According to the description of working capital management, it implies decisions taken for the short term, usually associated with the following one-year time. These decisions are capable of being reversed and are not made like the capital investment decisions (Net Present Value or associated methods) instead they are supported by profitability or cash flows.
The cash conversion cycle offers one method of cash flow and it is calculated as the number of days (net) from the outflow of cash for input materials (raw materials) to getting payment from the clients. In the form of a management device, this measurement expresses the correlation between decisions that are associated with stock, cash, accounts payable and accounts receivable.
As this figure efficaciously matches the time that the cash of the company is engaged in commercial activities and cannot be availed for other purposes, the management normally targets a small net count.
According to these circumstances, the most helpful technique for calculating profitability is ROC or Return on Capital. The outcome is demonstrated in the form of a percentage, which is ascertained by making a division of the crucial income for one year by the amount of capital employed. ROE or Return on Equity demonstrates this outcome for the stockholders of the company. The value of the firm is increased at the time the return on capital or ROC that ensues from working capital management is more than the cost of capital that is a consequence of capital investment decisions mentioned above. ROC techniques are since helpful in the form of management devices. They connect decision making in the long term with short-term plans.
Steered by the above-mentioned standards, the management frequently utilizes a blend of plans and methods for working capital management. These plans target at the handling of current assets (usually inventories, cash equivalents, cash, and debtors) as well as financing in the short term so that the earnings and cash flows are adequate.
The procedure of working capital management can be categorized into the following types:
Cash management: Here the balance of cash is differentiated that permits the firm to satisfy the daily expenditures, nevertheless it decreases cash retention expenditure.
Inventory management: The inventory level is distinguished that enables continuous manufacturing, however, it decreases the amount of investment in inputs (raw materials) and lowers reordering expenses. Therefore, it enhances cash flows. The different methods used in inventory management include Supply Chain Management or SCM, Economic Order Quantity (EOQ), JIT or Just in Time Method, and Economic Production Quantity (EPQ)
Debtors management: Recognizing the suitable credit policy, for example the terms and conditions that will be lucrative for the clients so that any affect on the cash conversion cycle and cash flows can be counterbalanced by higher revenue and thus Return on Capital (ROC) or the other way around.
Short term financing: Distinguishing the suitable root of funding taking into consideration the cash conversion cycle. In reality, the inventory is funded by the loan offered by the supplier; nevertheless, it might be essential to use an overdraft or a bank loan or changeover of debtors to cash with the help of factoring.
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Last Updated on : 27th June 2013