Page 32 - DCOM505_WORKING_CAPITAL_MANAGEMENT

Unit 2: Planning of Working Capital

goods are purchased or they follow a steady production policy throughout the year and produce Notes
goods at a level to meet the peak demand. In the former case, there are serious production
problems. During the slack season, the firms have to maintain their working force and physical
facilities without adequate production and sale. When the peak period arrives, the firms have to
operate at full capacity to meet the demand. This kind of arrangement would not only be
expensive but also inconvenient. Thus, serious difficulties will be encountered in trying to
match production to the ebb and flow of the seasonal demand pattern. A better alternative is a
steady production policy independent of shifts in demand for the finished goods. This means a
large accumulation of finished goods (inventories) during the off-season and their abrupt sale
during the peak season. The progressive accumulation of stock naturally requires an increasing
amount of working capital which remains tied up for some months. Working capital planning
has to incorporate this pattern of requirement of funds when production and seasonal sales are
steady. This strategy (steady production policy) is, however, not necessarily adopted by everyone.
It may be possible, for instance, for some to follow a policy of diversification which enables
them to engage the working force and the physical facilities in some other activity. If this is
possible, there will be no major working capital problem. Moreover, the nature of some products
may be such that accumulation of inventories may create special risk and cost problems. For
them, a production policy in tune with the changing demands may be preferable. Therefore,
production policies have to be formulated on the basis of the individual setting of each enterprise
and the magnitude and dimension of the working capital problems will accordingly vary.

Caselet Toyota’s Global Competitive Advantage

oyota’s global competitive advantage is based on a corporate philosophy known
Tas the Toyota Production System. This system is nothing but a very well defined
production policy which covers not only the human resource but also its suppliers and
components manufacturers.
Toyota Production System (TPS) includes principles like reduced setup times, small-lot
production, employee involvement and empowerment, quality at the source, equipment
maintenance, pull production, just-in-time production and supplies, supplier involvement,
etc.

TPS in Toyota is mainly concerned with making a profit, and satisfying the customer with
the highest possible quality at the lowest cost in the shortest lead-time, while developing
the talents and skills of its workforce through rigorous improvement routines and problem
solving disciplines. This results in higher and better production every year, and increased
working capital to reinvest for the production planned for the next year.

Credit Policy

The credit policy relating to sales and purchases also affects the working capital. The credit
policy influences the requirement of working capital in two ways:
1. Through credit terms granted by the firm to its customers/buyers of goods;

2. Credit terms available to the firm from its creditors.
The credit terms granted to customers have a bearing on the magnitude of working capital by
determining the level of book debts. The credit sales result in higher book debts (receivables).
Higher book debts mean more working capital. On the other hand, if liberal credit terms are
available from the suppliers of goods (trade creditors), the need for working capital is less. The

LOVELY PROFESSIONAL UNIVERSITY 27