The Importance of Working Capital Management

The Importance of Working Capital ManagementWorking metropolis management defines the management in the short term of the relationship between a companys current assets and liabilities. The some common elements of working capital will include inventory, receivables and payables which represent the run working capital (OWC) held by a company usually within a course of study. Fig.1 below shows the interaction between these elements of OWC.The goal of OWC management is to ensure that a company has enough cash flow, measure in terms of liquidity, to satisfy its short term debts and continue to support its day to day operations. Most articles and books address the signifi assholece of OWC in terms of obtaining an optimal balance between inventory, receivables and payables, McLaney E. and Atrill P., Accounting An Introduction (Prentice Hall, 2008). Abraham et al., Accounting for Managers, (Cengage, 2008) further expatiates on this critical importance and state that most organisations invest between 25 40% of their net assets on OWC which represents a major short term investment. However, these books present a generic methodology to OWC and do not conceptualize a firms unique nature, industries or size. Furthermore, this significance of working capital will depend on its size and composition and will transform between industries such as Rolls Royce Plc a manufacturing company will place particular attention to its high inventory levels and payables unlike British Airways Plc a expediency provider with no inventory. Thomas M. Krueger, An Analysis of Working Capital Management Results Across Industries, American Journal of Business, 2005, vol 20 presented a research based on the annual ratings of working capital management across industries published in CFO magazine. The result indicated that there was a consistency in working capital measures within industries but the working capital measures were ar not static everywhere time. In an online article Philip M cCoster (2003), Accountancy The Importance of Working Capital, (http//www.accountancy.com.pk/articles_students.asp?id=77).Online.(Accessed 28/03/11) agrees with this dynamical nature of working capital and highlights this importance in more subtle way that most organisations are profitable on paper but are forced to cease trading because they cannot meet short term debts. According to him, small businesses in particular are prone to fail especially during pelf up because they ignore the importance of working capital problems.Generally the importance of working capital is indisputable and whether its elements are managed as a whole or individual, its management is still important in order for an organisation to effectively manage its cash flow to continue operation. But while this is most say in papers, it seems rather paradixocal that in reality the importance OWC is ignore and most companies find themselves at the point of bankruptcy as was the case in the kind margin game.As a take manager in the Winning Margin game, I realised that the decisions I made especially in anticipate and managing machines output was very critical to the overall amount of finished goods inventory needed to achieve a positive OWC. This was clearly depicted in year deuce when two critical decisionsForecasted a total proceeds output of 11 costing $40 (appendix Production and Sales Plans For The Year Ahead).Purchase of two additional Mark II machines (See appendix Balance Sheet)This resulted to an increase in the amount of inventory to contracted amount although some inventory was tied up in Work in Progress and Finished goods leading to a drop in operating working capital (Year 2 Cash eat Statement). Furthermore, the cash spent on new machines also led to a drop in the operating cash flow of the business. Therefore, in real invigoration the production manager role is strategic and has a big impact on working capital and the overall business objective but his/her decisions can only be as effective when taken in collaboration with other departmental heads.2.2 BUDGETINGMcLaney E and Atrill P., Accounting An Introduction (Prentice Hall, 2008) defined a cipher as a short term financial syllabus prepared by a business as an integral part of its strategic plan framework. A calculate is use by managers to examine and compare between the actual to what was planned in a mathematical operation known as the budget control. By using this technique, Group E benefited from the budgetary process in many waysForward thinking and identification of short-term problems During the planning process of year 2, we realised that we had to budget for additional machine as well as additional loans. Doing this in good time gave us time to consider alternatives and chose the best course of action to take.Improved co-ordination Doing planning separately year meant we had to co-ordinate with each other. This was crucially serious because it improved visibility and decisions mak ing as all activities were linked together. For example, decisions on production depended on sales estimates, raw material availability and funding to finance it.It provided a system of Control At the beginning of each year, we had to compare year 1 and 2 performance and established areas of concerned. This provided a system of control and better planning for year 3.It created a system of authorisation By deciding on a master plan of action for each year, this helped set expenditure limits especially as I, the production manager, wanted to increase amount of machine purchased in year 2 but was restricted.The budget motivated us to perform better By establishing responsibilities to each member of the group, was beneficial to the whole team as each members felt they had contributed to the overall business objectives. Hence improving the teams spirit to perform.2.3 soaking up CostingAbsorption costing is a method of calculating the full output cost by charging direct cost with a fair share of indirect costs. The sum of absorption costing is to make costing simpler and easier so that management can make informed decisions. In the Winning Margin game, the use of this technique was beneficial to our group in several waysHelpful in making output decisions Absorption costing technique made calculating planned sales easier and as a team we were able to make informed decisions on production and cash flow.Exercising control decision absorption costing is very much used as a basis of budgeting and budget control. Therefore, it was beneficial to the team as it formed the basis of our budget and we were able to exercise control over our budget and plansFurthermore, the technique was particular useful to achieve efficiency since we were able to make decisions that compares alternative costs of doing similar things. For example we compared the costs of buying a Marked II or Mark III machine in year 2 as well as deciding between the various(a) types of product to produce. In addition to this, absorption costing technique was significant as we were able to assess our teams performance. Its use made calculating yearly production cost, sales, profit and other financial data easier. This made facilitated the process of assessing our business and team performance for any given year.Although widely practiced, in real keep the use of absorption costing technique will not be as simplistic as in the game. Moreover, the technique has been criticised for its use of past costs which are considered irrelevant in the decision making process as decisions need to reflect the future not the past. Other costing techniques such as variable costing are recommended. (Words 300)