unit 5 summary

Management of Working Capital

Managers handle key short-term decisions facing their companies on a regular basis. Specifically, the management of working capital - or current assets, and management of short-term financing. Management of Working Capital Working capital is another name for current assets- assets that can be liquidated rather quickly. Examples include cash, inventory, and receivables. We also have what is called Net Working Capital (NWC); or current assets minus current liabilities. NWC is a measure of solvency and financial strength of an enterprise. One of a manager’s main tasks is to set effective working capital policies for her/his business. Such policies set optimum levels for key current asset items such as cash, inventory and receivables. They also map out ways that such items will be financed. Finally, working capital policy helps to design and implement certain administrative actions that are necessary for the effective operation of a business such as collection actions and credit extension to new customers. Cash Management If there is one single management function that ties together all the short-term decisions within a given company, it is this: cash management - or more specifically, the task of preparing and implementing cash budgets. A detailed cash budget maps out the cash status (deficit or surplus) for a company during a forecast period - say over the next 12 months. By looking at a cash budget, a manager can tell how much money will be needed and when. Once this is an identified and known element, then management can start thinking about the ways future needs could be financed. Management, for example, may ask for a bank loan, issue short-term notes, or even enter into strategic partnerships with its suppliers. In short, we can see how central cash budget is to a sound working capital policy. Receivables and Inventory Accounts receivable and inventories are among the main balance sheet items that could tie up a company’s limited funds - funds that could be used elsewhere for more productive purposes. Given all funds have a cost; such mismanagements can certainly hurt the bottom line at any company. As such, managers need to watch such accounts very closely and take corrective actions if required. For example, one reason for inflated receivables may be due to late payment by some customers. In this case, the company’s credit policy toward late-payers needs to be re-examined and enforced or in case of inventory, just in time systems may need to be considered. Short Term Financing Businesses rely on short-term financing from external sources for two reasons; profits may simply not be high enough to keep up with the rate at which the company is buying new assets, and many firms would rather borrow the money at the outset and make their purchases on time rather than wait to save enough money from net profits to make their desired purchases. The most prevalent forms of short-term financing available to businesses are loans from banks and other institutions, trade credit, and commercial paper. While short-term financing is usually a cheaper option than long-term financing, it is also a riskier option. Unlike long-term financing, the loans come due soon, the lender may not be willing to renew financing on favorable terms, and short-term interest rates may rise unexpectedly. In short, finance is important to business people and the financial decisions a manager makes about how to raise, spend, and allocate money can affect every aspect of a business. In other words, financial managers need always be aware of the organization’s long-term and short-term financial needs and make reasoned, ethical, and sound decisions to add value to the firm.