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Accounting For Managers | Case Study

Working capital

Working capital is afinancial metric used as an indicator of the level of adequacy of available assets and which can be used in paying off liabilities and debts.The level of working capital changes with change in current assets and/or current liabilities. The level of working capital is dependent on nature of the business enterprise, production policy, market conditions, seasonality of operations and supply conditions.[1]Working capital is computed as follows: Working capital = current assets – current liabilities

Components of working capital.

Cash management. It encompasses all activities right from purchase of raw materials to marketing of finished outputs. Moreover, it helps account for the cash balance transactions which permit the business to cater for the daily expenditures but lower cash holding costs.[2]Ideally, cash management helps maintain a favorable cash balance.

Receivable management. This component deals with the money expected to be obtained by the business from sale of goods and services. It involves coming up with the appropriate credit policy and credit terms which will interest customers encouraging them to come to the business.[3]

Inventory management. This component seeks to identify the stock level which provides for constant flow of production. It seeks to minimize reordering costs and increasing the cash flow. Effective inventory management translates to maximization of earnings of the shareholders.

Accounts payable management.Also known as financial management, accounts payable management seeks to identify the source of financing.[4]Management of payables is closely related to cash management. When accounts pay ........

ure of the business enterprise, production policy, market conditions, seasonality of operations and supply conditions.[1]Working capital is computed as follows: Working capital = current assets – current liabilities

Components of working capital.

Cash management. It encompasses all activities right from purchase of raw materials to marketing of finished outputs. Moreover, it helps account for the cash balance transactions which permit the business to cater for the daily expenditures but lower cash holding costs.[2]Ideally, cash management helps maintain a favorable cash balance.

Receivable management. This component deals with the money expected to be obtained by the business from sale of goods and services. It involves coming up with the appropriate credit policy and credit terms which will interest customers encouraging them to come to the business.[3]

Inventory management. This component seeks to identify the stock level which provides for constant flow of production. It seeks to minimize reordering costs and increasing the cash flow. Effective inventory management translates to maximization of earnings of the shareholders.

Accounts payable management.Also known as financial management, accounts payable management seeks to identify the source of financing.[4]Management of payables is closely related to cash management. When accounts payables are management effectively, there is a steady supply of materials and in the overall, reputation is built.

Importance of working capital

Working capital is indispensable to large organizations for it helps them grow, boost the share price level as well as clear the short term bills and expenses.To miniatures enterprises and start-up companies, it enables harness sustainability initiatives. To maintain a balance between liquidity and profitability, the enterprise ought to have an efficient working management.Effective working capital management also enables the organization to a gain a competitive advantage.[5]

Factors for holding lower inventory levels

  • Speculations of increase in price levels in future.
  • Inadequate storage space.
  • Type of stock especially perishable goods.
  • Rules and regulations of storage.
  • Stock control method
  • Quality of stock.
  • Need to minimize inventory costs.    

Factors for holding higher inventory levels

  • High demand.
  • Technology in use.
  • Inventory costs
  • Supply chain capacities.
  • Transportation costs.
  • Lead times.

Motives for holding cash

In the present world, holding money is almost indispensable. According to Keynes, the amount of money held by a person is dependent on liquidity preferences interms of how much the individual is willing to part with or lend.[6]The desire for liquidity arises out of the following motives:

Transactionary motive.In this case, money is considered as an effective medium of exchange.[7] The gap between wages, salaries, income and expenditures, leaves households and firms with no option but hold onto money to meet daily expenditures.[8]The amount saved for transactionary purposes depends on the level of income as well as the general level of business activity.[9]The transaction motive of holding money is expressed using the following formula: Md = f(Y) where Md is the transaction demand for money while f(Y) is the income function.

Precautionary motive is one in which people hold money for purposes of catering for contingencies especially those which call for urgent attention and unforeseen expenditures.[10]Precautionary demand for money is given by the following expression: Mp= f(Y) where Mp represents the speculative demand of money.

Speculative motive validates the reason why consumers hold money inorder to take advantage of future interest-earning bonds of other financial assets in the stock market. Speculative holders of money expect a fluctuation of future prices and will not hesitate to take advantage of any money making opportunity arises when interest rates move to their favor. The speculative demand for money is given by the following expression:

M2 = f(r) where M2 is the speculative demand for money which is a function of interest rates.

Graphical representation

Image result for keynesian motives for holding money

Case Study: Management of Credit Risk

Credit risk is a susceptibility of a losing finances influenced by myriad internal and external. Ideally, it involves failure to honour pledges and financial obligations as defined and guided by the terms and conditions.[11]A good credit assessment entails conducting background scrutiny on the records and credit worthiness of debtors in order to establish their suitability to repay the debts. Credit assessment may involve analysing the financial viability and ability of the customer in terms of their previous debt repayment routines as well as the security pegged onto the debt agreement incase they are unable to settle the debt in the scheduled date. To ascertain the risk tolerance, there is need to amass substantive information data, analyse and verify and validate the information before finally coming up with an informed decision. All these information will be amassed from the assessment and application form. Some of the indispensable information to collect from a prospective client is the registered or trading name, an ACN or ARBN number, the entity type, the trade references, the registered addresses as well as the primary business addresses, as well as the date of birth and/or driving licence number especially if the trader is a sold trader, partnership or individual. The credit risk assessment should then take place after acquiring and validating all the required information from the prospective customer.

Some of the accredited reporting agencies useful in verifying information regarding a potential or actual customer include the Australian Taxation Office as well as the Australian Securities and Investment Commission. A perfect epitome of an indicator of risk is the length in which the customer has been conducting business. At the instance in which the customer has been conducting operations for a long period of time, the risk level is low.Some of the warning signs and hazards which point out to presence of high risk is a situation in which the directors in the company are directly connected the failure of the respective organisations accompanied by court actions or notices of defaults. Moreover, it is also important to ascertain the payments history and patterns of the organization with other enterprises.Perfect epitomes of information rendered by financial data of a business includes growth in turnover growth rates, gearing ratios, profitability ratios as well as the asset measurement.

Personal information amassed from personal assets and liabilities statement can easily be verified by credit reporting agencies especially if they have access to land titles, other assets as well as encumbrances such as mortgages. Positive information would definitely imply confidence in the customer and thus the customer should be accepted and granted the credit. On the contrary, presence of negative findings such as court actions against directors, default in payments as shown by the payment history may mean no confidence in the customer and such a client should be denied credit. A credit scoring software helps in the processing, analysis and assessing of information by assigning numerical values used in gauging the risk of a number of indicators given the benchmarks as well as historical data. Techniques such as acquiring personal guarantees, lowering credit limits as well as lowering the terms of trading.