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2019 CIA P3 SIV 1D 2 Working Capital
2019 CIA P3 SIV 1D 2 Working Capital
Management
Working Capital Management
Working capital management involves
making sure a company has enough cash
to pay for its expenditures as they come
due.
Working Capital
Current assets
– Current liabilities
= Working capital
Types of Working Capital
The minimum amount of working capital
that is maintained at all times is called
permanent working capital.
300 ! Re o rd e r P o in t ! Re o rd e r P o in t
200
100
S a fe t y S t o c k
0
0 5 10 15 20 25 30
Da y s
Economic Order Quantity Calculation
EOQ = 2aD
K
where
a = variable cost of placing an order
D = periodic demand
K = carrying cost per unit per period
Example: Medina Co. makes footballs and is trying to determine the quantity
of leather it should order every time an order is placed. The relevant
information is as follows:
• Over the year 12,000 square meters of leather will be needed.
• The cost of storing one square meter of leather is 3.
• The cost of placing an order is 450.
The EOQ for inventory is calculated as follows:
EOQ = √ (2×450×12,000) / 3 = 1,897.4
Every time Medina orders leather, it should order 1,898 square meters in
order to minimize its costs of ordering and carrying the leather inventory.
Furthermore, the EOQ can be used to determine the number of times that
Medina will need to order inventory per year. Given a demand for leather of
12,000 square meters per year and an EOQ of 1,898 square meters per
order, Medina will need to order inventory 7 times per year in order to have
enough leather for production during the year
(12,000 ÷ 1,898 = 6.3).
Just-in-Time Inventory Systems
The goal of a JIT system is to minimize the
level of inventories that are held in the
plant at all stages of production, while
meeting customer demand in a timely
manner with high-quality products at the
lowest possible cost.
Inventory Valuation
Inventory is defined by IAS 2, Inventories, as
an item that is “held for sale in the ordinary
course of business; in the process of
production for such sale; or in the form of
materials or supplies to be consumed in
the production process or in the rendering
of services.”
Inventory Cost Flow
Assumptions
When inventory items are not ordinarily
interchangeable, the cost assigned to
each sale is determined by means of
specific identification.
When the inventory constitutes large
numbers of interchangeable items, the
first-in, first-out (FIFO) or the weighted
average cost method should be used.
Valuing the Inventory
Inventory is recorded on the balance sheet
at the lower of:
1. Cost, or
2. Net realizable value.
Net Realizable Value
Selling price
- Costs to complete
- Costs to sell
= Net realizable value
360 Discount %
Total period for payment 100% - Discount %
x
– period for discounted
payment
If this is higher than cost of capital,
company should pay WITHIN discount
period.
Example: A vendor offers terms of 2/10, net 30. If the company
pays within 10 days, it will receive a 2% discount. If payment is
not made within 10 days, then the full (undiscounted) amount is
due in 30 days.
The calculation of the cost of not taking the discount is :