Financial management decisions are divided into the management of assets (investments) and liabilities (sources of financing), in the long-term and the short-term. It is common knowledge that a firm’s value cannot be maximized in the long run unless it survives the short run. Firms fail most often because they are unable to meet their working capital needs; consequently, sound working capital management is a requisite for firm survival.
About 60 percent of a financial manager’s time is devoted to working capital management, and many of the potential employees in finance-related fields will find out that their first assignment on the job will involve working capital. For these reasons, working capital policy and management is an essential topic of study. In many text books working capital refers to current assets, and net working capital is defined as current assets minus current liabilities. Working capital policy refers to decisions relating to the level of current assets and the way they are financed, while working capital management refers to all those decisions and activities a firm undertakes in order to manage efficiently the elements of current assets.
The term working capital originated with the old Yankee peddler, who would load up his wagon with goods and then go off on his route to peddle his wares. The merchandise was called working capital because it was what he actually sold, or “turned over”, to produce his profits. The wagon and horse were his fixed assets. He generally owned the horse and wagon, so they were financed with “equity” capital, but he borrowed the funds to buy the merchandise. These borrowings were called working capital loans, and they had to be repaid after each trip to demonstrate to the bank that the credit was sound. If the peddler was able to repay the loan, then the bank would issue another loan, and these were sound banking practices. The days of the Yankee peddler have long since pasted, but the importance of working capital remains. Current asset management and short-term financing are still the two basic elements of working capital and a daily headache for the financial managers.
Working capital, sometimes called gross working capital, simply refers to the firm’s total current assets (the short-term ones), cash, marketable securities, accounts receivable, and inventory. While long-term financial analysis primarily concerns strategic planning, working capital management deals with day-to-day operations. By making sure that production lines do not stop due to lack of raw materials, that inventories do not build up because production continues unchanged when sales dip, that customers pay on time and that enough cash is on hand to make payments when they are due. Obviously without good working capital management, no firm can be efficient and profitable.
Statements about the flexibility, cost, and riskiness of short-term debt versus long-term debt depend, to a large extent, on the type of short-term credit that actually is used. Short-term credit is defined as any liability originally scheduled for payment within one year. There are numerous sources of short-term funds, such as accruals, accounts payable (trade credit), bank loans, and commercial paper. The major elements of current liabilities are trade creditors and bank overdrafts, and these are further analyzed.
Questions related to capital management
Does anyone know where I can take Oracle Human Capital Management courses in the UK?
I have an engineering background and would like to change careers into Oracle Peoplesoft Human Capital Management. I have searched for relevant training courses in the UK especially courses lasting for 2 or 3 months and also contacted potential employers and employment agencies but I have been unable to get any direction which I should follow.
Any advice on where I can get information from and prices will be greatly appreciated.
Thanks
The best working capital management policy is Brainstorming done by group discussions and cooperation.
Poor capital management policy is cause by individual Decision making without consulting the subordinates.
It's a great question, and one of the best I have seen. However, the answers will vary all over the map.
First of all, this is less a question of the efficiency of working capital, in dollars, than the efficiency of the management of the items making up the "working capital". A very common one is the management of inventories which, in a lot of businesses is a large component of working capital. Yes, there are published numbers of inventory requirements for various industries as, often, a percent of equity value for example, with the major use as a general idea of how much will be required. However, these ranges are quite wide and being in the range doesn't mean much when you get into reality.
Inventories of, say, spare parts are evaluated by tracking "dead inventory", turnover rates, stock outs, etc. For example, you should at times be out of something – but not something extremely critical. A stockout of a critical pump part with a long lead time is generally not acceptable while a stockout of a common part easily obtainable is probably no big deal. So, naturally, there has to be a prioritization of the critical items. This exercise should be done periodically, since requirements change, and the minimum reorder points and reorder quantities adjusted. Dead inventory should be sold off or eliminated periodically and written down.
Alternative methods of supply then can be evaluated. One way to cut inventories is to contract with a "local" supplier for certain types of parts with the provision that the supplier will basically keep inventory for you and have it available within a designated time frame. Often the supplier's computer system is connected to your inventory system and purchase orders written and executed by him to maintain a proper "in house" inventory. Also, a vendor may keep your local inventory intact (chemicals, lube oils, etc) but not bill you until they are used up. Obviously these conveniences are not free, but they do free up working capital. They eliminate working capital and replace it with (smaller) expenses.
On and on you can go! Basically item by item, area by area. working closer and closer to the edge of your tolerance for risk!
working capital management has ALWAYS been important to business management.
If a business owner/manager does not properly handle the businesses working capital (funds to run the company) then the company goes broke very quickly.
Working capital is the money management uses to run the day-to-day business. It is current assets less current liabilities. That means cash+inventory+receivables less payables and accruals.
By reducing the amount of working capital needed to do day to day business, the company has more cash to use for investments, new capital, or dividends to shareholders.
Working capital is a valuation metric that is calculated as current assets minus current liabilities. Working capital is also known as operating capital.
In general terms, there are two main approaches, which are opposite but complement each other in some ways, to strategic management:
The Industrial Organization Approach
based on economic theory — deals with issues like competitive rivalry, resource allocation, economies of scale
assumptions — rationality, self descipline behaviour, profit maximization
The Sociological Approach
deals primarily with human interactions
assumptions — bounded rationality, satisfying behaviour, profit sub-optimality. An example of a company that currently operates this way is Google
D. A high ratio of debt to equity means that you don't have any reserves. You have borrowed too much..
The term working capital refers to the amount of capital which is readily available to a company. That is, working capital is the difference between resources in cash or readily convertible into cash (Current Assets) and organisational commitments for which cash will soon be required (Current Liabilities).
Current Assets are resources which are in cash or will soon be converted into cash in "the ordinary course of business".
Current Liabilities are commitments which will soon require cash settlement in "the ordinary course of business".
Thus:
WORKING CAPITAL = CURRENT ASSETS – CURRENT LIABILITIES
In a company's balance sheet components of working capital are reported under the following headings:
Current Assets:
Liquid Assets (cash and bank deposits)
Inventory
Debtors and Receivables
Current Liabilities:
Bank Overdraft
Creditors and Payables
Other Short Term Liabilities
The Importance of Good Working Capital Management
From a company's point of view, excess working capital means operating inefficiencies. Money that is tied up in inventory or money that customers still owe to the company cannot be used to pay off any of the company's obligations. So, if a company is not operating in the most efficient manner (slow collection), it will show up as an increase in the working capital. This can be seen by comparing the working capital from one period to another; slow collection may signal an underlying problem in the company's operations.
Approaches to Working Capital Management
The objective of working capital management is to maintain the optimum balance of each of the working capital components. This includes making sure that funds are held as cash in bank deposits for as long as and in the largest amounts possible, thereby maximising the interest earned. However, such cash may more appropriately be "invested" in other assets or in reducing other liabilities.
Working capital management takes place on two levels:
* Ratio analysis can be used to monitor overall trends in working capital and to identify areas requiring closer management
* The individual components of working capital can be effectively managed by using various techniques and strategies
When considering these techniques and strategies, companies need to recognise that each department has a unique mix of working capital components. The emphasis that needs to be placed on each component varies according to department. For example, some departments have significant inventory levels; others have little if any inventory.
Furthermore, working capital management is not an end in itself. It is an integral part of the department's overall management. The needs of efficient working capital management must be considered in relation to other aspects of the department's financial and non-financial performance.
Working capital mgt is a managerial accounting strategy focusing on maintaining efficient levels of both components of working capital, current assets and current liabilities, in respect to each other. Working capital management ensures a company has sufficient cash flow in order to meet its short-term debt obligations and operating expenses.
1. The essence of effective working capital management is proper cash flow forecasting. This should take into account the impact of unforeseen events, market cycles, loss of a prime customer, and actions by competitors. The effect of unforeseen demands on working capital should be factored in.
2. It pays to have contingency plans to tide over unexpected events. While market leaders can manage uncertainty better, other companies must have risk management procedures. These must be based on an objective and realistic view of the role of working capital.
3. Addressing the issue of working capital on a corporate-wide basis has certain advantages. Cash generated at one location can well be utilized at another. For this to happen, information access, efficient banking channels, good linkages between production and billing, internal systems to move cash and good treasury practices should be in place.
4. An innovative approach, combining operational and financial skills and an all encompassing view of the company's operations will help in identifying and implementing strategies that generate short term cash. This can be achieved by having the right set of executives who are responsible for setting targets and performance levels. They are then held accountable for delivering. They are also encouraged to be enterprising and to act as change agents.
5. Effective dispute management procedures in relation to customers will go along way in freeing up cash otherwise locked in due to disputes. It will also improve customer service and free up time for legitimate activities like sales, order entry, and cash collection. Overall, efficiency will increase due to reduced operating costs.
6. Collaborating with your customers instead of being focused only on your own operations will also yield good results. If feasible, helping them to plan their inventory requirements efficiently to match your production with their consumption will help reduce inventory levels. This can be done with suppliers also.
Huh, virtual reality meetings? Interesting idea.
(PS/2 Ftw!)