Page 95 - DCOM505_WORKING_CAPITAL_MANAGEMENT

Working Capital Management

Notes holding versus investing, and credit policies. Working capital management is the management
of cash, accounts receivable, inventories, accounts payable and short-term investments. All of
these items comprise the heart of an organization. Working capital management is a very
important part of the current business environment. Successful working capital management
can reduce costs, utilize inventory, raise profits, and increase shareholder value.

6.1 Disbursement and Follow Up of Working Capital Finance by Bank

To size up our problem of cash management, let us examine the flow of cash through a firm’s
accounts. It is useful to think of the process as cycle in which cash is used to procure inputs, from
which output is produced, which are then sold to customers, who later pay their bills. The firm
receives cash from its customers and the cycle repeats.

Figure 6.1: Cash Cycle

Opportunities to improve efficiency in collecting and disbursing funds centre on flows through
the current section of the balance sheet.

Example: Let us assume that XYZ Corporation orders raw materials at point A and
receives those 14 days later at B. Terms of 2/10, net 30 are offered, so the firm pays the invoice 10
days later at C. However, it takes 2 days for the cheque to clear, and XYZ’s bank account is not
debited until point D. XYZ turns over its inventory six times per year, so 60 days after the
materials are received, the product is sold and the customer is billed, the collection period is 30
days, 28 for the customer to pay and 2 for the cheque to arrive by mail (G). XYZ processes the
payment and deposits it 2 days later at H. Another 2 days elapse while XYZ’s bank collects the
funds from the customer’s bank.

Figure 6.2: Working Capital Cycle of a Typical Manufacturing Firm

The firm’s total financing requirements are affected by the total time lag from point B to
point I (from Figure 6.2). The firm itself can control some factors that determine the various lags,

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