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Working Capital Management – Are your financing functions well managed and cost-effective?
2019 Update: This blog has been reviewed and updated to contain information relevant to working capital management in 2019
This is a crucial area for the survival of your business. The goal of working capital management is to shield your organisation from considerable cash flow problems and facilitate improvements in business performance.
The management of working capital requires managing cash, accounts receivable, accounts payable and inventory.
Working Capital Management: Cash Management
Effective cash management ensures various benefits to your organisation, for example ensuring that your organisation has adequate funds for growth and for unforeseen investment opportunities.
Accounts Receivable Management
If your company provides credit to your customers, you need to have a collection policy in place and monitor your receivables by generating an aging schedule.
The aging schedule assists you in finding out if your customers are paying their bills according to the company’s credit terms. It does this by providing a breakdown of the company’s invoices and their due dates. An aging schedule is a useful tool for you to manage your business’s financial performance and increase your operational efficiencies
If a significant percentage of your customers are delinquent with their payments, it is advisable to re-evaluate your credit and collection policies. This could consist of:
- Reviewing your invoicing process
- Finding the best way to remind your customers without frightening them
- Taking a look at what technological systems you are using (what you are missing or could improve on) i.e. bookkeeping system.
Accounts payable management
Two major ways that accounts payable influences your company’s profitability are:
Your company’s relationship with your suppliers
It is essential that your business maintains strong and trustworthy relationships with your suppliers. This influences the way suppliers trade with you and can lead to getting in on the best deals, and being introduced to new and better products.
Your company’s cash flow
Taking advantage of discounts if paying your bills within a certain number of days (provided your business has enough cash flow) can have a positive effect on profitability. Poor management of payables can cause disruption to your business if suppliers withhold supply until payment is received and eventually ends in cancellation of credit.
There are two major tasks of inventory management:
Continuously recording the inflow and outflow of inventory combined with either continuous cycle counting of stock or period stock takes
Managing the costs
Acquisition costs, storage costs and opportunity costs (costs associated with stopped/held production or lost sales). One way to avoid opportunity costs is to hold extensive quantity of inventory. But this, in turn, will cause undesirable build-up of inventories which leads to decreased efficiency, increase in overall cost and, strenuous cash management. The economic order quantity (EOQ) model assists to calculate the order quantity that minimises total costs.
Economic Order Quantity (EOQ) model
EOQ = (2AB/C)0.5
A = fixed cost per order, setup cost (not per unit, usually cost of ordering and shipping and handling. This is not the cost of goods)
B = demand quantity over a period
C= holding cost per unit, also known as carrying cost or storage cost (capital cost, warehouse space, refrigeration, insurance, etc)
Let’s consider a simple example. Suppose your organisation purchases 4000 ski jackets per year; the cost of processing each order is $20; carrying costs are $4 per ski jacket. Therefore: A = 20; B = 4000; C = 5
EOQ = (2 x 20 x 4000) / 4)0.5 = 200
This shows that the order quantity that minimises costs is 200 ski jackets. In this situation, the ideal number of orders per year is 4000 / 200 = 20 orders
Inventory Management Software
When considering your inventory management system it is also good to know that there are many software options available to assist you and your business. These software’s aim to ease the process of inventory management and help increase the efficiencies of your business. Some inventory management software to check out if you’re interested:
Check out another recent blog in this category.
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