Working capital management

Working capital

Working capital management refers to a company's decisions that ensure it has adequate resources for day-to-day running expenditures while maintaining resources invested in an efficient way. It's a standard measure used to evaluate an organization's short-term health. Measurements of working capital can be derived from the assets and liabilities on an organization's balance sheet. An organisation is better able to understand its liquidity in the near future by just looking at imminent obligations and balancing them with the most liquid assets. Working capital may also be used to assess a company's operational efficiency and short-term financial health. If the current assets of a business are below its current liabilities, it may struggle to grow or repay creditors. It may even declare bankruptcy. Working capital management includes Liquidity management, Inventory management, short-term debt management, and account receivable and payable management.

• The difference between a company's current assets and current liabilities is represented by working capital, often known as net working capital.

• Working capital is a measure used to assess a company's liquidity and short-term financial health.

• If a company's current asset-to-liability ratio is less than one (or if it has more current liabilities than current assets), it has negative working capital.

• An organisation with positive working capital may support its present operations while also investing in future activities and growth.

• A large amount of working capital isn't necessarily a good thing. It might signal that the company has too much inventory, is not spending its extra cash, or is not taking advantage of low-cost lending options.

The Cash Conversion Cycle (CCC)

The Cash Conversion Cycle (CCC) is a measure that describes how long it takes an organisation to convert its inventory assets to cash. The CCC assesses how quickly an organisation can turn its initial capital investment into cash. Businesses with low CCC tend to be those with the best management. For a precise assessment of a company's management, the CCC should be paired with other ratios such as ROE and ROA and compared to industry competitors during that similar time frame.

 To calculate CCC requires the information from the company's financial statements such as Average inventory over the period {(Beginning Inventory + Ending Inventory) ÷ 2 },  Cost of goods sold or cost of sales,  Accounts receivable balance,  Annual revenue, Ending accounts payable

CCC = Days Inventory Outstanding (DIO) + Days Sales Outstanding (DSO) – Days Payables Outstanding (DPO) 

Economic order quantity

EOQ is the short form of Economic Order Quantity. It is a measure used in the areas of Operations, Logistics, and Supply Chain Management. In simple terms, EOQ is a technique for determining the volume and frequency of orders required to meet a given level of demand while minimising cost per order. The economic order quantity (EOQ) is the best order number for an organisation that satisfies demand while minimising the overall costs associated with ordering, receiving, and holding inventory. The concept of EOQ works best when demand, ordering, and holding costs stay consistent over time. One of the most significant disadvantages of the economic order quantity is that it assumes constant demand for the organization's products all over time.

The equation for EOQ =  Q =   √(2DS ÷ H) 

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Where : D: Annual Quantity Demanded , Q: Volume per Order , S: Ordering Cost (Fixed Cost) , C: Unit Cost (Variable Cost) , H: Holding Cost (Variable Cost) , i: Carrying Cost (Interest Rate). 

Equation needs to know : Number of order = D ÷ Q,  Annual ordering cost = ( D ÷ Q) x S , Holding cost = i x C , 

Annual Holding cost = (Q ÷ 2) x H ,  Annual total cost = {(D ÷ Q)x S }+ {(Q ÷ 2) x H} ,  or  Annual total cost = Ordering cost + Holding cost