Weekly Finance Tips

Archive for February, 2012

Management of working capital

Guided by the above criteria, management will use a combination of policies and techniques for the management of working capital. These policies aim at managing the current assets (generally cash and cash equivalents, inventories and debtors) and the short term financing, such that cash flows and returns are acceptable.

Cash management. Identify the cash balance which allows for the business to meet day to day expenses, but reduces cash holding costs.
Inventory management. Identify the level of inventory which allows for uninterrupted production but reduces the investment in raw materials – and minimizes reordering costs – and hence increases cash flow. Besides this, the lead times in production should be lowered to reduce Work in Progress (WIP) and similarly, the Finished Goods should be kept on as low level as possible to avoid over production – see Supply chain management; Just In Time (JIT); Economic order quantity (EOQ); Economic quantity
Debtors management. Identify the appropriate credit policy, i.e. credit terms which will attract customers, such that any impact on cash flows and the cash conversion cycle will be offset by increased revenue and hence Return on Capital (or vice versa); see Discounts and allowances.
Short term financing. Identify the appropriate source of financing, given the cash conversion cycle: the inventory is ideally financed by credit granted by the supplier; however, it may be necessary to utilize a bank loan (or overdraft), or to “convert debtors to cash” through “factoring”.

Decisions relating to working capital and short term financing are referred to as working capital management. These involve managing the relationship between a firm’s short-term assets and its short-term liabilities. The goal of working capital management is to ensure that the firm is able to continue its operations and that it has sufficient cash flow to satisfy both maturing short-term debt and upcoming operational expenses.

Decision criteria

By definition, working capital management entails short term decisions – generally, relating to the next one year period – which are “reversible”. These decisions are therefore not taken on the same basis as Capital Investment Decisions (NPV or related, as above) rather they will be based on cash flows and / or profitability.

One measure of cash flow is provided by the cash conversion cycle – the net number of days from the outlay of cash for raw material to receiving payment from the customer. As a management tool, this metric makes explicit the inter-relatedness of decisions relating to inventories, accounts receivable and payable, and cash. Because this number effectively corresponds to the time that the firm’s cash is tied up in operations and unavailable for other activities, management generally aims at a low net count.

In this context, the most useful measure of profitability is Return on capital (ROC). The result is shown as a percentage, determined by dividing relevant income for the 12 months by capital employed; Return on equity (ROE) shows this result for the firm’s shareholders. Firm value is enhanced when, and if, the return on capital, which results from working capital management, exceeds the cost of capital, which results from capital investment decisions as above. ROC measures are therefore useful as a management tool, in that they link short-term policy with long-term decision making. See Economic value added (EVA).

Credit policy of the firm: Another factor affecting working capital management is credit policy of the firm. It includes buying of raw material and selling of finished goods either in cash or on credit. This affects the cash conversion cycle.

Do you have several unsecured debts? Can you no longer afford your agreed monthly payments? Having debts you’ve lost control of can be a stressful and difficult situation for many people. But getting some debt advice could help you find an answer to the problem.

Debt management is designed to give struggling borrowers a way of repaying their unsecured debts at a manageable pace, with lower monthly repayments – and could go a long way to easing the stress of debt troubles.

Let’s look at just why a debt management plan could be a suitable approach for people in this situation.

1.    You’ll make monthly repayments you can afford

On a debt management plan, you’ll ask your lenders to agree to new, lower monthly repayments that you can afford. These payments will be based on what you can pay towards your debts after all your essential monthly outgoings (rent/mortgage, food, utilities, Council Tax, transport, etc.) have been covered.

Your unsecured lenders are likely to agree to a debt management plan if they consider it the best way of getting back the money you owe them.

Even if a debt management plan isn’t the best way for you to deal with your debts, there are other flexible debt management solutions from Gregory Pennington that could provide a suitable alternative.

2.    You may be able to freeze interest on your debts

When agreeing a debt management plan, it’s important to ask your unsecured lenders to freeze interest and charges on your debts.

If your unsecured lenders agree to freeze interest, your debts won’t continue to grow as you’re repaying them. (Just bear in mind that if your lenders don’t agree to this, making smaller repayments over a longer period will end up costing you more overall.)

3.    A debt management plan is a flexible arrangement

A debt management plan offers a fair bit of flexibility. Lenders understand that your disposable income could very well go up and down, so if you experience a drop in income, they may agree to let you further reduce your monthly payments until your income rises again. Similarly, if your income increases, you may be required to make larger repayments – which should see you become free of your debts faster.

Finally, although making smaller payments will damage your credit rating, it’s likely your credit record will have already been affected, since debt management is only an option for people who can’t keep up with their agreed payments. Speak to a professional if you’re looking for debt help.

Definition of ‘Asset Management’
1. The management of a client’s investments by a financial services company, usually an investment bank. The company will invest on behalf of its clients and give them access to a wide range of traditional and alternative product offerings that would not be to the average investor.

2. An account at a financial institution that includes checking services, credit cards, debit cards, margin loans, the automatic sweep of cash balances into a money market fund, as well as brokerage services.

Also known as an “asset management account” or a “central asset account”.

explains ‘Asset Management’
1. The expense of this service generally restricts it to high net-worth individuals, governments, corporations and financial intermediaries. This includes such products as equity, fixed income, real estate, agriculture and international investments.

2. When individuals deposit money into the account, it is placed into a money market fund that offers a greater return that can be found in regular savings and checking accounts. The added benefit to individuals is that they can do all of their banking and investing at the same institution instead of having a bank and brokerage account at two different companies.

These types of accounts came about with the passing of the Gramm-Leach-Bliley Act in 1997, which replaced the Glass-Steagall Act. The Glass-Steagall Act was created during the Great Depression and did not allow financial institutions to offer both banking and security services.

Comparing commercial energy rates and pricing is as easy as getting online and requesting free quotes. Most energy providers now offer this as a standard part of their business, and the information they provide may certainly be to your advantage. While there is no guarantee, there is a very real chance that you could be paying less for the energy you need for your business.

Whether you need to set up a commercial energy account for the first time, or already have service and want to see what else is available, quotes will be informative. No one wishes to pay more than they have to for what is virtually the same type of product. Doing so would not make sound business sense. What everyone does want is to safe money, and taking the time to see what the current rates are, you may indeed be able to do this.

You can gather rates from British Gas Business and see how they compare to those of other providers. This company offers competitive pricing and most definitely should be on your list of companies to gather quotes from. Pricing has always been important, and may be even more so today than ever before. Overpaying for your energy should not be an option, as different companies do offer different rates. See what prices are available today.

Definition of ‘Working Capital Turnover’
A measurement comparing the depletion of working capital to the generation of sales over a given period. This provides some useful information as to how effectively a company is using its working capital to generate sales.

Working Capital Turnover

explains ‘Working Capital Turnover’
A company uses working capital (current assets – current liabilities) to fund operations and purchase inventory. These operations and inventory are then converted into sales revenue for the company. The working capital turnover ratio is used to analyze the relationship between the money used to fund operations and the sales generated from these operations. In a general sense, the higher the working capital turnover, the better because it means that the company is generating a lot of sales compared to the money it uses to fund the sales.

For example, if a company has current assets of $10 million and current liabilities of $9 million, its working capital is $1 million. When compared to sales of $15 million, the working capital turnover ratio for the period is 15 ($15M/$1M). When used in fundamental analysis, this ratio can be compared to that of similar companies or to the company’s own historical working capital turnovers.