Summary
Working capital (WC)
lWC =inventories +trade receivables +cash −trade payables.
lAn investment in WC cannot be avoided in practice – typically large amounts
are involved.
lManagement of WC is concerned with striking a balance between the risks
and costs of having too much of each element, with those of having too little.
lDecisions on WC tend to be frequent and routine.
lWC must be managed as a whole, not just individual elements. Ratios (for
example, current ratio) and operating cash cycle (see below) are useful here.
lOvertrading means operating at a level beyond the capacity of the working
capital. Can be a particular problem for rapidly expanding businesses.Operating cash cycles
lOperating cash cycle (for a manufacturer) =length of time from buying raw
materials inventories to receiving cash from trade receivables less trade pay-
ables settlement period (in days).
lAn objective of WC management is to limit the length of the operating cash
cycles, subject to any risks that this may cause.Inventories
lCosts of holding inventories:
lFinancing cost.
lStorage cost.
lInsurance cost.
lObsolescence.
lCosts of not holding sufficient inventories:
lLoss of customer goodwill.
lProduction dislocation.
lLoss of flexibility – cannot take advantage of opportunities.
lReorder costs – low inventories implies more frequent ordering.
lPractical points on inventories management:
lIdentify optimum order size – models can help with this.Summary
Manage exchange rate risk
This is the other side of the coin from the similar problem related to trade receivables
that we discussed in that context earlier in the chapter. It will be discussed at some
length in Chapter 15.Ratios
The most useful ratio in the monitoring of trade payables is the trade payables settle-
ment period ratio (average trade payables ×365/annual credit purchases). This gives
a view of how long, on average, the business is taking to pay its suppliers, which can
be compared with the planned period.‘