The Treasurer’s Guide to Trade Finance

Chapter 2 Understanding working capital management

In the past, a treasurer would not have

been able to engage in the production

process in any meaningful way. However,

with increased information about processes

available, the treasurer is able to assist the

company by calculating the cost of every

stage in the production process. By focusing

on itemised costs, the company can work

to improve the efficiency of the overall

production process, minimising the amount

of cash tied up in inventory, and thus the

amount of working capital financing which

may be required.

Inventory optimisation is a specialist

skill in its own right. Too little stock of raw

materials for production, or of finished goods

for sale, can result in lost production and lost

sales. On the other hand, too high a level of

stock results in higher costs of financing and

of physical storage. Other factors can affect

optimal stock levels: these include discounts

on bulk deliveries, the risk of deterioration

in storage or even obsolescence, changes

in customer preferences and the wider

market place, as well as potential benefits

from fixing input costs and security of

supply. Some organisations use complex

mathematical modelling to refine their

calculations. Base models include the

Economic Order Quantity formula and the

Baumol and Miller Orr models.

The physical order to delivery cycle

1. Forecast demand.
   The first stage in any manufacturing
   process is to forecast demand for goods.
   This can be a function of last year’s output,
   or a simple response to existing orders.


2. Anticipate required output.
   Once a view has been taken on
   expected demand, the company will
   need to quantify this to anticipate the
   precise nature of the items which need
   to be produced. (Depending on the
   production process, this may be as
   detailed as anticipating colour trends for
   cars, for example.)


3. Plan production process.
   The task of planning the production
   process is a critical element in
   ensuring working capital is not left

idle. Ideally, the company will plan a

production process which allows the

company to use purchased inputs

as they are received into the factory,

and for the manufactured output to

be sent to the customer straight off

the production line. In reality, such a

level of efficiency is almost impossible

to achieve, as allowances have to be

made for logistical problems, emerging

labour issues, and breakdowns on

the factory floor. However, identifying

the most efficient production timeline,

incorporating likely delays and setbacks,

is critical in minimising the amount of

cash tied up in inventory.

4. Purchase required inputs.
   Once the process has been planned, the
   production to pay cycle can be initiated
   (see above).


5. Manufacture product.
   Manufacturing the product is the core
   function of the company. However,
   goods need to be manufactured to
   the satisfaction of current and future
   customers. Therefore this process must

1 Forecast demand

2 Anticipate required output

3 Plan production process

4 Purchase required inputs

Start of production to pay cycle

5 Manufacture product

6 Store finished goods

7 Deliver finished goods to

shipper or customer