Management of

Working Capital
 Session Summary (1)
learning objectives

working capital and working capital requirement

the operating cycle

Flatco plc balance sheet as at 31 December 2005

Flatco plc profit and loss account for the year ended 31
December 2005

working capital policy

stocks management

just in time (JIT), materials requirement planning (MRP),

and optimised production technology (OPT)
 Session Summary (2)

debtors and credit management

example of an aged debtors report

creditors management

example of an aged creditors report

operating cycle performance

balance sheet items that impact on short-term and

long-term cash flow

cash management
 Learning Objectives (1)

explain what is meant by working capital and the

operating cycle

describe the management and control of the working

capital requirement

outline some of the working capital policies that may be

adopted by companies

implement the systems and techniques that may be used

for the management and control of stocks, and
optimisation of stock levels
 Learning Objectives (2)

outline a system of credit management and the control

of debtors

consider the management of creditors as an additional

source of finance

use the operating cycle to evaluate a company’s working

capital requirement performance

consider the actions and techniques to achieve short-term

and long-term cash flow improvement
 Working Capital and Working
Capital Requirement

working capital requirement, WCR

= stocks + debtors – creditors – accruals + prepayments

the difference between working capital (WC) and working

capital requirement (WCR) is cash less short-term
financial debt (bank overdraft)

WC = WCR - short-term debt + cash

 The Operating Cycle (1)

the operating cycle relates to working capital (WC), the

net of current assets less current liabilities

the operating cycle is the period of time, which elapses

between the point at which cash begins to be expended
on the production of a product, and the collection of
cash from the customer
The Operating Cycle (2)
Flatco plc Balance Sheet as at
31 December 2005
Flatco plc Profit and Loss Account for
the Year Ended 31 December 2005
 Working Capital Policy (1)

the working capital requirement is normally financed by

bank overdraft because of

its flexibility in accommodating the fluctuating

nature of net current assets

the general lower cost of short-term financing

the working capital policy adopted depends on individual

company objectives and there is inevitably a conflict
between the goals of profitability and liquidity
 Working Capital Policy (2)

aggressive policies may involve holding low levels of

cash and stocks, with the risk of potential cash
shortages and stock-outs

conservative policies may be more flexible with higher

levels of cash and stock, giving lower risk at the expense
of reduced profitability
 Stocks Management (1)

Effective management and control of stocks requires

its appropriate location and storage

establishment of robust stock purchase procedures and

reorder systems

accurate and timely systems for the recording, control

and physical checks of stocks
 Stocks Management (2)
Stock levels may be monitored using the following ratios:

stock days = stock value_________

or stock average daily cost of sales in period
turnover

stock weeks = total stock units_____

average weekly units cost of sales

Internal stock utilisation efficiency may be measured

using

finished goods raw materials work in progress

average weekly average weekly raw average weekly
despatches material usage production
 Just in Time (JIT)

JIT is a management philosophy that incorporates a

‘pull’ system of producing or purchasing components
and products in response to customer demand

in a JIT system products are pulled through the system

from customer demand back down through the supply
chain to the level of materials and components

the consumer buys, and the processes manufacture the

products to meet this demand - the consumer therefore
determines the schedule
 Materials Requirement
Planning (MRP)

Materials requirement planning MRP (or MRPI) is

a system that converts a production schedule into a

listing of the materials and components, required to
meet that schedule

a system that ensures that adequate stock levels are

maintained and items are available when needed
 Manufacturing Resource
Planning (MRPII)

Manufacturing resource planning (MRPII) is an

expansion of material requirements planning (MRPI) to
give a broader approach than MRPI to the planning and
scheduling of resources, embracing areas such as

finance
logistics
engineering
marketing
 Optimised Production
Technology (OPT) (1)

OPT is a philosophy, combined with a computerised

system of shopfloor scheduling and capacity planning

OPT differs from a traditional approach of balancing

capacity as near to 100% as possible and then
maintaining flow
 Optimised Production
Technology (OPT) (2)

OPT aims to balance flow rather than capacity, and like

JIT, it aims at improvement of the production process
and focuses on factors such as

manufacture to order
quality     
lead times
batch sizes
setup times
 Debtors and Credit
Management (1)
Effective management and control of debtors requires the
establishment of appropriate policies covering

the choice of customers

the way in which sales are made

the sales invoicing system

the means of settlement

the implementation of a credit management and overdue

accounts collection system
 Debtors and Credit
Management (2)

Debtor levels may be monitored using the following ratio

debtor days = accounts receivable x 365

sales
Example of an
Aged Debtors Report
 Creditors Management (1)

although not free, trade creditors provide the company

with an additional source of finance

effective management and control of creditors requires

the establishment of appropriate policies covering

the choice of suppliers

the way in which purchases are made

the purchase invoicing system

the means of settlement

 Creditors Management (2)

Creditor levels may be monitored using the following

ratio

creditor days = accounts payable x 365

cost of sales (or purchases)
Example of an
Aged Creditors Report
 Operating Cycle Performance
regular measurement of the operating cycle, which
determines the short-term financing requirements of the
business, enables the company to monitor its working
capital performance against targets and identify areas for
improvement

operating cycle (days) = stock days + debtor days -

creditor days
 
Or alternatively as a percentage
 
operating cycle % =
working capital requirement (stocks + debtors -
creditors)
sales
Balance Sheet Items that
Impact on Short-term and
Long-term Cash Flow
 Cash Management (1)
The short-term cash position of an organisation may
be improved by reducing current liabilities, and/or
increasing current liabilities
stock levels
debtors
cash at bank
creditors
overdrafts
taxation
VAT
PAYE/NI
dividends payable
 Cash Management (2)

The long-term cash position of an organisation may be

improved by increasing equity, and increasing long-term
liabilities, and reducing the net outflow on fixed assets:

shareholders’ capital
loans
leasing and hire purchase
purchases of fixed assets
sales of fixed assets