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Close to 50% of the typical industrial and retail firm's assets are held as working capital. Many newly minted college graduates work in positions that focus on working capital management, particularly in small businesses in which most new jobs are created in today's economy.
To prepare for this Discussion: Shared Practice, select two of the following components of working capital management: the cash conversion cycle, the cash budget, inventory management, and credit policies. Think about scenarios in which your selected topics were important for informing decision-making. Be sure to review the video links above and conduct additional research using academically reviewed materials, and your professional experience on working capital concepts to help develop your scenarios. Support your discussion with appropriate examples including numerical examples as necessary.
Working capital has historically been described as the portion of total capital a firm has on hand to execute daily, monthly, and annual operations without facing any interruptions linked to financial demands and without incurring further debt (Bendavid, et al., 2016). Companies with more control over their working capital could increase output and profit concurrently. In addition, it'd assist firms in meeting unexpected increases in demand for their goods and services, boost inventories and boost the company's entire value proposition. Credit policy and inventory management are two of the essential components. Both are vital to improving and stabilizing a company's financial condition.
As a whole, credit policy is a collection of rules that revolve around two fundamental concepts: lending & borrowing. This section explains how credit durations and credit limits were established. With the new lending policy, more significant sales and a more flexible cash flow can be obtained. When a firm is just starting, it may offer consumers credit, including supplying them with various benefits, since customers are more likely to purchase from a corporation if provided credit. Increasing sales need credit rules that require consumers to pay for things over a defined time, referred to as the credit facility and the period during which they were allowed to get credit (Das, et al., 2021). When a credit limit is specified, it represents the maximum amount of credit granted to an individual or organization at any moment. Companies may continue to operate, sell, and earn a profit thanks to these terms and conditions, which outline credit standards. A firm's operational operations could benefit from the use of credit rules. Companies benefit from credit policies in situations like stakeholder management, customer retention, and the ability to create more significant returns on investments.
Historically, inventory management has been described as obtaining all of the raw materials, funds, and other resources needed for a project. For the project (Bendavid, Herer & Yücesan, 2016). Regarding inventory management, the focus is on how companies use their resources most efficiently. "Simply defined" indicates that businesses and industries can acquire and store resources, move raw materials, and handle completed goods to consumers effectively and without waste. Maintaining a sufficient supply of inventory to fulfill consumer demand is a primary objective in inventory management. Inventory management also aims to ensure that completed goods are delivered to consumers in the period they anticipate. Efficient inventory management gives businesses the assurance they need to continue operating efficiently even if there are no new rules.
A cash budget is a document to assist the managers or business professionals in adequately managing cash flow. Cash budgets are being ready and formulated in advance, reflecting on the planned cash inflows or receipts and the scheduled cash outflow or payments of the business. The cash budget can be developed yearly, monthly, and even weekly, depending on the company's requirements. The cash budget aim is to give an understanding to the business about their performance by keeping track of the cash budget over a particular period (Wadesango, et al., 2019). When seasonal variations occur in product demand, the business can use a cash budget as a strategic tool to devise realistic budget objectives. If the company's cash flow achieves stability without any fluctuations, then the business can use an annual cash budget. The business management can correctly estimate cash requirements for future operations, allowing the company to adequately plan and devise strategies to increase or arrange cash flows by identifying investment sources before any unpleasant situations can cause harm to business activities.
Importance of Cash Budget for Decision-Making
A cash budget is helpful for the business to make proper management decisions because a cash budget allows for understanding and predicting surpluses in advance. The business professionals can remain prepared and make proper decisions to prevent any crisis scenario due to engaging in wrong investment opportunities. The cash can also assist the business professionals in making strategic decisions to handle the seasonal variations to alter adverse situations into beneficial opportunities. The cash budget can assist in making proper expenditures which can help to make timely payments to suppliers, creditors, and employees. For example, if a company spends $2500 on employee payments, advertising costs $ 1000, repair and update costs $1000, and printing costs $500 when the total cash is $15000. Hence the total forecasted price is $ 10000 so the cash budget at the end will be $ 500 ( $15000- $10000) = $2,500,000.
Cash Conversation Cycle
A cash conversion cycle is a measurement tool for businesses that demonstrates the time the company takes to transform their inventory into actual cash flows generated from the sales (Nwude, et al., 2018). The cash conservation cycle aims to calculate the period in which the investment of cash is tied up with sales procedure as well as production and the conversation of the same into the returns or cash inflow. Business professionals can use the CCC tool to identify how long it will take to obtain actual cash from the previous investment.
Importance of Cash Conversation Cycle for Decision-Making
The company can use the historical data of the cash conversion cycle and compare the same with the current data to determine proper long-term decisions based on the business's health (Boisjoly, et al., 2020) as the cost of the raw materials is increasing in the current scenario so when the business calculates their CCC they can identify whether or not expenses of raw materials in terms of average inventory affect the bottom line of the company. The business can make proper decisions on product pricing as the cash conversion cycle can provide data regarding how long generations of profit will take. For example, a business has to start an inventory of $ 2,000 and a closing inventory of $4,000 over a fiscal year of $ 30,000 products sold. Then days of inventory outstanding will be ($ 2,000 + $ 3,000)/ 2 = $2500/ $30,000 = 0.0833333333* 365 = 30.41. It will take 30 days to convert inventory into sales.
The concepts that have been chosen for further discussion are credit policies and inventory management.
Credit policies are guidelines set by the organizations for the customers that specify their credit limits while making their payments during purchases (Box et al., 2019). Moreover, it also describes the company's actions if the price is not done within a specific time limit. The credit policy is known to be quite helpful when undertaking essential investment decisions for the company. Since it is an organization's policy to market a product to the customers or distributors, it is known to impact the company's growth and financial stability. Based on the credit policy, my company tries to conclude the amount of loan to be taken from the market and understands the need to have a higher capital hold (Boisjoly et al., 2020).
A numerical example of the credit policy would be as follows:
In 2017, the net credit sales of the company Beta Ltd were $1,200,000, with a beginning balance of accounts receivable of $400,000. The ending balance of the accounts receivable was $440,000. These companies can use this information to mine the credit period. Considering there are 365 days a year, the credit period can be identified by:
Average Accounts Receivable = (Beginning Balance of Accounts Receivable + Ending Balance of Accounts Receivable) / 2
Therefore, ($400,000 + $440,000) / 2 =$420,000
$420,000 / ($1,200,000/ 365) = 127.75 days.
Inventory management helps determine which stock is about to exhaust and helps the managers to p track it from time to time so that it can be refilled for use. There is a positive impact on inventory management practices adopted by different organizations to be competitive and enhance their overall performance (Atnafu & Balda 2018). It has been seen that a higher level of inventory management practice can lead to an enhancement in competitive advantage attempt by the organization along with improvising the organizational performance. In the decision-making process, it can be used as a strategic tool for better resource management. Inventory management had been widely used within my previous organization to determine the products with the highest and lowest demand. This further helps them to research these products to determine the qualities or characteristics of the product that makes them different from the others (Boisjoly et al., 2020). Then the most appropriate product is developed and introduced in the market. The formula for inventory management is TC = PC + OC + HC. TC is the Total Cost, PC is Purchase Cost, OC is the Ordering Cost, and HC is the Holding Cost. A numerical example of inventory management would be as follows:
If the total cost is to be determined, it is essential to determine the purchase cost, ordering cost, and holding charge. The raw materials for a manufacturing company had been purchased at $30,000, whereas the ordering cost was 35,000 and the holding cost $40,0000. Therefore, the total cost would be
TC= $30,0000 + $35, 000 + $40, 0000
TC= $105, 0000.
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