Working capital cycle
Get assignment help for this. Mail us for query at:- assignment4finance@gmail.com
The working capital cycle
As an introduction to the working capital cycle, here is a quick
reminder of the main types of cash inflow and outflow in a typical business:
Inflows
|
Outflows
|
Cash sales to customers
|
Purchasing finished goods for re-sale
|
Receipts from customers who were allowed to buy on credit (trade
debtors)
|
Purchasing raw materials and other components needed for the
manufacturing of the final product
|
Interest on bank and other balances
|
Paying salaries and wages and other operating expenses
|
Proceeds from sale of fixed assets
|
Purchasing fixed assets
|
Investment by shareholders
|
Paying the interest on, or repayment of loans
|
Paying taxes
|
Cash flow can be described as a cycle:
- The business
uses cash to acquire resources (assets such as stocks)
- The
resources are put to work and goods and services produced. These are then
sold to customers
- Some
customers pay in cash (great), but others ask for time to pay. Eventually
they pay and these funds are used to settle any liabilities of the
business (e.g. pay suppliers)
- And so the
cycle repeats
Hopefully, each time through the cash flow cycle, a little more
money is put back into the business than flows out. But not necessarily, and if
management don’t carefully monitor cash flow and take corrective action when
necessary, a business may find itself sinking into trouble.
The cash needed to make the cycle above work effectively is known
as working capital.
Working capital is the cash needed to pay for the day to day
operations of the business.
In other words, working capital is needed by the business to:
- Pay
suppliers and other creditors
- Pay
employees
- Pay for
stocks
- Allow for
customers who are allowed to buy now, but pay later (so-called “trade
debtors”)
What is crucially important, therefore, is that a business actively
manages working capital. It is the timing of cash flows which can be vital
to the success, or otherwise, of the business. Just because a business is
making a profit does not necessarily mean that there is cash coming into and
out of the business.
There are many advantages to a business that actively manages its
cash flow:
- It knows
where its cash is tied up, spotting potential bottlenecks and acting to
reduce their impact
- It can plan
ahead with more confidence. Management are in better control of the
business and can make informed decisions for future development and
expansion
- It can reduce
its dependence on the bank and save interest charges
- It can
identify surpluses which can be invested to earn interest
It will important to read out following chapters:
No comments:
Post a Comment