capital management essay

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The Importance Of Working Capital Management Essay

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Topic: Business , Trade , Management , Banking , Finance , Investment , Money , Company

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Published: 11/25/2019

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Introduction

The success of a company depends on the company’s attention to the short-term decisions. Short-term decisions affect the management of current assets and current liabilities. The company’s liquidity position depends majorly on the level of current assets of the company. If a company is to survive in the business, it must have the ability of generating enough cash that meets its short-term (current) needs (Bhattacharya, 2004).

Working capital management is therefore an important factor in the success of a company, both in the short term and long term. The degree of solvency or liquidity depends on the extent to which the company’s current assets exceed the current liabilities.

Working capital management is a strategy in accounting that focuses on maintenance of efficient levels of the working capital components, current assets and the current liabilities. For a company to meet its operating expenses and current debt obligations, it must efficiently manage its working capital. If a company wants to improve its earnings, it must implement an effective system of working capital management (Bhattacharya, 2004).

Working capital management has two main aspects: the management of the individual working capital components, and ratio analysis.

Objectives of working capital management

The main aims of working capital management are (Pass and Pike 1984):

1. To increase the company’s profitability.

2. To ensure that the company has sufficient liquidity in order to meet its short-term obligations. Profitability relates to the wealth maximization goal of the shareholders. Therefore, investing in current assets should only be considered if the return is acceptable. Liquidity, on the other hand, is necessary to keep the company in operation.

It’s worth noting that profitability and liquidity have conflicting goals as the liquid assets have the lowest returns.

For a company to manage its working capital effectively, it must formulate clear policies in the management of every component of the working capital. The main consideration is the working capital investment level for the operations, and the financing of the working capital.

A company must have clear policies on the management of the inventories, the trade receivables, the short-term investments, and the cash so as to minimize the chances of the managers making decisions that are not in the company’s best interests. Such decisions include giving credit to clients who are not likely to repay, and the ordering of inventories of raw materials that are not necessary.

Effective working capital management policies should reflect the corporate decisions on the investment required in current assets, and the financing methods of current assets. The policies should put into account the nature of the business of the company since every business has different requirement for working capital (Solawu, 2006). Considering a manufacturing company, heavy investment in raw materials, components and spares is required, which may result into more receivables. Such a company should have clear policies on receivables management. For a food retailer, large inventories are required for resale; however, very few trade receivables may result. A food retailer does not need to make credit sales thus no need for receivables management.

Inventory Management

Inventory is defined as a documentation of the company’s raw materials, work-in-progress and goods finished but not yet sold. It’s either direct or indirectly incurred in a company. For example, to produce tea, tea leaves are used as direct materials. Its management is of critical importance to the operations of any productive company. Efficient management of raw materials and work-in-progress facilitate a balance in the various levels of production. Managing finished goods however ensures guaranteed satisfaction of the consumer as the demand is met without a hitch arising in delivery delays. (Gopalakrishnan, 1980).

Objectives of Inventory Management

Core objective is to make certain that stock is adequate for the continuity of the company’s operations. It also aims at reducing the costs of holding an inventory, e.g. costs associated with holding finished tea in company stores (Shin and Soenen, 1998).

Types of inventory

Indispensable types of inventory include raw materials, work in progress and finished goods. For a company to realize an effective inventory management, decisions relating to commodities to stock, and how much to stock must be undertaken. A company can decide on which commodities to stock by using the material planning and sales ledgers accounts. For instance, based on how frequently a commodity is sold, a company can decide to stock more of the commodity (Gopalakrishnan, 1980).

Major approaches to inventory management include the following.

Economic Order Quantity Model

This model enables decision makers come up with an optimum quantity of stock to order solely to minimize total costs. These costs are the holding or carrying costs, ordering costs or set up costs and shortage costs. They must be minimized to increase efficiency and consequently productivity (Shin and Soenen, 1998). To determine how much to stock, the annual demand, cost of making an order and holding costs per unit order unit per annum must be known. For instance, to determine how much tea to stock, its annual demand, cost of making one order and holding cost for every order unit per annum must be used as under to arrive at the optimum stock (Gopalakrishnan, 1980).

D is the annual demand for tea

Co is the cost of making one order for tea

Ch is the holding cost per unit of tea per annum

Stock Level and its management

Decisions are made of stock level with a view to minimize costs but maximizing on efficiency in material availability. Therefore, a clear cut control levels should be put in place. For instance, minimum stock level, maximum stock level, re-order level and re-order quantity may be used to manage the stock level (Gopalakrishnan, 1980).

i. Minimum stock level

This is the minimum level which the stock should not fall. It the buffer stock level, calculated as Reorder level less the product of normal consumption and normal reorder period.

ii. Maximum stock level

This is the limit above which stock should not be allowed to go past. Each material kept in store must have a maximum level. Besides, stock should not be allowed to go past set level. It is determined as:

Maximum stock level = Re-order level + re-order Quantity - (Minimum consumption x minimum re-order period)

iii. Re-order level

This is a point that lies between minimum and maximum stock levels at which purchase orders must be placed to ensure that goods ordered are received before the minimum stock level is reached. It is the level of stocks at which replenishment must be made to avoid a stock-out and is estimated by obtaining the product of maximum consumption and maximum re-order period (Gopalakrishnan, 1980).

Pareto Analysis

Pareto analysis is an inventory management approach basically used to determine how much to optimally stock. For the analysis, items are grouped as either class A, class B or class C. Class A items are of high cost, fast moving and used highly. They are generally few and add up to only 20% of total items. Class B are the medium moving goods, accounting for only 15% of total item budget. Lastly, class C are slow moving cheap value items. They are generally many, constituting 65% of total number of items. It thus demands a company to group its core item as either fast moving, medium or slowly moving to know exactly how to optimally make an order (Bhattacharya, 2004).

Just In Time Inventory System (JIT)

This approach of inventory management helps determine when to stock. It advocates for 100% quality by ensuring that there is zero inventory and stockless production. Besides, it focuses on minimizing the time taken between the delivery and use of inventory. Basically, it upholds quality and reliability from supplier to curtail production hitches (Bhattacharya, 2004). Thus, it allows a company to benefit from reduced inventory holding, ordering and handling costs as it facilitates direct inventory movement from reception to production line. For example, a company producing tea may use a Just In Time approach to avoid costs associated with inventory holding, ordering and handling costs through ensuring that there is zero inventory in stores.

On the other hand, JIT manufacturing policy aims at reducing inventory by acting as a balance between various production stages. It is realized as a result of reorganizing company layout to minimize long queues of work in progress and production batches (Bhattacharya, 2004). Proper production planning is thus essential.

Cash Management

Cash management focuses on optimizing the available cash, increasing interests earned from other funds not put to use at a given time and reducing losses incurred as result of transmission of funds. It basically aims at establishing optimal cash balance to help meet both short term and long term company obligations. Its management is crucial in the sense that the company can easily figure how much cash is hold and the opportunity cost equal to the benefit which could have been reaped in an event where the cash was put to a different productive investment (Yong, 1996).

On the other hand, low cash associated with minimizing the foregone benefit cost might plunge a company in liquidity problems. This may make a company unable to meet its short term maturity obligations like paying off liabilities. This is why cash management is undertaken to come up with an optimum cash balance geared towards satisfying the transactional motive, precautionary motive and speculative cash motive. A number of techniques that can be used to by companies to maximize the amount of incoming cash and outflow and guarantee smooth running of business are below as was noted by Pass and Pike (1984).

Cash Budgeting

A cash budget records cash flows, i.e. recording of inflows and outflows anticipated from each functional budget. It manages cash by indicating to a company the anticipated cash inflows and out flows over a given budget duration. Expected extra cash and any likelihood of any cash shortfall can be easily identified as well. For instance, it presents detailed information to a company on the availability of excess cash that can be channeled to short term investments (Pass and Pike, 1984).

Besides, it is vital to an organization in that it eases planning of borrowing and investment. It shows the effect of each periodical demand, large stocks, unusual receipts and any laxity in accounting for receivables.

Recording Accounts Receivables

This approach upholds tracking who owes company money, how much they owe and when exactly the payment is due. It focuses on accounting for receivables and should show any outstanding total amounts and the reasons behind the why the payments are not yet made. It takes a proactive approach to fully record any unpaid bills (Yong, 1996). Accounts receivable database is often employed to follow keenly what the company is owned. Once put in place, any outstanding invoice can be accounted for.

Tracking Expenses

This approach basically helps manage the cash outflows, i.e. the company operating expenses. It efficiently manages cash by taking note of all the expenses linked with company operations. This is likely to maximize the available cash that can be used to meet any short term maturity obligations.

It is undertaken by developing a comprehensive report of every company’s expenses for each and every month that it is in operation. The expenses can be simplified further to as either rent, utilities or for office maintenance. Thorough reduction on these expenses then follow suit. For example, a company can reduce office supplies expenses by contracting and negotiating for lower prices as opposed to sourcing for supplies from store (Yong, 1996)

Creating Credit Lines

Well developed credit lines with the lenders help effectively manage cash flows and thus curtail any cash deficit. It is undertaken by establishing a line of credit that will cover the entire cash deficit times in events where sales decreases and expenses shoot.

Investing surplus cash

A company can as well manage cash surplus by investing in treasury bills and money market deposits to earn a return and thus avoid its holding costs. It is however crucial for a company to set limits of deposits to reduce likely losses due failure of these investments to perform.

Before a company commits to cash investment, factors such as yield and risk associated with the investment and ease with which returns can be achieved need to be put into consideration (Pass and Pike, 1984).

Managing cash flows

Cash flow management is another approach to manage cash effectively. This approach stresses that debt collection should be correlated to agreed credit conditions. Cash obtained should be timely banked to decrease the cost of interest charged on outstanding overdraft and to avoid the cost associated with holding cash like forfeiting returns. Also, it may be undertaken as prompt as possible to increase the level of return on cash deposits. The time between initiating payments and receiving cash into a company’s bank account --float--should be minimized as possible (Pass and Pike, 1984).

Receivables Management

Receivables are money a company is owed. Its management aims at eliminating losses and maximizing anticipated returns/profits. Its effectiveness is determined by a company’s operating terms of sales and company’s capability to match to similar terms of sale. The basic approaches that can be used to efficiently manage receivables include employment of discount for early payment, insuring against bad debts, credit control systems, trade receivables collection systems and putting in place credit analysis systems (Bhattacharya, 2004).

Credit control system

This approach of receivable management focuses on setting credit limit. It upholds that a company should ensure that the costumer is allowed credit that is in line with the terms of trade and to the credit limit of the organization. The company keeps customers account within an agreed credit limit. To promote timely payments, invoices and statements are thoroughly checked for correctness. However, this approach detests advancing of credit sales to customers who have surpassed the credit limit. By doing these, the accounts receivables will be reduced (Bhattacharya, 2004).

For example, assume that Company ABC wants to buy stock worth $100 on credit from XYZ manufacturing company whose credit limit is $90. Company ABC will not be advanced the credit as its order surpasses the credit level. Therefore, it implies that XYZ manufacturing company shall have avoided $100 receivables.

Offering discount for early payment

This approach aims at winning the customers to pay earlier enough to benefit from discounts. A company may decide to scale discounts received when payment are made at a given time, i.e. after a week, one month or after three months. It may then allow customers to pay less with respect to the duration taken to make payment. However, such discount must be lower than the total financing savings. Customers are likely to compete with time so that a larger discount is awarded. This way, the level of bad debts and long term debts is minimized thus receivables management effectiveness.

This is the selling of a company’s debts to a third party, known as a factor, at a fee usually paid in cash. In this approach, a company gives a factor a responsibility of sales administration and debts collection. It is therefore the responsibility of the factor to ensure that the debts are fully collected by following defaulters to the letter. Besides, a factor is in position to offer cash to the company against the security of the debts. This way, it results in a decrease in the value of working capital held up in trade receivables and hence likelihood of realizing higher returns since cost of holding debts is minimized (Bhattacharya, 2004).

Invoice discounting

This approach to receivables management entails sale of trade receivables to a third party but retaining ownership over sales ledger. For instance, if a company has trade debts amounting to $1000, it may decide to sell $500 to an invoice discounting agent at a fee but retain ownership of sales ledger

Managing Payables

The level of importance of creditors vary i.e. some are more important as compared to others. Some creditors are so essential that the business cannot run without prior settling of such bills. These bills are given the top priority. Such bills include the business insurance, the licenses and permits issued by the governmental authorities, the income taxes, the company’s key suppliers, the sales taxes and the company’s payroll, the mortgage payments or rents on the business premises, the utilities like water and electricity bills, and the wages, among others. All these bills are crucial for the day to day operation of the company and should be given priority.

The less important bills must also be paid. Failure to pay such bills makes the company be in a doubtable financial position. It is important to contact the creditors regularly and give the reasons for late payment. In some cases, the debts can be eliminated through provision of goods and or services. In cases where the business has seasonal fluctuations of cash flow, a negotiation can be made with suppliers so that payments are made during high cash flow seasons.

Lessons learned

The presentation of this paper has instilled in me the significance of having optimum inventory, trade receivables, payables and cash in a company. Besides, it presents me with ability and knowledge on the scope of methods that can be employed to effectively manage cash, inventory, trade receivables and trade payables. In essence, it gives me an in depth understanding of inventory management practices like the economic order quantity model, Pareto analysis, Just In Time and the importance of having a buffer inventory and lead times. It equips me with clear understanding of how factoring and invoice discounting assists in the management of working capital.

It has as well shed light in me why effective control of trade receivables demands thorough analysis of customer’s credit merit, control of credit awarded and effective collection of trade receivables. It’s marvelous to recognize that excess cash can be invested either in treasury bills or any other instrument to earn a return to a company as this shall have reduced cash holding costs hence profitability. Lastly, the presentation gives me an understanding as to why steps must be taken to establish why large value of cash is tied up in inventories of raw materials, work in progress and finished goods.

Bhattacharya, H., 2004. Working Capital Management: Strategies and Techniques. Prentice-Hall of India Pvt.Ltd. Cheatham, C., 1989. ‘Economizing on cash investment in current assets’, Managerial Finance, Vol. 15, No. 6, pp. 20–25. Chiou, J. R., Cheng, L. and Wu, H.W., 2006. “The determinants of working capital management”, The Journal of American Academy of Business, Vol. 10, No. 1, pp. 149-155. Deloof, M., 2003. “Does working capital management affect profitability of Belgian firms?” Journal of Business Finance and Accounting, 30(3) & (4), pp. 573-587. Devore, Jay L., 1995. Probability and Statistics for Engineering and the Sciences, 4th Edition, Duxbury Press. Filbeck, G. and Krueger, T. M., 2005. “An analysis of working capital management results across industries”, American Journal of Business, Vol. 20, Issue 2, pp. 11-18. Gitman, L.J., 2008. Principles of Managerial Finance, 12th edition, Boston: Pearson Education. Gopalakrishnan, P., 1980. Inventory and Working Capital Management Handbook. Macmillan Publishers, India. Howorth, C., and Westhead, P. ,2003. The focus of working capital management in UK small firms. Management Accounting Research 14, 94-111. Keown, A.J., Martin, J.D., Petty, J.W. and Scott, D.F., 2004. Financial Management: Principles and Applications, 10th ed, Harlow: Prentice Hall. Lazaridis, I., and Tryfonidis, D., 2006. Relationship between Working Capital Management and Profitability of Listed Companies in the Athens Stock Exchange. Journal of Financial Management and Analysis, 19(1), 26-35. Moyer, R. C., Mcguigan, J. R., and Kretlow, W. J., 2003. Contemporary Financial Management 9th ed. United States of America: Thomson. Padachi, K., 2006. Trends in working capital management and its impact on firms’ performance: an analysis of Mauritian small manufacturing firms. International Review of Business Research Papers, 2(2), 45-58. Pass, C. and Pike, R., 1984. ‘An overview of working capital management and corporate financing’, Managerial Finance, Vol. 10, No. 3/4, pp. 1–11. Peel, M. L. and Wilson, N., 1996. Working capital and financial management practises in small firm sector. International Small and Business Journal, 14(2), 52-68. Sanger, J. S. (2001). Working capital: a modern approach. Financial Executive, 69. Shin, H. H. and Soenen, L., 1998. “Efficiency of working capital management and corporate profitability”, Financial Practice and Education, Vol. 8, No. 2, pp. 37-45. Shin, H. H., and Soenen, L., 1998. Efficiency of working capital management and corporate profitability. Financial Practice and Education, 8(2), 37-45. Smith, K. V.,1980. Profitability and liquidity trade off in working capital management. In Reading on the Management of Working capital (pp. 549-562). St. Paul: West Publihing Co. Solawu, R. O., 2006. Industry Practice and Aggressive Conservative Working Capital Policies in Nigeria. European Journal of Scientific Research, 13(3). Van Horne, J.C. and Wachowicz, Jr., J.M., 2009. Fundamentals of Financial Management, 13th edn, Harlow: FT Prentice Hall. Weinraub, H. J. and Visscher, S., 1998. Industry practice relating to aggressive conservative working capital policies. Journal of Financial and Strategic Decisions,11(2). Yong H. K., 1996. Advances in Working Capital Management, Volume 3. Emerald Group Publishing Limited.

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• Working Capital Management
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Working Capital Management: What It Is and How It Works

What Is Working Capital Management?

Working capital management is a business strategy designed to manage a company's working capital. A company's working capital refers to the capital it has left over after accounting for its current liabilities. Working capital management ensures that a company operates efficiently by monitoring and using its current assets and liabilities to their most effective use. The efficiency of working capital management can be quantified using ratio analysis .

Key Takeaways

• Working capital management requires monitoring a company's assets and liabilities to maintain sufficient cash flow to meet its short-term operating costs and short-term debt obligations.
• Managing working capital primarily revolves around managing accounts receivable, accounts payable, inventory, and cash.
• Working capital management involves tracking various ratios, including the working capital ratio, the collection ratio, and the inventory ratio.
• Working capital management can improve a company's cash flow management and earnings quality by using its resources efficiently.
• Working capital management strategies may not materialize due to market fluctuations or may sacrifice long-term successes for short-term benefits.

Investopedia / Sydney Saporito

Understanding Working Capital Management

Working capital is a key metric used to measure a company's short-term financial health and well-being. It is the difference between a company's current assets and current liabilities. As such, it is the capital that is left after accounting for its current liabilities. Working capital management is a strategy that companies use to manage their leftover cash.

Current assets include anything that can be easily converted into cash within 12 months. These are the company's highly liquid assets. Some current assets include cash, accounts receivable (AR), inventory, and short-term investments. Current liabilities are any obligations due within the following 12 months. These include accruals for operating expenses and current portions of long-term debt payments.

The primary purpose of working capital management is to enable the company to maintain sufficient cash flow to meet its short-term operating costs and short-term debt obligations. A company's working capital is made up of its current assets minus its current liabilities.

Working capital management monitors cash flow, current assets, and current liabilities using ratio analysis, such as working capital ratio , collection ratio, and inventory turnover ratio .

Working Capital Management Components

Certain balance sheet accounts are more important when considering working capital management. Though working capital often entails comparing all current assets to current liabilities, there are a few accounts that are more critical to track.

The core of working capital management is tracking cash and cash needs. This involves managing the company's cash flow by forecasting needs, monitoring cash balances, and optimizing cash flows (inflows and outflows) to ensure that the company has enough cash to meet its obligations.

Because cash is always considered a current asset, all accounts should be considered. However, companies should be mindful of restricted or time-bound deposits .

Receivables

To manage capital, companies must be mindful of their receivables. This is especially important in the short term as they wait for credit sales to be completed. This involves:

• Managing the company's credit policies
• Monitoring customer payments
• Improving collection practices

At the end of the day, having completed a sale does not matter if the company is unable to collect payment on the sale.

Accounts Payable

Accounts payable refers to one aspect of working capital management that companies can take advantage of that they often have greater control over. While other aspects of working capital management may be uncontrollable, such as selling goods or collecting receivables, companies often have a say in how they pay suppliers, what the credit terms are, and when cash outlays are made.

Companies primarily consider inventory during working capital management as it may be the most risky aspect of managing capital. When inventory is sold, a company must go to the market and rely on consumer preferences to convert inventory to cash.

If this cannot be completed quickly, the company may be forced to have its short-term resources stuck in an illiquid position. Alternatively, the company may be able to quickly sell the inventory but only with a steep price discount.

Types of Working Capital

In its simplest form, working capital is the difference between current assets and current liabilities. However, different types of working capital may be important to a company to best understand its short-term needs.

• Permanent working capital: Permanent working capital is the amount of resources the company will always need to operate its business without interruption. This is the minimum amount of short-term resources vital to a company's operations.
• Regular working capital: Regular working capital is a component of permanent working capital. It is the part of the permanent working capital that is required for day-to-day operations and makes up the most important part of permanent working capital.
• Reserve working capital: Reserve working capital is the other component of permanent working capital. Companies may require an additional amount of working capital on hand for emergencies, seasonality , or unpredictable events.
• Fluctuating working capital: Companies may be interested in only knowing what their variable working capital is. For example, companies may opt to pay for inventory as it is a variable cost . However, the company may have a monthly liability relating to insurance it does not have the option to decline. Fluctuating working capital only considers the variable liabilities the company has complete control over.
• Gross working capital: Gross working capital is simply the total amount of current assets of a business before considering any short-term liabilities.
• Net working capital: Net working capital is the difference between current assets and current liabilities.

Why Manage Working Capital?

Working capital management can improve a company's cash flow management and earnings quality through the efficient use of its resources. Management of working capital includes inventory management as well as management of accounts receivable and accounts payable. 

Working capital management also involves the timing of accounts payable like paying suppliers. A company can conserve cash by choosing to stretch the payment to suppliers and make the most of available credit .

In addition to ensuring that the company has enough cash to cover its expenses and debt, the objectives of working capital management are to minimize the cost of money spent on working capital and maximize the return on asset investments.

Working Capital Management Ratios

Three ratios that are important in working capital management are the working capital ratio, the collection ratio, and the inventory turnover ratio.

Working Capital Ratio

The working capital ratio or current ratio is calculated by dividing current assets by current liabilities. This ratio is a key indicator of a company's financial health as it demonstrates its ability to meet its short-term financial obligations.

A working capital ratio below 1.0 often means a company may have trouble meeting its short-term obligations. That's because the company has more short-term debt than short-term assets. To pay all of its bills as they come due, the company may need to sell long-term assets or secure external financing .

Working capital ratios of 1.2 to 2.0 are considered desirable as this means the company has more current assets compared to current liabilities. However, a ratio higher than 2.0 may suggest that the company is not effectively using its assets to increase revenues. For example, a high ratio may indicate that the company has too much cash on hand and could be more efficiently utilizing that capital to invest in growth opportunities.

Collection Ratio (Days Sales Outstanding)

The collection ratio, also known as days sales outstanding (DSO) , is a measure of how efficiently a company manages its accounts receivable. The collection ratio is calculated by multiplying the number of days in the period by the average amount of outstanding accounts receivable.

This product is then divided by the total amount of net credit sales during the accounting period. To find the average amount of average receivables, companies most often simply take the average between the beginning and ending balances.

The collection ratio calculation provides the average number of days it takes a company to receive payment after a sales transaction on credit. Note that the DSO ratio does not consider cash sales. If a company's billing department is effective at collecting accounts receivable, the company will have quicker access to cash which it can deploy for growth. Meanwhile, if the company has a long outstanding period, this effectively means the company is awarding creditors with interest-free, short-term loans.

Inventory Turnover Ratio

Another important metric of working capital management is the inventory turnover ratio. To operate with maximum efficiency, a company must keep sufficient inventory on hand to meet customers' needs. However, the company also needs to strive to minimize costs and risk while avoiding unnecessary inventory stockpiles.

The inventory turnover ratio is calculated as the cost of goods sold (COGS) divided by the average balance in inventory. Again, the average balance in inventory is usually determined by taking the average of the starting and ending balances.

The ratio reveals how rapidly a company's inventory is used in sales and replaced. A relatively low ratio compared to industry peers indicates a risk that inventory levels are excessively high, meaning a company may want to consider slowing production to ease the cost of insurance, storage, security, or theft. Alternatively, a relatively high ratio may indicate inadequate inventory levels and risk to customer satisfaction.

In addition to the ratios discussed above, companies may rely on the working capital cycle when managing working capital. Working capital management helps maintain the smooth operation of the net operating cycle, also known as the cash conversion cycle (CCC) .

This is the minimum amount of time required to convert net current assets and liabilities into cash. The working capital cycle is a measure of the time it takes for a company to convert its current assets into cash, or:

Working Capital Cycle in Days = Inventory Cycle + Receivable Cycle - Payable Cycle 

The working capital cycle represents the period measured in days from the time when the company pays for raw materials or inventory to the time when it receives payment for the products or services it sells. During this period, the company's resources may be tied up in obligations or pending liquidation to cash.

Inventory Cycle

The inventory cycle represents the time it takes for a company to acquire raw materials or inventory, convert them into finished goods, and store them until they are sold. During this stage, the company's cash is tied up in inventory.

Though it starts the cycle with cash on hand, the company agrees to part ways with working capital with the expectation that it will receive more working capital in the future by selling the product at a profit.

Accounts Receivable Cycle

The AR cycle represents the time it takes for a company to collect payment from its customers after it has sold goods or services. During this stage, the company's cash is tied up in accounts receivable.

Though the company can part ways with its inventory, its working capital is now tied up in accounts receivable and still does not give the company access to capital until these credit sales are received.

Accounts Payable Cycle

The AP cycle represents the time it takes for a company to pay its suppliers for goods or services received. During this stage, the company's cash is tied up in accounts payable.

On the positive side, this represents a short-term loan from a supplier meaning the company can hold onto cash even though they have received a good. On the negative side, this creates a liability that needs to be managed.

Limitations of Working Capital Management

With strong working capital management, a company should be able to ensure it has enough capital on hand to operate and grow. However, there are downsides to the approach. Working capital management only focuses on short-term assets and liabilities.

It does not address the long-term financial health of the company and may sacrifice the best long-term solution in favor of short-term benefits.

Even with the best practices in place, working capital management cannot guarantee success. The future is uncertain, and it's challenging to predict how market conditions will affect a company's working capital.

Whether there are changes in macroeconomic conditions and customer behavior, or there are disruptions in the supply chain, a company's forecast of working capital may simply not materialize as expected.

While effective working capital management can help a company avoid financial difficulties, it may not necessarily lead to increased profitability. Working capital management does not inherently increase profitability, make products more desirable, or increase a company's market position.

Companies still need to focus on sales growth, cost control, and other measures to improve their bottom line. As that bottom line improves, working capital management can simply enhance the company's position.

Working capital management aims at more efficient use of a company's resources by monitoring and optimizing the use of current assets and liabilities. The goal is to maintain sufficient cash flow to meet its short-term operating costs and short-term debt obligations while maximizing its profitability. Working capital management is key to the cash conversion cycle, or the amount of time a firm uses to convert working capital into usable cash.

Why Is the Current Ratio Important?

The current ratio or the working capital ratio indicates how well a firm can meet its short-term obligations. It's also a measure of liquidity . If a company has a current ratio of less than 1.0, this means that short-term debts and bills exceed current assets, which could be a signal that the company's finances may be in danger in the short run.

Why Is the Collection Ratio Important?

The collection ratio, also known as days sales outstanding, is a measure of how efficiently a company can collect on its accounts receivable. If it takes a long time to collect, it can be a signal that there will not be enough cash on hand to meet near-term obligations. Working capital management tries to improve the collection speed of receivables.

Why Is the Inventory Ratio Important?

The inventory turnover ratio shows how efficiently a company sells its inventory. A relatively low ratio compared to industry peers indicates a risk that inventory levels are excessively high, while a relatively high ratio may indicate inadequate inventory levels.

Working capital management is at the core of operating a business. Without sufficient capital on hand, a company is unable to pay its bills, process its payroll, or invest in its growth. Companies can better understand their working capital structure by analyzing liquidity ratios and ensuring their short-term cash needs are always met.

Dr. Ajay Tyagi, via Google Books. " Capital Investment and Financing for Beginners ," Page 3. Horizon Books, 2017.

Dr. Ajay Tyagi, via Google Books. " Capital Investment and Financing for Beginners ," Page 4. Horizon Books, 2017.

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AGC Human Capital Management Essay

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Introduction

Human capital management problems at agc, data collection methods, drawing conclusions from the collected data, causes of agc human capital management issues.

Human capital management plays an integral role in the life cycle of any successful business venture. It can be defined as a set of practices concerning the management of the company’s human resources, including acquisition and optimization (D’Angelo, 2021). Meanwhile, a change management plan includes methods of leveraging organizational change through preparation, implementation, and follow-through stages (Stobierski, 2020). A thorough diagnosis should be carried out to discover the existing human capital management issues and determine the causes for their occurrence. Such a diagnosis is critical as the change management plan is based upon it and the discoveries made through the diagnosis.

Currently, AGC experiences several human capital management issues that prevent the company from advancing in the market. The most significant issue is employee motivation and retention. Acquisition, retention, and motivation of employees are crucial for the organization’s success as qualified workers can propel its growth and development. The second human capital problem at AGC is employee dissatisfaction. This issue is the cause of low retention and lack of motivation among different worker groups. It also contributes to employees being neglectful of their responsibilities and low productivity (Di Fabio & Peiró, 2018). AGC’s last human capital issue is the lack of diversity among employees. Although it is important to ensure that human capital acquisition is based on qualifications, diversity is essential as it enhances the business through exposure to different views and experiences.

Different data collection methods can be used to gather data on the existing human capital problems at AGC. Thus, data on the issues of low retention, motivation, and employee dissatisfaction can be collected via employee interviews and surveys (Currence, 2019). For example, exit interviews can help reveal reasons for leaving the company, while surveys help discover current issues or assess the effectiveness of the venture’s policies and programs (Currence, 2019). Data on the problem of insufficient diversity can be collected from the demographic data already available to the human resources (HR) department.

The described data collection methods are expected to produce large data sets that require careful analysis. Thus, all exit interviews should be evaluated using thematic analysis to determine the lead causes for employees deciding to leave the company (Rouder et al., 2021). The given reasons can contribute to a better understanding of the company’s inability to prevent high turnover and will allow us to address it effectively in the future. Similarly, the data collected from surveys will be analyzed with the use of thematic analysis. This approach will allow noticing patterns in employee dissatisfaction with their place of work (Rouder et al., 2021). Conclusions on workforce diversity will be drawn from the data on the demographic composition of the employees. Specifically, data on employee ethnicity, sex, age, family status, and education will be taken into consideration.

In summary, AGC faces serious human capital management issues, including low retention, lack of motivation, employee dissatisfaction, and lack of diversity. Such issues as high turnover, dissatisfaction, and lack of initiative are interrelated and stem from the company’s failure to create a sense of loyalty among employees. In addition, employees are not provided with a development plan and do not consider AGC as an organization where they can progress and develop their skills. Furthermore, the lack of diversity among managerial staff and the continuous failure of the HR department to hire groups underrepresented in the company should be viewed as the primary reasons for AGC’s uniform workforce.

Currence, J. (2019). Three key tools for collecting qualitative data . SHRM. Web.

D’Angelo, M. (2021). How to improve human capital management . Business News Daily. Web.

Di Fabio, A., & Peiró, J. (2018). Human capital sustainability leadership to promote sustainable development and healthy organizations: A new scale. Sustainability , 10 (7), 1–11. Web.

Rouder, J., Saucier, O., Kinder, R., & Jans, M. (2021). What to do with all those open-ended responses? Data visualization techniques for survey researchers. Survey Practice , 14 (1), 1–9. Web.

Stobierski, T. (2020). What is organizational change management? Business Insights. Web.

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Tesla Inc.’s Finances and Capital Management

Introduction

Tesla is an American multinational company that produces electronic cars and spare parts. From the annual report’s assessment, the organization had positive stocks, which made it record positive net income. At the same time, Tesla’s revenue generation outweighs its expenses, and the entity has a favorable cash position, indicating it can pay its costs and remain with accessible capital. Notably, the company’s financial ratios are positive, indicating that short-term and long-haul obligations can be met.

The automotive market segment has historically been essential to economic growth and development. According to Saberi (2018), it represents almost 4% of the world GDP, and, in the context of developed economies, 1% of automotive industry growth triggers respective 1,5% growth in the country’s GDP. Such a relationship is caused by the automotive sector’s strategic position in the middle of other market segments, which results in a multiplier effect. However, the industry nowadays has to face serious environmental concerns and anticipate energy crises. In this context, electric cars and the companies producing them, including Tesla Inc. (Tesla), receive much attention.

Tesla is a relatively new electric vehicle company that dedicated itself to researching, developing, and selling electric vehicles and their spare parts. It was founded in 2003 by people willing to prove that electric vehicles present a reasonable alternative to their fuel counterparts (Shao et al., 2021). Due to the specificity of Tesla’s chosen course, the company has a long history of enthusiastic research and development activity (Flehantova&Redka, 2021). However, this activity yielded little profit, and Tesla required substantial external investments to sustain itself in the first seven years (Shao et al., 2021). Eventually, the company decided to transition from being privately held to a public state.

Tesla made an Initial Public Offer (IPO), listing its shares on the NASDAQ stock exchange. The stock then grew gradually and eventually tripled its IPO value in three years (Shao et al., 2021). In 2014, the stock rose even more with the presentation of the auto-pilot function (Shao et al., 2021).

During the years that followed, the price of the stock remained approximately constant until 2020, when the share increased 4,5x more, overcoming the expectations. Thus, for the first time, Tesla managed to close a year with a positive net income.

Tesla presents an interesting case in terms of its capital structure. Being in a high growth stage, it does not generate enough revenue to pay dividends. However, paying dividends is more commonly attributed to more mature companies, while recent profits can be considered promising. According to Zhao (2021), in 2020, the company had a negative EBIT due to not having profit for the previous five years. Consequently, Tesla’s interest coverage ratio can not be greater than 0, which indicates that an optimal debt ratio should theoretically be 0 (Zhao, 2021). In addition, it implies the company does not have enough profit to pay all its debts; therefore, issuing any debt in this state would not be a good idea. Table 1 presents the respective calculations of a company’s capital structure.

The fact that Tesla finally started to earn money in 2020 does not have a significant influence on the overall state. Despite the company being able to pay the interest in the first half of the year, even the lowest 5% debt ratio would not allow it to pay for the total interest (Zhao, 2021). The displayed capital structure of Tesla can be considered reasonable only due to the sharp drop in the debt ratio from approximately 19% to 3%, which caused the company’s stock price to increase (Table 1). Another implication of the presented calculations highlights a higher cost of capital sensitivity in 2020 than in the previous years. Ultimately, it means Tesla has to be more attentive to its debt ratio fluctuations than it used to be.

To conclude, Tesla’s future seems promising even despite its rather volatile stock standings. It operates in a new, fast-growing, and unpredictable market; consequently, Tesla cannot rely on possible high expected future returns. Nevertheless, the external factors affecting the industry are greatly in Tesla’s favor. Natural resource depletion resembles a time bomb that will eventually cause significant disruption. Therefore, a focus on an alternative to fuel means of transportation slowly rises in value.

The company is listed on USA NASDAQ, with an IPO in June 29, 2010 and its headquarters is located in Austin, Texas, United States. The company was founded on July 1 2003 by Elon Musk, Martin Eberhard, JB Straubel, Marc Tarpenning and Ian Wright (Dzialo, 2018). Tesla is better described as a battery manufacturer, even if its name is most commonly associated with electric vehicles. The firm operates within the automotive sector where it is well-known for its expertise in solar panels and Lithium-ion battery energy storage.

According to the past three years’ worth of stock activity at Tesla Inc., the average share price for the company was about $205.39 as per the data provided by Yahoo Finance. Based on the data on the site, the stock price for 2020 was 29.53 USD, 2021 was 235.22 USD and as of December 31 2021 it was 352.26 USD (Microsoft Corp., 2022). The previous three years have seen a tremendous increasing trend in the price of Tesla Inc. shares with the December 2021 share prices being the highest.

The highest stock price as on October 3 rd 4:00 p.m. was $414.50 while the lowest was $206.86. Tesla’s 52-week high was at $414.50 on November 5, 2021.Today, this trend has reduced to $242.40 (Microsoft Corp., 2022). Over a span of three years, the prices of Tesla shares have increased in overall by about 4.8 percent and this is expected to rise over time at a similar rate. Similarly, the previous three years have witnessed the company’s revenue increase tremendously due to improved client base and sales.

When a company decides to split its stock into several shares, it is typically to reduce the price for investors and broadening the availability of the stock within the market. For example, when stocks are split, their value is divided up into smaller shares with a lessened buy-in value. However, the number of shares increases, and an existing investor owns a higher number of shares with the same value prior to the split.

With the company stock split having been rumoured for many months, the company ended up approving the 3-for-1 stock split during its annual general meeting held on August, 4, 2022. As research on the outstanding share of stock for Tesla has revealed that as per the quarter that was ending on June 30, 2022, there was about 3.465 billion outstanding share of stock (Microsoft Corp., 2022). This represents nearly 3.22% increase as compared to the previous financial year (Microsoft Corp., 2022). As of June, 30, 2021, Tesla’s shares outstanding were 3.387 billion representing an increase of 4.25% from the 2020 financial year.

Considering the variety of companies that are listed and are available for investment on the NASDAQ, I believe it would be prudent to invest into a company with a NASDAQ basis such as Tesla Inc. In addition, NASDAQ is such a well-known and trustworthy exchange, investors may be certain that they are receiving a fair return on their investment. To reiterate, NASDAQ companies are verified, legitimate investment opportunities due to the exchange’s history, stability, and reputation in addition to the level of vetting that occurs prior to inclusion with NASDAQ.

The New York Stock Exchange and the NASDAQ both operate within the same industry. An example of a company listed on the New York Stock Exchange include Forward Industries, Inc. (FORD). On comparison between the two companies, it is evident that the stocks are traded more often and are more costly on the NASDAQ stock exchange as they are on the New York Stock Exchange (Dzialo, 2018). This finding clearly depicts that an investor who purchases a single share on the NASDAQ stock exchange platform does so at a more expensive cost than on the New York Stock Exchange. This cost is probably high due to greater demands of stocks on the NASDAQ stock exchange.

Regardless, Tesla’s standing within the market has been fairly consistent and consistently sought after. Tesla’s ability to be on the cutting edge of technology, renewable resource investment, and futuristic endeavors make it appealing to individual investors and firms as well. With the level of innovation, excitement, and opportunity continuing to rise, Tesla will be a forerunner in the international market for years to come.

Financial Analysis of Tesla Inc.

To a great extent, Tesla is an automotive company mainly focused on researching, designing, and selling electric vehicles and their spare parts. The key areas of Tesla’s balance sheet include liabilities and assets, which stood at $30,584,000 and $62,131,000, respectively (Jonathan & Siegfried, 2021). Therefore, it indicates that the company has no debts and can sell its properties to cater for its expenses, indicating a positive and healthy status. In addition, Tesla’s income statement’s main areas involve the total expenses of $56,289,000, the entire revenue is $67,166,000, and the net income stands at $9,160,000 (Jonathan & Siegfried, 2021). It indicates that the company makes a profit and the revenue gathered can cater to its expenses without borrowing.

Ratios Reflection

For a firm to thrive, it must conduct a detailed ratio analysis, which assists in evaluating its books and obtaining an overview of its financial health. The liquidity (cash ratio and current ratio), profitability (return on equity and rotational of assets), and solvency (debts-to-assets ratio and the equity ratio) ratios selected help Tesla’s shareholders whether to continue investing. The current ratio quantifies an entity’s prowess to pay short-haul obligations. Tesla’s current analysis for 2021 was 1.37, indicating good financial stability as the firm can refund its debts sufficiently (Macrotrends, 2022). Notably, the cash ratio is a liquidity measure showcasing the organization’s short-term charges using cash and money equivalent. Tesla’s cash ratio is 1.59, thus the reason why it is preferred by creditors, analysts, and investors, as the firm can cover its current liabilities and have some remaining earnings (Macrotrends, 2022). Therefore, the liquidity ratio analysis of Tesla Inc. indicates that the company has pragmatic financial health.

Rotational of Assets (ROA) is evaluated by dividing actual earnings by the entire properties, and the more the sales and profits are generated by Tesla, the more it amasses its assets. Currently, Tesla’s ROA stands at 9.08, showcasing positive monetary fitness (Macrotrends, 2022). The return on equity (ROE) calculates the capability of a firm to earn profits from its speculations. Tesla’s ROE is 18.19, manifesting it remains effective in manufacturing and outperforming other entities in the same market (Macrotrends, 2022). The debt-to-asset ratio measures how much of the venture is owned by creditors contrasted to the shareholder’s possessed properties. For Tesla, it is 0.53, indicating that for every $1 debt, Tesla assets are worth $2 (Macrotrends, 2022). Lastly, Tesla’s equity ratio is 0.9177, and since it is zero, the company has good financial health (Macrotrends, 2022). The solvency and profitability ratios are positive, showcasing that the company management is making good decisions to ensure the entity has more assets.

Healthy Status of Tesla Inc. and Comparison

Significantly, Tesla Inc. is heading in the right direction as the solvency, profitability, and liquidity ratios are all positive, indicating good financial health to meet its short-haul and long-term obligations without bankruptcy. In addition, from the balance sheet, the company’s assets outweigh its liabilities, indicating no financial distress as it can pay short-term debts and still have substantial earnings.

By comparing Tesla and Volkswagen entities based on the ratio categories, it is clear that Tesla is more efficient than its competitor as its ratio analysis is extensively valuable and stable. Regarding the solvency ratio, Tesla’s cash flows are high, and con covers its long-term debt compared to Volkswagen, which has a high chance of defaulting on its bills. Tesla’s profitability ratios metrics show that analysts, shareholders, and investors would prefer the company to Volkswagen due to its high capability of generating more income (Jonathan & Siegfried, 2021). Contrasted to Volkswagen, Tesla has positive solvency ratios, whereby the company can meet its long-haul debt obligations and pay its lenders. Therefore, it shows Tesla has sufficient cash flow to meet its long-term liabilities, indicating good financial health.

Cash Position and Reflection

Tesla’s annual report offers data and analysis concerning its operations and financial performance. The assessment of the key financial statements enables the entity to summarize its achievements over the past year. To a great extent, the cash position represents the amount of money that Tesla has on its books of accounts at a given period. Tesla’s cash on hand for 2022 was $18 billion, a 17% increase contrasted to 2021. In 2021, its accessible capital was $17 billion, an 8% decline from 2020 (Macrotrends, 2022). Therefore, Tesla’s cash position is positive, as the decline witnessed in 2021 was due to low sales of electronic cars due to the COVID-19 impact (Macrotrends, 2022). At the same time, for the last three years’ annual report examination, Tesla reflects positive cash balances. After paying its costs, Tesla has some accessible money, including assets that can be liquidated into cash within 90 days (Laws, 2019). The firm can meet its short-term obligations successfully without facing financial obstacles.

Cash Flow Sustenance Methods

Tesla’s management uses various approaches to ensure the enterprise maintains pragmatic cash flows. At first, they charge a deposit, invest in bitcoin, and establish milestones for the long-haul projects, making the customers purchase more commodities from the company (The Fly, 2022). Secondly, Tesla’s high product prices target wealthy people, making them record more profits and keep a positive net income. In addition, the firm’s management negotiates terms with vendors to reduce expenses. The leveraging of the costs makes the company record improved revenue (Laws, 2019). Finally, Tesla’s executives implement systems, including streamlining workflow, enhancing customer communication, and processing returns to ensure they save costs by improving productivity, thus maintaining positive cash flow.

Financing Methods

The trade credit is Tesla’s first short-term financing method, whereby the company’s management buys materials and supplies on solvency from other entities, recording the debt as an account payable. Due to prompt payments, Tesla receives extensive discounts from the sellers, enabling the executives to fund its operations successfully. From the firm’s annual report balance sheet, it is evident that commercial bank lending is another monetary approach, which is recorded as notes payable (Zhu et al., 2021).

Tesla requires extra capital to meet its growing needs, including investing in research and development to manufacture eco-friendly cars. Lastly, commercial paper is used to finance key operational activities at Tesla. The organization’s well-established promissory notes are sold to other core ventures, banks, and insurance enterprises. Tesla has a high credit rating, enabling most investors to support tasks undertaken at the company (Jonathan & Siegfried, 2021). Commercial papers have substantial liquidity value and an elaborate maturity range that is flexible. Therefore, Tesla can save more money and earn a good return from the investments made.

Conclusion and Recommendations

Tesla is a multinational company that manufactures electronic cars and spare parts. The final recommendation is that Tesla Inc. would be a good investment for potential investors. Based on the financial performance, the company has a positive generation of revenue to cater to the expenses and has a positive net income indicating it makes more profits. In addition, the company has more assets compared to its assets. To a great extent, Tesla’s financial performance has been sustainable within the last three years with no liquidation uncertainties despite reduced sales due to the COVID-19 pandemic. The financial analysis regarding profitability, liquidity, and solvency ratios is positive, showcasing Tesla’s positive monetary health, and the investors should fund the company operations as they will receive substantial dividends.

Dzialo, B. (2018). Charging down the road: A historical analysis of the American auto industry and Tesla . (Publication No. 144578) [Master’s thesis, the University of Vermont]. Sage.

Flehantova, A., &Redka, O. (2021). Innovation as the main driver for the future economic growth of the company (on Tesla, Inc. example). In Economy and Human-Centrism: The Modern Foundation for Human Development: V International Scientific Conference (pp. 89-92).

Jonathan, H. U. K. E., & Siegfried, P. (2021). Finance methods in the automotive sector-business agility in the age of digital disruption. International Journal of Automotive Science and Technology , 5 (3), 281-288. Web.

Laws, Jason. (2019). Essentials of financial management . Liverpool University Press.

Macrotrends. (2022). Tesla financial ratios for analysis 2009-2022 . Macrotrends. Web.

Microsoft Corp. (2022). Profile, business summary, and analysis . Yahoo Finance. Web.

Saberi, B. (2018). The role of the automobile industry in the economy of developed countries . International Robotics & Automation Journal , 4 (3), 179-180. Web.

Shao, X., Wang, Q., & Yang, H. (2021). Business analysis and future development of an electric vehicle company – Tesla. In 2021 International Conference on Public Relations and Social Sciences (ICPRSS 2021) (pp. 395-402). Atlantis Press. Web.

The Fly. (2022). Tesla ceo says bitcoin conversion intended to ‘maximize cash position.’ The Fly. Web.

Zhao, L. (2021). Capital structure of new energy automobile industry. In Proceedings of the 4th International Conference on Economic Management and Green Development (pp. 236-246). Web.

Zhu, E., Zhang, Q., & Sun, L. (2021). Enterprise financing mode and technological innovation behavior selection: An empirical analysis based on the data of the world bank’s survey of Chinese private enterprises. Discrete Dynamics in Nature & Society, 26 (4), 1–11. Web.

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Management of Working Capital in Business

The inventory management techniques, the way to manage the inventories, the example of the eoq techniques, the cash models techniques, the examples of the cash model techniques, list of references.

Working capital demonstrates how much liquid asset is accessible to satisfy the short-term cash requirements obligatory by current liabilities in a business. The working capital assumes that current asset and current obligation are short-term concepts; thus, it is defined as a short-term concept. A working capital shows the efficiency and stability of the short-term financial in the business. In case the working capital is stale it shows that the business is capable of meeting its debt obligation without any difficulties. The main component of the working capital includes asset that comprises current and fixed assets and liabilities that comprises the short-term operating liabilities, long and short terms financial debt and equity. The current liabilities are also referred to as a long-term capital; therefore, working capital is usually defined as; Working Capital = Current Assets – Current Liabilities. Thus, the thesis statement of working capital will be; working capital management ensures that sufficient liquid resources are available to understand the influences and affect the developments and profitability in the business environment.

The working capital plays significant roles in the development and profitability of the businesses in the economy by reducing risks of business. Important corporations implement managing working capital because it not only protects business from recession period and non-forecast situations, but it also allows expansions when business formulate new plans strategies. The working capital gives a business a strong foundation, flexibility, and strength to undertake business opportunities in the market despite the competition.

It builds the inventories required to generate the optimum profit needed to stabilize the business from collapsing due to lack of proper management. The prospects of the business have improved gradually because working capital aid in making the fabulous ideas into reality due to, an establishment of working capital loans that do not require securities.

Therefore, working capital fulfils the expectations of business and overcome challenges to meet the business targets despite the current situations in the economy market. It maximizes the possibilities of establishing lasting and successful business ideas and measures for operational efficiency. The large number of debtors in the company indicates the company is not prepared to undertake the obligations of paying its arrears obligations. The proper management of working capital ensures the debtors get their dues on time, consequently, if a company is not operating efficiently, it will indicate working capital is low, therefore, significant problem in the company’s developments and profitability.

The business can manage the working capital properly to obtain the solution to amend the problem so that shareholders can increase their trustworthiness to the company. By managing and controlling the stocks and the financial situations that lead to significant performance of the company Stock ownership. The working capital gives the employees financial rewards during the profitability period of the business. Afza and Nazir (2008) demonstrated that if the company has a negative, working capital it shows, debtors use excessive credit transfer facilities in the company and the firms borrow high amount of loans to manage the business. This will lead business into problems with debt collection or the financial position of significant customers, and management of the business should control the problem to avoid the dissolution. In conclusion, the working capital is hugely significant in business, and it improves the development and the profitability of the business in the market.

The working capital management is founded on the basic balance sheet identity that consists the working capital components, written as (Carole, 2003).

Networking capital (cash + other current asset)-current asset) + fixed asset =long-term debt equity. Alternatively, cash may follow:

• Cash =Long term +Equity + current liabilities- Current assets other than cash – Fixed assets.

The increased need for cash in the business finances long-term debt of the company, and it consider raising long-term loan from banks to fund the intended investment to expand the profits of the company. Meanwhile, the business should consider increasing its equity by issuing shares to increase capital that will help to manage the working capital effectively; the additional costs related to such method are reduced due to proper management of capital. The company may increase its current liabilities management by negotiation of long credit periods from its general creditors, to increase the payable periods. Such management methods are dependent on the operating cycles of its creditors. Besides, such negotiation depends on the bargaining power of the business and during adverse scenario may destroy the business relationship between the company and its suppliers in the process of management.

The company may decrease its current assets other than cash, for instances the company may consider selling some inventories for cash by promotion. Chiou et al (2006, 149-155) state that the company may further reduce the inventories period by adopting Economic Order Quantity model (EOQ) or Just in Time (JIT) techniques used in the working capital management.

The current system and the purchase cycle of the company have to determine the optimum quantity ordered for EOQ techniques in working capital management. Finally, the business may decrease its fixed assets because there may be certain plant or equipments that are obsolete or no longer required by the company for business production. Realizing such fixed assets for cash can be a means to manage the working capital in the business (Deloof, 2003).

The components of working capital are managed by use of the following methods:

• The Trade Credits

The perish ability and collateral value as well as consumer demand, are factors that influence the credit period of the company. Products that are established have more rapid turnover, costs, profitability, and standardization. Relatively, inexpensive goods tend to have shorter credit periods, risks and the greater the credit risk, the shorter the credit periods are likely to be. The size of accounts and the bigger the accounts customers the longer the credit period required for the management of the components of the working capital.

• The Trade Debt

The payable period of the long-term capital, contribute to the high and low liquidity of the company. The company finances working capital not only by short-term bank loans but also by the trade debts that have an unusually long payable period (Dev, 2003). Alternatively, in view of the high level of cash management in the company, it should consider taking any trade discount from the suppliers, if there are no existing or contemplated projects that require substantial cash (Eugene and Brigham, 2009).

• Cash Management

There are three motives for the liquidity, namely speculative, precautionary, and the transaction motives (Filbeck and Krueger, 2005). There may be additional reasons to hold sufficient cash balances at the commercial banks to compensate for the banking services that the company receives. The company may require cash for working capital management activities and need cash for possible expenditures, such as acquiring other business.

• Cash operating cycle management

Cash operating shows the parameters used to measure the management performance of the company. The receivables and payable in the operating cycle show how the company manages decisive operational, capital assets. The average cash operating cycle of the company is demonstrated in the following formula (Eljelly, 2004).

Cash cycle = operating cycle (inventory period + Accounts receivable period) – Accounts payable period. Therefore, the company should manage and control the inventories of the company well to expand its operations in the market niche.

Management of stocks and other financial instruments Filbeck et al (2007) on their research demonstrated that shareholders increase their trustworthiness to the company manages; control the stocks and the financial situations. The business should improve the international operations, to face the foreign exchange exposure, including transaction and translation exposure. It helps the company to monitor its total foreign currency exposure centrally to net off affiliate positions and hedge transactions with the banks. The company is capable to protect the anticipated foreign currency revenue with appropriate foreign exchange contracts; hence, the company is capable of managing the components of working capital through the foreign sources.

Working capital management techniques used by business helps in efficiently management of working capital. Working capital management means managing current assets and working capital management techniques are very effectual tools.

Working Capital = Current Assets – Current Liabilities. The business focuses on current assets because they forecast the current liabilities, therefore, controlling the current assets can as while controlling the current liabilities. The following are the working capital technique that manages different components of working capital.

During the recession and tight money periods the business has to be flexible in the inventory management for instance the quantity to be ordered may need to be adjusted to reflect the increase costs.

Garcia and Martinez (2007, pp164-177) state that inventory costs comprise ordering costs and carrying costs ordering costs include the cost of placing order and receiving the goods. Examples are freight changes and clerical costs, these costs assume constants for each order, irrespective of the number of the units in the order.

Total number of orders = S/EOQ,

• S = sum usage

EOQ =economic order quantity: the maximum amount of order (ordering and carrying)

Total order costs = S/EOQ *O

• O = cost per order

Carrying the costs includes the shortage, handling, and insurance costs as well as required return rate on the inventory investment. James (2010) demonstrated the inventory technique model that assumes constant per unit of the inventory is obtained by the following equation.

Total carrying cost = EOQ/2 * C

• C = carrying cost per unit

EOQ/2 = average inventory quantity for the period.

Total inventory cost = (S/EOQ *O) + (EOQ/2 * C)

Jae and Joel (2009) show that there exists a swap between the order size and the carrying cost, the higher the order quantity (EOQ), the higher the carrying cost, the lower the ordering cost.

EOQ= square root of (2SO/C).

The Business is trying to determine the frequency of orders for an item from a supplier. Each item cost $ 10. Carrying cost that estimates at $200 per year. The business anticipates selling 100 units per month. Average desired inventory is 100. Order cost is $10 and the business want to know the optimum quantity and the order frequency.

EOQ= the square root of (2SO/C), the square root of {(2) (12 *100) *10}/ 2 = the square root of 12000 =109, C = Carrying cost / Average inventory, (which equals unit cost * average quantity).

200/10 * 100 =200/1000 =0.2 or 20%

C = Purchase price * percentage of carrying cost to average investment

C = $100*0.2=2

The number of orders per year = S/ EOQ= 1200/109=11(rounded)

The inventory techniques help the business to evaluate the efficiency associated with buying and controlling inventory in case there is a lack of control and the restrict inventory balances (Hrishikesh,2004). In addition, it evaluates the future trends in the product and the services prices, if the expected price increase it is good for the company to buy more resources. It also utilizes computer techniques and the operations research properly to manage the inventory of the business. The weakness of the inventory techniques is that, in case of the resources shortage on the safety of the stock balance the problem could cause the shutdowns of the business.

Lorenzo and Virginia (2010) in their research demonstrated that several mathematical models have been formulated to assist the financial managers in distributing a company’s finances so that they can provide a maximum return to the company. The objective of the model is to reduce the sum of the fixed costs of the transactions and the opportunity of holding the cash balances that are non-profitable. Nazir and Afza (2008) in their work showed the cost model equation as F (T)/C + I (C)/2.

• F = the fixed cost of a transaction
• T =the total cash needed for the period involved
• I = the interest rate on the marketable securities
• C= cash balances
• The optimal level of the cash C* is determined using the following
• C* = square root of (2FT/ i)

The business estimate cash for $5000, 000 over a non-month period during which the cash accounts at a constant rate. The rate of return is 5 percent per annum and the transaction cost each time the business borrows or withdraws is $50. The optimal transaction size and the number of the transaction the business should make during the month follows:

C* = square root of (2FT/I ) = square root of the[ ( 2 * 5000000 *50)/ 0.05] = 100000

C* = $100000

C*/2 = $100000/2=500000

Therefore, $50000/500000=1 (transaction during the month).

The main weakness of the cash model techniques is that the fixed costs of the securities transaction are assumed to be the same, for buying and selling of which is not reality in the market, and the randomness of the cash flow is another weakness of the cash technique(Myers, 2007). Meanwhile, the cash model helps the managers to distribute the company’s finances so that they can provide a maximum return to the company. Michalski (2007, 42-53) states that management of the working capital consists, evaluating of various types of the current assets and current liabilities and evaluation helps in making decisions on assets finances. Working capital involves transaction between return and the risks, if the funds go from fixed assets to current assets, there is a reduction in liquidity risks, greater ability to get short term financing, and enhancing the conflicting objectives of the working capital (Mathuva, 2009).

In conclusion, financing with noncurrent debt has less risk than financing with the current debt; however, the long-term debt has a higher cost than short debt because of the greater uncertainty that detracts from overall return. When there is conflicting objective of the working capital, the business should use the hedging approach of financing where asset finances liabilities of the similar maturity. Meanwhile, the longer the period required to purchase and produce goods, working capital available to finance the situations. Finally, the company should analysis working capital to ensure gives a good result in the net saving and obtaining optimum profitability.

Afza, T., M. S. Nazir, 2008. Working Capital Approaches and Firm’s Returns:  Journal of Commerce and Social Sciences , 1(1), 25-36.

Carole, P.W., 2003. The Focus of Working Capital Management in UK Small Firms; Management Accounting Killington : Vol. 14, (2), p.94.

Chiou, J. R., Cheng, L., Wu, H.W., (2006). “ The determinants of working capital management”, The Journal of American Academy of Business, Vol. 10, No. 1, pp. 149-155.

Deloof, M., (2003). “Does working capital management affect profitability of Belgian firms?” Journal of Business Finance and Accounting, 30(3) & (4), pp. 573-587.

Dev, S., 2003. “ The Impact of working capital investment on the value of a company ,” Published by RMA Journal.

Eugene, F. Brigham, J. F., 2009. Fundamentals of Financial Management . New York: Cengage Brain.com.

Eljelly, A., 2004. Liquidity Profitability Tradeoff: An Empirical Investigation in an Emerging Market: International Journal of Commerce and Management , 14: 48- 61.

Filbeck, G., Krueger, T. M., 2005. “ An analysis of working capital management results across industries,” American Journal of Business, Vol. 20, Issue 2, pp. 11-18.

Filbeck, G., Krueger, T. M., Preece, D., (2007). “CFO Magazine’ Working Capital Survey: Do Selected Firms Work for Shareholders?” Quarterly Journal of Business & Economics, Vol. 46, No 2, pp. 5-22.

Garcia, T., Martinez, S. P., (2007). Effects of Working Capital Management on SME Profitability. International Journal of Managerial Finance . 3(2), 164-177.

Hrishikesh, B., 2004. Working Capital Management: Strategies and Techniques . New Delhi: PHI Learning Pvt. Ltd.

Jae, K. S., Joel, G. S., 2009. Handbook of Financial Analysis: Forecasting and Modeling. 3 rd Ed. New York: CCH Inc.

James, S., 2010. Essentials of Working Capital Manag ement. New York: John Wiley and Sons Inc.

Lorenzo A. P., Virginia S., 2010. Working capital management . 3 rd ed. New York: Oxford University Press.

Myers, R. 2007. “ Growing Problems: The Working Capital Survey ”, CFO Magazine.

Mathuva, D., 2009. The influence of working capital management components on corporate profitability: a survey on Kenyan listed firms. Research Journal of Business Management, 3: 1-

Vijay, A.K., 2001. Working Capital Management . New Delhi: Northern Book Centre.

Michalski. G. 2007. Portfolio Management Approach in the Trade Credit Decision Making. Rom J Econ. Fore. 3 42-53.

Mohammad, D.H., Nahian, R., 2005. Financial Management Decisions in the Newspaper Industry in Bangladesh: a case of the daily prothom Alo . 34 577-582.

Nazir Ms., Afza, T., 2008. On the Factors Demining Working Capital Requirements . Proc. ASBBS, 15(1): pp293-301.

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Every Successful Company Needs to Manage Working Capital Management

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