Financial managers have to be aware of the funds available to operate on a day-to-day basis and this is referred to as working capital management. The keyobjective is to minimise the risks of insolvency and increase profitability by making sure bills are paid and overtrading/overstocking is avoided. It is calculated as follows:
Working Capital = Current Assets minus Current Liabilities.
Some of the policies a financial manager may focus on in working capital management are:
- Inventory– How to best reduce the cost of holding inventory in business.
- Receivables/Payables-How do we reduce the time it takes to receive payments and should we increase time it takes to pay payables.
- Cash-Holding too much cash a business may lose out on profitable investment opportunities.
Cash operating cycle
Working capital management requires the handling of cash inflow and outflows. The cash operating cycle identifies how working capital is affected by the length of time it takes for cash outflows (eg Inventory) to turn into cashinflows (eg Cash).
For example, if firm’s receivables were taking longer to pay, this would mean the cycle gets longer and more working capital investment is required.
When calculating the Cash operating cycle the following require calculating:
- Trade Receivables
- Trade Payables
- Work in progress (WIP) Holding
- Inventory turnover period