UNIT 18:

Profitability is determined in part by the way in which a company manages its working
capital. Basically, there will be a drop in profit if working capital is raised without a
corresponding rise in production or margins. So, one of the principal functions of
financial management is to provide the correct amount of working capital at the right
time and in the right place to realize the greatest return on investment.

Working capital can initially be broken down into two types: permanent and temporary.
Permanent working capital is tied up in keeping the business flowing throughout the
year, while temporary working capital is needed from time to take account of seasonal,
cyclical or unexpected fluctuation in the business. The latter type is usually serviced
from an overdraft facility.

Both types of working capital have three major applications: firstly inventories,
secondly debtors and finally cash.

Over-stringent cost control

Loss of sales Disruption in production

Loss of customer goodwill Failure to meet customer orders

Inventories can be further divided into inventories of raw materials, working in progress
and finished goods. These three can soak up an enormous amount of excess working
capital if not well managed. It is the job of the financial manager to minimize the stocks
of raw materials, the level of the work in progress and the quantity of finished goods.
However, over-stringent control can lead to disruption in production caused by the
delay in receiving raw materials, a failure to take account of costly price rises in the
pipeline, a failure to keep the production volume required by future sales and resulting
expensive and damaging effects on customer goodwill. As one can see from the
foregoing diagram, this can become a vicious circle where the loss of goodwill finally
leads to loss of sales and results once again in stringent cost controls.

The just-in-time philosophy, developed in Japan, is aimed at reconciling these

conflicting interests and keeping inventory costs to a minimum.

On the debtor side, working capital is required to finance the gap between payment due
to suppliers and payment owed by customers. It is the task of financial management to

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see that generous credit terms are negotiated with suppliers, but minimal credit is
offered to customers. Again, a balance must be achieved between getting and giving
good credit terms in order to attract customers and maintain positive relationships with
suppliers on one hand and minimizing cash outlay on the other hand.

Finally, cash is needed for both normal and abnormal requirements. Sound cash
management will ensure that adequate cash is always available for meeting the
company’s day-to-day debts and that there is also a small reserve on hand to meet
contingencies.

COMPREHENSION
COMPREHENSION
VOCABULARY QUESTIONS
EXERCISES

1 Just-in-time
Of course, it costs money to keep
components and goods in stock: stocks
have to be financed (paid for), stored
(perhaps in special buildings: warehouse)
and handled (move from one place to
another). So, Dryden is asking its
suppliers to provide components just-
in-time, as and when they are needed.
This is part of lean production or lean
manufacturing, making things
efficiently: doing things as quickly
and
cheaply as possible, without waste.

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Replace the words in speech bubbles with the correct forms of words from the text above.

1 Let’s get the materials in to keep the cost down.

only when we need them
2 It’s difficult to find the right Special buildings to put our finished goods
in.

3 You’ll have to decide well in advance to

how pay
for all this.

4 It’s very important that kee these components at the right temperature.
we p

5 There must be quicker and method than this!

a cheaper

6 They want to introduce a system making things efficiently.

of

2. Put the solutions for managing cash flow 1-6 into the correct category below.
1 just-in-time manufacturing
2 making payments to suppliers in installments (= part
payments) 3 leasing fixed assets rather than buying them
4 offering a discount for early settlement (= complete payment) of a bill
5 improving sales forecasting so that the warehouse holds less inventory
6 cancelling the office Christmas party

Credit control:
Stock control:
Expenditure control:
LANGUAGE
LANGUAGEFOCUS
FOCUS
Expressions with “time”
The word “time” appears in a lot of expressions used in production and operations like
“just-in-time”. Write each word in the box next to its definition:

changeover time cycle time downtime lead time

lag time overtime set-up time time-to-market
1 when equipment (or the whole line) stops working and
…………………… production is lost.
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 2 time between one job/ batch finishing and the next one
…………………… beginning (includes time taken to prepare machinery for a new

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 process)
3 time required from receiving a customer order to final
…………………… delivery; it includes order processing, pre-pack time, in transit
time, receiving and inspection
4 time taken for a given job / batch to pass through all the
…………………… operations needed
5 extra hours that someone works, beyond their contractual
……………………. obligation (and often paid at a higher rate)
6 time taken to prepare machinery and equipment for a new job /
……………………. batch
7 time required from the initial concept for a new product to
……………………. when it first goes on sale
8 any period of delay between one event and another (eg.
…………………… between giving an instruction and the operation beginning)

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