Every business must have sufficient liquid resources (cash) to maintain day to day trading sufficient liquidity must be maintained in order to ensure both the short and longterm future of a business. Overcapitalisation means that the return on investment will be lower than it should be, and long term funds will be unnecessarily tied up. A company must have adequate cash inflows to survive, so management should plan and control cash flows as well as profitability.
Every business must have sufficient liquid resources (cash) to maintain day to day trading sufficient liquidity must be maintained in order to ensure both the short and longterm future of a business. Overcapitalisation means that the return on investment will be lower than it should be, and long term funds will be unnecessarily tied up. A company must have adequate cash inflows to survive, so management should plan and control cash flows as well as profitability.
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Every business must have sufficient liquid resources (cash) to maintain day to day trading sufficient liquidity must be maintained in order to ensure both the short and longterm future of a business. Overcapitalisation means that the return on investment will be lower than it should be, and long term funds will be unnecessarily tied up. A company must have adequate cash inflows to survive, so management should plan and control cash flows as well as profitability.
Copyright:
Attribution Non-Commercial (BY-NC)
Available Formats
Download as DOC, PDF, TXT or read online from Scribd
liabilities • current assets- cash, stocks of raw materials, WIP and finished goods, and debtors • current liabilities-trade creditors, tax(VAT, PAYE, & CT), dividends, loans, overdraft etc. • every business must have sufficient liquid resources (cash) to maintain day to day trading • sufficient liquidity must be maintained in order to ensure both the short and long- term future of a business WORKING CAPITAL MANAGEMENT • i.e ensuring that the business has and will have sufficient liquid resources • involves balancing the needs of ensuring the solvency of the business with making sure that the business achieves maximum return from its assets • holding too much cash is as much of a problem as not holding enough- the business misses out on making a return on the assets that the cash could have bought
• current assets can be financed either by
long term funds or by current liabilities • current liabilities are a cheap source of finance, and some companies may consider that in the interest of higher profit (i.e no interest to pay) it is worth accepting some risk of insolvency by increasing current liabilities and taking the maximum credit possible from suppliers • the volume of current assets required depends on the nature of the business e.g a manufacturing company needs to hold more stock that a company in a service industry • OVER-CAPITALISATION • if there are excessive stocks, debtors
and cash, and very few creditors there
will be an over-investment by the company in current assets • working capital will be excessive and the
company will be described as over
-capitalised • over-capitalisation means that the return on investment will be lower than it should be, and long term funds will be unnecessarily tied up when they could be invested elsewhere • the ratios that might indicate over- capitalisation are • sales/working capital • liquidity ratios • turnover periods WORKING CAPITAL AND CASH FLOW • the operating cycle i.e the period between paying creditors and receiving cash from debtors • purchase raw materials • pay creditors • produce goods • hold onto stock before selling • cash received from debtors
• a company must have adequate cash
inflows to survive, so management should plan and control cash flows as well as profitability • cash budgeting is a very important part of this process, because as shortfalls are anticipated , measures can be put into place to avoid any crises • managing the timing of cash flows is therefore very important, and this involves controlling the component parts of ‘working capital’ THE MANAGEMENT OF CASH • how much should be kept as ‘cash in hand’ or ‘on short call’?- must balance liquidity with profitability • methods of easing cash shortages: • postpone capital expenditure- but what if urgent? • press debtors- but risk loss of goodwill • sell assets • take longer credit • re-negotiate loan repayments • agree deferral of CT with IR • reduce dividends- but what about shareholder expectations? • surplus cash- what to do? • if surplus long term could consider: • invest in long term high return asset • redeem some debt • pay dividend • if surplus not permanent could put on short term deposit, but must consider rates and notice periods THE MANAGEMENT OF DEBTORS • the efficient management of debtors is
concerned with achieving an optimum
level which involves • a trade-off between extending credit and therefore increasing sales and profits; and the interest and administrative cost of carrying debtors and suffering bad debts • analysis of individual customers
is instrumental in deciding the
level of risk a company is prepared to take in extending credit • debt collection management is also important in determining the volume of debtors and bad debts • formulating a credit control policy involves considering: • the administrative costs of debt collection • procedures for controlling the credit given to individual customers • the amount of extra capital required to finance an extension of credit e.g overdraft interest • any additional costs e.g extra work needed • the way credit policy is to be implemented- are discounts to be offered to encourage early payment (the cost will be the amount of the discount) • what the effect of easing credit might be e.g it might encourage increased bad debts • if the increased contribution from the additional sales exceeds the additional costs then extending credit will be worthwhile • credit control: individual accounts • new customers should give at least two good references, including one from a bank • their credit rating should be checked through a credit agency • the credit offered should be set at a low level , and only extended when the payment record of the customer warrants it • any additional information on customers should be kept if available e.g statutory accounts, press cuttings etc • aged debtor listings should be
produced and reviewed regularly
• credit limits should be looked at
before an order is allowed to
proceed • debt collection- main areas to consider: • paperwork • debt collection • • paperwork • invoices to be sent out
immediately after delivery
• checks should be carried out to ensure that the invoices are correct • investigation of queries etc should be carried out promptly • regular statements of account should be sent out
• debt collection- possible procedure
• request payment by telephone • letter • personal visit • withdraw credit • involve debt collection agency • instigate legal proceedings THE MANAGEMENT OF CREDITORS AND SHORT TERM FINANCE • this involves • attempting to obtain satisfactory credit from suppliers • attempting to extend credit during periods of cash shortage • maintaining good relations with regular and important suppliers
• sources of short term finance
• trade credit • bank overdraft • factoring/ invoice discounting
• trade credit is a very important source of
finance, but the costs include • loss of early payment discounts • loss of supplier goodwill THE MANAGEMENT OF STOCKS • for a manufacturing or retailing business stock can often amount to a substantial proportion of the total assets of the business • it is important that stocks are kept at the optimum level-if too low stock-outs will occur, if too high , unnecessary costs will be incurred • stock ‘costs’ include: • holding costs- cost of capital
tied up, warehousing and
handling costs, deterioration, obsolescence, insurance and pilfering • procuring costs- costs of
ordering and delivery
• shortage costs- i.e not having
the item in stock when ordered-
they include the loss of sale & contribution of the lost sale; the extra cost of buying in emergency stock (often at a high price);the cost of lost production and sales , where stock-out brings whole process to a halt • cost of stock itself- this will need to be considered if the supplier offers a discount for bulk buying • stock control levels • there are 4 critical control levels that can be used to maintain stock at their optimum level • re-order level- this is often
predetermined and considers
the maximum rate of consumption and length of lead time(time between placing order & receiving stock) • maximum & minimum levels -stock levels must not exceed or fall below these limits • re-order quantity- a predetermined quantity that is ordered when the stock reaches the re-order level • some businesses attempt to control stock on a scientific basis e.g EOQ- economic order quantity), but this depends on various assumptions e.g that demand and lead times are constant. This is often unrealistic, and businesses therefore have to work out when to re- order - to ensure that they don’t run out of stock in the re-order period many business hold a buffer stock • other businesses operate a JIT (just in time) system which involves ordering goods at the very last minute, so avoiding the need to carry stock -this can save on holding costs but is unsuitable for some businesses e.g hospitals, and is considered too risky by many