Essay on Study On The Shortage Of Working Capital
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Working capital is defined as the operating
liquidity available to a business, organisation or any other business entity.
It is also part of a company’s operating capital. A business is said to be
liquidated when its current asset are more than its current liabilities, but it
would have a working capital deficiency when its current liabilities are more
less the current assets.
Calculation:
Net Working Capital = Current assets – Current
liabilities.
To ensure that the a firm is able to continue
its operation and that there is sufficient cash flow to satisfy both maturing
short-term debt and upcoming operational expenses, working capital should be
well managed.
Working Capital Management
This is a strategy of
maintaining proficient levels of both aspects of working capital,
current assets and current liabilities, in deference to one another. Working
capital management guarantees that a company has adequate cash flow in order to
meet its short-term debt duty and operating expenses.
Liquidity Cycle
Managing working capital is all about ensuring
that cash available for business (day-to-day) use is sufficient to meet cash
requirements at any given time. This means having enough liquidity.
The management of working capital is a
continuous process, such that when a business takes off production, it takes
time to generate income. Money to pay for stock and other running costs will
need to be found from the initial capital invested in the business. As the
business cycle continues, income from customers will be available to offset
expenditure.
Sufficient funds are needed to pay for
additional expenditure until the revenue revives. This continuous process is
known as Liquidity Cycle.
Credit Sales
Customers (Debtors) Pay up
Capital injected into a big firm
Purchase of Materials
Produced goods
Purposes of working capital management
To ensure that a business firm has enough
finance to meet short-term financial needs
To keep cash moving rapidly through the cycle,
so that there is enough funds to make future orders
Effects of shortage of working capital Related topics:Raising finance - an overview
Main Financial Ratios
Insufficient working capital is the commonest
cause of business failure and liquidity. Many liquidity problems are a result
of the firm not setting aside sufficient more for working capital (resulting to
a hand-to-mouth)
suppliers
A firm with too little working capital will
struggle to pay its bills on time because it has no spare cash and hence resort
to delaying payments which also affects suppliers. It may need to borrow more
money to pay supplier at high interest charge.
Bank
High additional cost of interest charges from
banks are mostly associated to borrowed funds. However, loan providers also
find out and want to be sure or assured that their borrowers are efficiently
managing their working capital problems before loans are granted
Missed opportunities
A firm with shortage of working capital will
miss many profit generating opportunities ranging from inability to exploit
profitable investment opportunities to inability to buy supplies in bulk.
Restricted present and future development or
growth
Working capital shortage will hinder the present
and future growth and expansion of a business and will make a firm unable to
complete with its dominant competitors in a competitive business environment
Causes of working capital shortage
There are two places where the cause of the
shortages of working capital could be identified, and these are the Internal
and external. These areas are addressed as follows:
Internal causes
Production delays and interruption that do not
make the finished good reach end users
Industrial strikes
Marketing problems which are provoked by low
demand of a product and longer credit terms aimed at shifting unsold stocks
Managerial problems due to poor stock management
or production management that can result to additional costs.
External Causes
Changes to economic climate such as inflation,
taxation, interest rate, recession
Demand decrease (fall) caused by changes in
taste, fashion etc
Unexpected non-payment by customers resulting to
bad debt.
Working capital control measures
To maintain a good liquidity ratio, a firm
should effectively/efficiently manage the elements of its working capital such
as; debtors, cash, stocks, creditors etc. The following are measures taken to
manage a firm’s working capital and also to avoid insufficient or shortage in
the capital:
TRADE DEBTORS MANAGEMENT
Establish a credit policy in relation to normal
credit periods and overall credit control
Establish a policy on individual credit
(oblique) limit.
Debt collection management such as;
Prompt Invoicing
Offer discount to clients who pay on time
Issue monthly statement to debtors(as reminder)
Institute an effective debt collection and
control system
Collect overdue debt
TRADE CREDITORS MANAGEMENT
Increase the range of goods and services bought
on credit i.e. have a good credit rating
Don’t over extend the period of time taken to
pay debt
Collecting payments efficiently by increasing
the portion of cash customers
STOCK MANAGEMENT
Ensure an efficient production process
Minimising stock levels of work in progress
Ensure goods are delivered promptly
Minimising stocks of finished
Minimising stock losses
Efficient inventory control
CASH MANAGEMENT
Use of cash-flow forecast
Plan for moments where there will be too little
cash to avoid liquidity crisis
Cash planning and budgeting
Cash flow management
Accelerate fund movement among banks
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