Summary of Chapter 3:Using financial data to measure and assess performance(Part 2)

WORKING CAPITAL

Working capital(net current assets)=current assets - current liabilities

The working capital cycle:

Factors influencing the level of working capital:

1. The nature of the product: Items such as clothing that must be displayed in order to entice customers require higher inventory levels that those that do not need display
2. The durability of the product: Companies try to have lower levels of inventories of perishable items or finished products that may become unfashionable
3. The efficience of suppliers: If suppliers can supply large quantities at short notice ,a business will be able to hold lower inventory levels
4. Lead-time: If it takes a long time to make a product,companies will be more likely to hold them in the stock
5. Customer expectations: If the customer is prepared to wait ,it may be unnecessary to hold inventories;if the customer wants the item immediately,inventories should be held.
6. Competition: A business needs to match its rivals,so invetory levels are influenced by the policies of competitors

• Causes of working capital difficulties:

1. Failure to control inventory levels: as high levels of inventories 'tie up' resources unnecessarily and cost the business money in storage costs
   
2. Poor control of receivables(debtors) : a firm that allows receivables to delay payments needs to hold higher levels of other current assets,such as cash ,as a precaution.
   
3. Cash-flow problems: a firm that pays its payables too quickly will damage its working capital.
   
4. Poor internal planning and coordination: If individual departments of a firm are unable to meet targets ,working capital problems will occur.
   
5. External factors: Unforeseen changes can affect consumers' tastes.If the business is not able to adapt quickly ,this may lead to unsold stock or low levels of cash.
   

• Solving working capital problems:

1. Inventory control : Ideally inventory levels should be maintained at a low level,as this means that less money is tied up in inventories
   
2. Low inventory levels: reduce the needs of storage space,and the chances of damage,deterioration and obsolescence.
   
3. Receivables control: this can be achieved by:

• Managing credit control
• Chasing up late payers
• Obtaining a credit rating
• Controlling the quality of the service of the product