FINM6221 LU3
FINM6221 LU3 – Managing Working
Capital
3.2 Working Capital Management
Net working capital = net difference between the current assets and current liabilities of a
business.
Net working capital is used to assess a business’s ability to meet its short-term debt
obligations.
Current assets = assets of the firm that circulate from one form to another in the ordinary
course of operations.
- Cash to Inventory to debtors and back to cash (cash cycle)
Current liabilities = debts that have to be settled within a year.
The objectives of working capital management
Primary Objective - Ensure a Smooth Operating Cycle
A Smooth operating cycle should allow a business to convert current assets and
liabilities to cash efficiently.
This may be achieved through:
o Maintaining sufficient cash for operational needs.
o Ensure raw materials are always available to prevent stoppages.
o Ensure production requirements are in place before production begins
o Sell finished goods quickly.
o Collect receivables promptly.
o Pay creditors on time.
Secondary Objective - Optimise the Level of Working Capital
Find a level of investment in working capital where the retrun generated and the
exposure to risk are finely balanced.
A high working capital may lead to high interest costs as more inventory is bought on
credit
A low working capital, may lead to low inventory and loss of customers
Third Objective - Minimise Interest rate or Cost of Capital
This will increase the profits of the org
Fourth Objective – obtain a optimal return on the current assets in the org
- FM must aim to obtain a return on current assets that is higher than the cost oof
capital or interest rates in order to finance these current assets
FINM6221 LU3 – Managing Working
Capital
3.2 Working Capital Management
Net working capital = net difference between the current assets and current liabilities of a
business.
Net working capital is used to assess a business’s ability to meet its short-term debt
obligations.
Current assets = assets of the firm that circulate from one form to another in the ordinary
course of operations.
- Cash to Inventory to debtors and back to cash (cash cycle)
Current liabilities = debts that have to be settled within a year.
The objectives of working capital management
Primary Objective - Ensure a Smooth Operating Cycle
A Smooth operating cycle should allow a business to convert current assets and
liabilities to cash efficiently.
This may be achieved through:
o Maintaining sufficient cash for operational needs.
o Ensure raw materials are always available to prevent stoppages.
o Ensure production requirements are in place before production begins
o Sell finished goods quickly.
o Collect receivables promptly.
o Pay creditors on time.
Secondary Objective - Optimise the Level of Working Capital
Find a level of investment in working capital where the retrun generated and the
exposure to risk are finely balanced.
A high working capital may lead to high interest costs as more inventory is bought on
credit
A low working capital, may lead to low inventory and loss of customers
Third Objective - Minimise Interest rate or Cost of Capital
This will increase the profits of the org
Fourth Objective – obtain a optimal return on the current assets in the org
- FM must aim to obtain a return on current assets that is higher than the cost oof
capital or interest rates in order to finance these current assets
