The importance of the management of working capitalinventories very quickly. Tesco plcis quite similar to Wetherspoon in this regard.
Rolls-Royce plc’s inventories tend to be non-perishable and it needs to hold invent-
ories in various stages through what must be a fairly long production cycle. This level
of variation in the amounts and types of working capital elements is typical of the
business world.
The relative vastness of the typical business’s investment in working capital has led
to the management of working capital increasingly being treated as fundamental to
the welfare of the business and to its ability to survive and prosper.The financing cost of working capital
Although, as we shall see as we consider each type of current asset in more detail,
financing is not the only cost of holding them, it still represents a considerable cost. To
illustrate this, let us consider Associated British Foods plc, using information pro-
vided in the business’s 2007 annual report. Applying the cost of capital value revealed
in the annual report (an average of 9.5 per cent), the financing cost of its current assets,
after taking account of the benefit of the ‘free’ trade payables finance provided by its
suppliers, was £131 million for 2007. This represented 24 per cent of the business’s
operating profit and 2 per cent of its revenue for that year. These are massive figures.
This example should not be taken to suggest that ABF mismanages its working
capital. This level of financing cost is typical of businesses operating in ABF’s areas of
activity. We shall refer to the cost of financing individual elements of ABF’s working
capital at several points in the chapter.The nature of decisions on working capital
We have just seen that the difference between working capital decisions and those
involving non-current assets and long-term finance does not apparently lie in the
amount of finance involved. To the extent that there is a difference, it lies in the tend-
ency for working capital decisions to be short term, reversible at relatively short notice
and more frequently made.
While they may be made more frequently, many working capital decisions are
straightforward since they tend to be repetitive. There will (or should) be a policy that
creates a set of rules to be followed. For example, each time a customer seeks to buy
goods on credit, a decision will be needed as to whether to grant credit at all and, if so,
how much. Most businesses will have decided on some formula that can be applied to
help them to reach a decision. The existence of such formulae has the advantage that
many decisions can be made by employees quite low in the management hierarchy,
and therefore they can be made fairly quickly and cheaply.
In establishing these formulae or sets of rules for the day-to-day management
of working capital, great care should be taken to assess which approach will most
advance the business’s objectives. Once a set of rules has been established it should
be regarded as the framework within which all working capital decisions must be
made.
It is unlikely that rules established at one time will continue to represent the most
beneficial approach over long periods of time. Circumstances, including the business’s
competitive position, interest rates and the economic environment generally, alter
over time. Policies must therefore be reviewed periodically and, if necessary, revised.