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Hello everybody and welcome to really important, it comes up all the time in the
exam, the management of working capital okay. And all working capital is, our
current assets and current liabilities what goes into current assets? Things
like inventory, receivables and what goes into current liabilities: payables, okay
and of course we could have cash that bank or we could have an overdraft okay.
And it's just how we manage these, you know
and how we manage these all depends on our focus. Is it on profitability or is
it on liquidity. Okay liquidity means I want cash
desperately okay so you think about this right.
You're in a business and you want to be really really
profitable but you're not too worried about being liquid, you're not too
worried about getting lots of cash in and so therefore what will you do with
receivables if you were aiming to be profitable okay. Would they be high or
low? Now well, what you want to be profitable
is lots and lots of sales and one way to attract customers is to say: don't pay me
for another six months, okay, that will attract more customers
and will make you more profitable because you have more sales, you haven't any
cash, you have to go to liquidity so your liquidity or your cash will be low
but your profitability will be high okay. Now if you were focused on the other
hand on liquidity saying look I really really need money to keep my business
going you won't have any receivables you'll say like you have to pay me now
so high receivables would mean you're focusing on profitability and low
receivables policy you would mean you're focusing on liquidity. Think about it with
inventory. If you wanted to be really profitable you want to make sure you've
always got stock to sell! So high inventory would make sure you're
profitable, but always having stock to sell means you
gonna you gonna have that cash tied up in stock so high inventory would mean
also yeah high inventory would mean you have very little money so you wouldn't be
focusing on liquidity. Low stock is when you're focusing on liquidity okay and
it's the opposite way round for payables. Right but we'll come back to that in the
next session. I just wanted to mention it now this really important thing on
working capital management is your focus on profitability or liquidity. Anyway
moving on. Let's say, right that we buy something. Now when we buy something it
goes into inventory okay and then we sell it and I'm presuming we sell on
credit here when we sell it it goes into receivables okay and then we get the
cash we receive cash, thank you very much okay. Now because I bought something I
also have to pay for we don't I, so maybe maybe I get some good credit terms
so my payables is quite long but still I have to pay cash here now can you see
the problem with this working capital management is that I'm receiving cash
here later then I'm paying the cash here so in order to pay the cash here I need
to get some money someone received anything yet
so this period of time, here, I don't have any cash to pay my creditors and I've
got to pay my creditors so I'm gonna get this cash from somewhere and that needs
funding. The working capital funding problem.
That's what generally happens is your inventory and your receivables are
bigger than your payables. Not always, you can have a negative one which is great
news but generally that's what happen, you have to pay people before you
actually receive the cash so obviously you're gonna receive more cash than you
going to pay, so you are going to be profitable but you need to fund it.
And remember what we're saying if you're focusing on profitability, your inventory
days would be really big because you want to make sure that there's stop
there. And your receivable days will be really big because you want to try and
get customers in okay and so therefore this funding problem, if you're focusing
on profitability, gets even bigger okay. Not so bad if you are focusing on liquidity
because your inventory days will be small your receivables will be small, your
payable days will be big, you'll have no problem. So this is generally a problem
when you're focusing on profitability okay. Now I just want to write that out
in a different way. So same idea, we call this by the way "the working capital
cycle" or "the cash operating cycle", "cash management cycle" sometimes and so it's
basically your inventory days - how long it's in inventory plus your receivable
days - how long it's in receivables
- the fact that you don't have to pay people immediately that's good so - your
payable days, that's how long needs funding, that's that figure there okay.
Now that will need funding out of an overdraft or long term loans okay and
the way we do that again will depend on things as we'll see later. We'll need
funding out of long term loans now the only other question then is well how do
I calculate these 3 things. Well I left days out there - at the end on
purpose because how many days are in a year? Hopefully you know, 365. Well then you
say right, take my inventory which is what I wanna calculate. Now where is that on
my income statement, where's the opposite side? Cost of sales, receivables, let's say
that, where is the opposite side of that on the income
statement - sales. Credit sales and then payable days, take my payables,
where's the opposite side of that on the income statement - purchases or credit
purchases. Now in this exam it's easy we just put it to cost of sales okay.
So what it is it's that plus that minus that okay and that will give you the
working capital cycle that will need funding okay. You can do more questions
in a little mini sessions coming up, I'm not worried with questions yet, I'll
leave those to you. Okay now, obviously you want that to be as small as possible
but my question is really why might that be high? Okay why might that be high,
well if that's high it means - that must be high, that must be high and that must
be low (generally). So high plus high - a low would give me a headache it would
give me a big amount of time to fund so why might that happen? Because that
seems ridiculous when I always wanna have them low. Well as we said, firstly is that
my focus was on profitability not, hopefully, can remember, not liquidity
I was just focused on being profitable so I got lots of stock in, I got lots of
credit days, I gave them away, I gave up big creditors with lots of receivables
okay. Another reason why it might be that
might just be poor management, inefficient management of working capital,
okay. I wasn't keeping my eye on the stock levels and didn't really care, I was
letting people pay me whenever. So poor management of working capital that will
also result in a high amount of time with no cash that needs funding. And the
other one will be the nature of the business because you think about this
okay I am going to give you 2 businesses: a construction company
and a supermarket. Which one of them, one of them has a high working capital
funding problem and the other one has a low one so they'll give a construction
company? Will they have lots of inventory, yes they will, you know,
because they're building something for a long time they tend to not get paid to
later, do they, so they'll have a loads of stock, loads of receivables until they
eventually get paid so this would be high. Where's the supermarket, yes, they
have lots of inventory but they turn it over really quickly generally and they
will have no receivables because generally you just pay them cash, don't you,
so a supermarket wouldn't have a high cash operation cycle generally they'll
have a very very low one okay. All right yeah, so on the other sessions we'll have,
we are gonna be doing some figures on this and and focusing a bit more on how we
fund it and the costs of funding, all right?
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