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15 Cards in this Set
- Front
- Back
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Working capital definition
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Total amount of cash tied up in CA & CL. Financed by either ST or LT. Needs to be suff but not overcapitalisation.
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WC cycle
('Operating cycle', 'trading cycle', 'cash cycle') |
WC cylce = total in days of raw materials in stock, WIP, finished goods in stock, periods between despatch/invoice to customer & invoicing/customer payment - less period of credit taken from suppliers.
(p231) |
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WC needs of diff forms of bus
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Manufacturing sector -
CA sig - RCWIT - raw materials, components, WIP, inventory (completed), trade receivables. JIT systems to reduce inventory-holding (suppliers deliver precise quantities at specific times). CL also sig - bulk purchases, expensive raw materials. Service sector - CA much less sig - stationery, trade receivables. No inventory of finished goods bc of 5 features of output of service sector orgs - SHNIP - simultaneous production & consumption, heterogeneous, not transferable, intangible, perishable. (p233) CL may inc small amounts owed to suppliers. Distributive sector - CA - finished inventory will be v high (esp in retail sector), but trade receivables prob low (customers tend to pay when goods acquired. CL - trade payable may be sig as retailers tend to purchase from manufactures/wholesalers on credit. |
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WC assessment ratios
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Current ratio (or WC ratio)
- target 2:1 but depends on nature of bus & imp to monitor trends CA/CL Liquidity ratio (or quick asset ratio) - removes items which can't eaasily/quicly be converted into cash at full value (e.g. inventory). Target 1:1 but depends on industry practice, co rel's & a/gs, working methods, & trend over time most imp. CA-stock/CL Poor current & liquidity ratios need overdraft facilities on standby. However, too much cash means underutilising resources. |
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Overtrading
(financial impact of changes to WC policies) |
Symptoms of overtrading - WC in nature & financial impact of those changes. Key areas to examine:
- growth in sales but falling profit margins (discounts for quicker payment, lower sales prices to wine orders, higher unit costs bc smaller orders, writing off obsolete inventory) - net profit margin declined (increased wages/bonuses) - inventory turnover ratio - surplus cash used & bank borrowing increased - payables credit days - NCA increased using ST finance - need to increase perm capital to match increased investment in NCA & increase in CAs - falling ratios - indicates worsening in ST financing position (p235) |
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Overcapitalisation
(financial impact of changes to WC policies) |
Overinvestment in WC - excessive inventory, receivables & cash, and fewer creditors. Leads to lower return on investment & use of LT funds for ST assets. Overinvestment costs the co inc missing out on potential opps.
Indicators - long debtor& stock turnover periods, high liquidity ratios and low sales/WC ratio. WC is 'not working hard enough' and CA balances are too high. Compare against industry standards - standard ratio figure/365 and then... x COS (for av inventory & trade payable) and x sales (for trade receivables). |
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Manufacturing co's 4 types of stock/inventory & reason for holding inventory:
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raw materials - suff stocks for production
WIP - suff for smooth operation of production processes finished goods - enough finished goods to meet customer reqs misc (toos, fuel) Need to find balance between ability to provide good service & restricting amount of capital tied up in slow-moving lines. |
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Stockholding costs
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Principal costs of stockholding:
SHOP Storage & handling (rent, rates, maintenance, space, insurance) Holding losses (deterioration, obsolescence, theft, damage in stores/transit) Operating costs higher bc production facility full of material less efficient than if not Providing finance for the money invested in inventory (cost of capital may be WACC, overdraft rate or opp cost of capital) |
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Stock-out costs
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Stock-out costs are those of running out of inventory:
BISHOP business or customers for the future lost idle time caused by interruptions to production sale lost higher prices paid when ordering small quantities or w/ short delivery times to make good shortages overtime, rescheduling & related costs bc rush order production lost |
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Forecasting future stock levels - stock days
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Ratios to relate stock to some measure of throughput
Stock days (no. of days' stock in hand) = av stockholding x no. of days in period / cost of materials purchased in the period Then: no. of days in period / stock days = x times a yr (stock turnover ratio) |
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Levels of inventory control - 80/20 rule (Pareto's law & sometimes called 'ABC analysis')
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Large % (80) of stock value accounted for by small no (20) of stock lines. These may be subject to detailed stock control system compared to larger no. of low-value lines.
3 types of stock: A items - low vol, high cost. Usually controlled individually, 80/20, poss high level of security. B items - 30% of items, 15% of the value. Stocks controlled by monitoring levels & setting levels at which reorder. C items - high vol, low-priced items. Control not necy, can be controlled by bulk-issue methods (e.g. 'two-bin' systems). |
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EOQ (economy order quantity) theory
(inventory mngt & reordering) |
EOQ - formula for calculating the size of order to place when stocks are replenished - designed to minimise the combined cost of ordering & holding stock.
Ordering costs (costs obtaining inventory apart from purchase price): AURIS Admin/clerical costs of procurement Unit cost changes for purchases (for diff sized orders) Receiving & checking goods when delivered Inward transport costs Setting up equip, tooling, production scheduling costs (switching productions of products) Assumptions: PAUNCH Placing & receiving order - cost known & constant Accurate predictions re delivery times so that goods delivered exactly as needed - so max stock level just after delivery arrives is Q & average is Q/2 Use/demand rate is steady & known No bulk discounts Constant price per unit (so no need to change freq/size of orders) Holding each unit of inventory for given period - cost known & constant |
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EOQ (economic ordering quantity) formula
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Combined costs minimised b/c as order quantity increases, av stock level rises & so do stockholding costs BUT, large orders mean fewer orders placed during yr so ordering costs lower.
Reorder quantity is most economic when Q = sqr of 2cd/h h = cost of holding one unit of inventory for 1yr c = cost of ordering a consignment from a supplier d = annual demand in unites Q = reorder quantity Then: Q x c = total ordering costs Assumptions can be modified (e.g. discounts for large orders. gradual replenishment). In practice, inventory level doesn't run down steadily to zero just as next order arrives; rate of demand & date of delivery varies t/f may decide to keep a 'safety stock'/'buffer stock' if using EOQ formula. Doesn't affect formula. |
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MRP systems (material requirement planning systems)
(inventory mngt & reordering) |
Manufacturing work flows usually follow map/route for job or batch production, or along a production line for continuous production. More economical to produce large bathes. But modern customer requires rapid response w/ wide variety of high-qual, low-price products.
Response is 'advanced manufacturing techniques' - IT to achieve higher qual & cheaper products more quickly. Technique = MRP which 'explodes' materials specs for finished products backwards through production cycle, so that production schedule can be designed to optimise ordering & production of req'd parts & sub-assemblies. 'Top down' approach to sourcing of all materials used in process. |
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JIT methods of procurement (Just-in-time)
(inventory mngt & reordering) |
Aim is to minimise holding of inventory. Complementary to modern manufacturing methods inc flexible manufacturing.
Advs: PLASH Production lead times reduced Labour costs per unit reduced due to increased productivity Accounting req's for raw materials simplified Stockholding costs reduced Healthier current ratio & lower WC reqs Inventory minimised throughout factory (raw/WIP/finished). Suppliers now chosen not on basis of price but on service & quality - freq/small deliveries needed. Customer shares info re planned production, even commercial sensitive info. Have fewer suppliers than past when worry that they might fail to deliver or use dependence on them as leverage in price negotiations. |
