hold cash and expect a rise in interest rates and security prices will fall.

Self Assessment Exercise 3

Explain the three principal motives for holding cash

3.2.2Receivables Management

Trade credit make way for trade debtors otherwise known as account receivable which a business (an enterprise) expects to receive in form of cash in the near future (usually which a short period within the financial period e.g. a week, fortnight, month, quarter, half a year, a year). The customers benefiting from this gesture are known as trade debtors or generally listed as debtors (to be claimed as asset of the organisation.
Receivables are risk elements, meaning that management must identify some elementary facts (characteristics).

1.  It involves the analysis of the implication of value of credit sales. Cash sales are riskless. Credit sales need to be carefully analysed as cash payment will be in future. The integrity of the beneficiary of the sales must not be in doubt judging by the track record of the trade business. 
2.  Based on economic value, the purchaser benefits at the time sales immediately while the owner of the sales expects an equivalent of the trade value in future time. 
3. It connotes that the buyer will provide the cash payment for the good/services received in a future period. 

The time lag is the risk which is borne by the seller. He need be sufficient and surplus in its cash holding, control and management to stay afloat till that aspect of account is received as a whole. Any hiccup in repayment by the customer (beneficiary) will negative affect the cash flow level at the expected time. You should note that debtors form a reasonable part of current assets of many enterprise especially where the customer need this service to enhance their being in business as a going concern.

Self Assessment Exercise 1

“Receivables expect cash in future”. Discuss

3.2.3 Inventory management

Inventory management is a tool to avoid excessive and inadequate levels of inventories and maintain sufficient inventory for the smooth operations of the enterprise in terms of production and sales output. The management should provide the enterprise with an order at the right time with the right source to acquire the right quantity at the right price and quality.
An effective inventory management ensures

1.  A continuous supply of raw materials to facilitate functional production and distribution. 
2. The maintenance of sufficient stocks of raw materials in short supply period and anticipate changes in price level 
3.  Sufficient finished goods inventory for smooth sales distribution in order to sustain efficient customer service. 
4.  Minimum carrying cost and time and 
5.  Investment control in inventories and optimum level of operation. 

4.0 CONCLUSION 

We have identified cash management as a tool to maintain control over cash position which enhances the effectiveness of an enterprise to keep the required liquidity level and utilise the excess cash for profitable venture.
We conclusion is that the major factor of managing receivables is that the organisation expects to receive cash eventually in the future.

5.0 SUMMARY

In this unit, we have discussed cash management steps and control, sensitivity analysis and motives for holding cash. You have also learnt about receivables management. And In this unit, you have learnt about inventory management as part of working capital and the techniques there of.