BUSF_A01.qxd

Management of working capital

In this chapter we shall deal with the following:

13.3 The importance of the management of working capital

‘its importance as a source and use of short-term finance

13.4 Working capital and liquidity

‘the management of the individual elements of working capital: inventories,

trade receivables, cash (and bank overdrafts), and trade payables

‘the necessity for establishing policies on each element of working capital

and so providing a framework for its practical management

Chapter 13

Objectives

13.1 Introduction

The need for working capital

When businesses make investment decisions they must not only consider the financial

outlay involved in acquiring the new machine or the new building, or whatever, but

also take account of the additional current assets that any expansion of activity will

usually entail. Increased output tends to engender a need to hold additional inventor-

ies of raw materials and work in progress. Increased sales revenue usually means that

the level of trade receivables will increase. A general increase in the scale of operations

tends to imply a need for greater levels of cash. As with any investment, working

capital exposes the business to risk.

Financing working capital

The current assets (inventories, trade receivables and cash) tend not to be financed

entirely from long-term sources of finance. Most businesses also have access to two

major short-term sources. The first of these is trade credit, arising from the fact that

purchases of goods and services are usually on credit; in other words, the buyer does