MANACC TERM 2
Alexandra Shtein
2021
, WORKING CAPITAL
What is working capital
• The capital of a business which is used in its day-to-day trading operations
• Current assets LESS current liabilities
• Invest in working capital (inventory, debtors and cash) as we would invest in property, plant and equipment
• Investment must be financed through creditors, banks, overdrafts and interest bearing debt
• Working capital policy ð basic policy decisions in optimising current asset investments and its financing
Net working capital (NWC)
• An indicator of:
- a company's liquidity
- its operational effectiveness
- its short-term financial well-being.
• A significant positive NWC creates the potential to grow by making additional investments.
• If current assets do not exceed current liabilities, a company will not be able to grow ð paying creditors is going to be difficult, and the
company may even go bankrupt.
Net working capital Current assets – current liabilities
Current assets Convert into cash in less than 1 year
Current liabilities Repay within 1 year
Working capital
• The composition of working capital will differ between industries, nature of the firm etc.
• The compositions impacts cash flows, liquidity and risk areas
◦ Invest in more inventory ð cash decreases, increase admin and other expenses
◦ Are existing cash flows stable or volatile? ð Increase or decrease in net working capital
• By effectively managing and optimizing working capital levels, cash flow can be generated
Working Capital Cycle
Materials /
Creditors purchases
Production
Payment
Collection Inventory Store
Debtors / Sales
,Working capital ratios
Working capital ratio Current Assets: Current Liabilities
Quick ratio (Current Assets – Inventory): Current Liabilities
Debtors collection period Trade Debtors x 365 * If credit sales are not
Credit Sales available, use sales
Creditors payment period (days) Trade Creditors x 365 * If credit purchases are not
Credit Purchases available, use cost of sales
Inventory turnover Cost of sales or 365 Av. inv = OB + CB inv.
Number of times p.a. that inventory is Average Inventory inventory days 2
replaced
Inventory days Inventory or 365
Number of days’ inventory on hand Cost of Sales inventory turnover
Raw material days on hand Raw material inventory x 365 Use total purchases if
Raw material purchases inventory categories’
individual purchases are not
given
Work in progress days on hand Work in Progress inventory x 365
Cost of Sales
Finished good days on hand Finished Goods Inventory x 365
Cost of Sales
Net investment in working capital (days) Net working capital x 365
Sales
Cost of Discount foregone [(1 + D/(100 – D))(365/t) – 1]
Cash Procurement Production Sales
Impact on SFP: Impact on SFP: Impact on SFP: Impact on SFP:
•∆ Debtors •∆ Creditors •∆ Raw materials •∆ Debtors
•∆ Creditors •∆ Raw materials •∆ WIP •∆ Finished goods
•∆ Bank •∆ Finished goods
Example:
Raw Materials Manufacture Pay Creditors Sell Finished Receive
Ordered products R1 000 Products R1 500 from
debtor
T0 T30 T60 T105
Inventory days = 60 days Debtors days = 45
Creditors days = 30 days Working Capital Cycle = 75 days (105 – 30)
Management goal is shortening of the working capital cycle (cash cycle)
How:
Eg:
Inventory days ð 55
Debtor days ð 50
Creditor days ð 50
Working capital cycle ð45
, • Lower levels of raw materials
• Faster production
• Faster sales (marketing)
• Quicker collection of debtors
• Postpone creditor payments
Ratio calculations:
Use closing balance if no information is given for opening balance
Opening Closing Average
Inventory 2 000 3 000 2 500 Purchases Cost of sales + closing inventory – opening
Account 1 600 2 000 1 800 inventory
receivable 8 200 + 3 000 – 2 000 = 9 200
Accounts payable 750 1 000 875
Sales 11 500
Cost of sales 8 200
Raw materials days Inventory days = 2 500/8 200 x 365 Operating cycle = 168.4
= RM/Purchases x 365 = Inventory/COS x 365 = 111.3 days = 111.3 + 57.1 days
Work in progress days Debtors’ days = 1 800/11 500 x 365
= WIP/COS x 365 = Debtors/credit sales x 365 = 57.1 days
Finished goods days LESS
= FG/COS x 365
Creditors’ days = 875/9 200 x 365
= Creditors/Purchases x 365 = 34.7 days
EQUALS
Working capital cycle = 111.3 + 57.1 - 34.7
(or Cash cycle) = 133,7 days
INVENTORY DAYS = Raw Materials Days + Work-in-Progress Days + Finished Goods Days
WORKING CAPITAL CYCLE = Inventory Days + Debtors Days – Creditors Days
OPERATING CYCLE = Inventory Days + Debtors Days
WORKING CAPITAL CYCLE Inventory Days + Debtors Days – Creditors Days
Inventory days Debtors days Creditors days
Increase WCC: increase increase decrease
Decrease WCC: decrease decrease Increase
Optimal WC policy = balance risk & return
Effect on cash flow
Objective
Risks
Working capital too high cash flow under pressure
Working capital too low risk of stockouts, loss of profits, less debtors, cannot pay creditors
Alexandra Shtein
2021
, WORKING CAPITAL
What is working capital
• The capital of a business which is used in its day-to-day trading operations
• Current assets LESS current liabilities
• Invest in working capital (inventory, debtors and cash) as we would invest in property, plant and equipment
• Investment must be financed through creditors, banks, overdrafts and interest bearing debt
• Working capital policy ð basic policy decisions in optimising current asset investments and its financing
Net working capital (NWC)
• An indicator of:
- a company's liquidity
- its operational effectiveness
- its short-term financial well-being.
• A significant positive NWC creates the potential to grow by making additional investments.
• If current assets do not exceed current liabilities, a company will not be able to grow ð paying creditors is going to be difficult, and the
company may even go bankrupt.
Net working capital Current assets – current liabilities
Current assets Convert into cash in less than 1 year
Current liabilities Repay within 1 year
Working capital
• The composition of working capital will differ between industries, nature of the firm etc.
• The compositions impacts cash flows, liquidity and risk areas
◦ Invest in more inventory ð cash decreases, increase admin and other expenses
◦ Are existing cash flows stable or volatile? ð Increase or decrease in net working capital
• By effectively managing and optimizing working capital levels, cash flow can be generated
Working Capital Cycle
Materials /
Creditors purchases
Production
Payment
Collection Inventory Store
Debtors / Sales
,Working capital ratios
Working capital ratio Current Assets: Current Liabilities
Quick ratio (Current Assets – Inventory): Current Liabilities
Debtors collection period Trade Debtors x 365 * If credit sales are not
Credit Sales available, use sales
Creditors payment period (days) Trade Creditors x 365 * If credit purchases are not
Credit Purchases available, use cost of sales
Inventory turnover Cost of sales or 365 Av. inv = OB + CB inv.
Number of times p.a. that inventory is Average Inventory inventory days 2
replaced
Inventory days Inventory or 365
Number of days’ inventory on hand Cost of Sales inventory turnover
Raw material days on hand Raw material inventory x 365 Use total purchases if
Raw material purchases inventory categories’
individual purchases are not
given
Work in progress days on hand Work in Progress inventory x 365
Cost of Sales
Finished good days on hand Finished Goods Inventory x 365
Cost of Sales
Net investment in working capital (days) Net working capital x 365
Sales
Cost of Discount foregone [(1 + D/(100 – D))(365/t) – 1]
Cash Procurement Production Sales
Impact on SFP: Impact on SFP: Impact on SFP: Impact on SFP:
•∆ Debtors •∆ Creditors •∆ Raw materials •∆ Debtors
•∆ Creditors •∆ Raw materials •∆ WIP •∆ Finished goods
•∆ Bank •∆ Finished goods
Example:
Raw Materials Manufacture Pay Creditors Sell Finished Receive
Ordered products R1 000 Products R1 500 from
debtor
T0 T30 T60 T105
Inventory days = 60 days Debtors days = 45
Creditors days = 30 days Working Capital Cycle = 75 days (105 – 30)
Management goal is shortening of the working capital cycle (cash cycle)
How:
Eg:
Inventory days ð 55
Debtor days ð 50
Creditor days ð 50
Working capital cycle ð45
, • Lower levels of raw materials
• Faster production
• Faster sales (marketing)
• Quicker collection of debtors
• Postpone creditor payments
Ratio calculations:
Use closing balance if no information is given for opening balance
Opening Closing Average
Inventory 2 000 3 000 2 500 Purchases Cost of sales + closing inventory – opening
Account 1 600 2 000 1 800 inventory
receivable 8 200 + 3 000 – 2 000 = 9 200
Accounts payable 750 1 000 875
Sales 11 500
Cost of sales 8 200
Raw materials days Inventory days = 2 500/8 200 x 365 Operating cycle = 168.4
= RM/Purchases x 365 = Inventory/COS x 365 = 111.3 days = 111.3 + 57.1 days
Work in progress days Debtors’ days = 1 800/11 500 x 365
= WIP/COS x 365 = Debtors/credit sales x 365 = 57.1 days
Finished goods days LESS
= FG/COS x 365
Creditors’ days = 875/9 200 x 365
= Creditors/Purchases x 365 = 34.7 days
EQUALS
Working capital cycle = 111.3 + 57.1 - 34.7
(or Cash cycle) = 133,7 days
INVENTORY DAYS = Raw Materials Days + Work-in-Progress Days + Finished Goods Days
WORKING CAPITAL CYCLE = Inventory Days + Debtors Days – Creditors Days
OPERATING CYCLE = Inventory Days + Debtors Days
WORKING CAPITAL CYCLE Inventory Days + Debtors Days – Creditors Days
Inventory days Debtors days Creditors days
Increase WCC: increase increase decrease
Decrease WCC: decrease decrease Increase
Optimal WC policy = balance risk & return
Effect on cash flow
Objective
Risks
Working capital too high cash flow under pressure
Working capital too low risk of stockouts, loss of profits, less debtors, cannot pay creditors
