The Importance of Working Capital Management

The Importance of functional Capital ManagementWorking seat of government heed defines the management in the brief term of the relationship between a companys current assets and liabilities. The some common elements of functional capital will include inventory, receivables and payables which represent the operating workings capital (OWC) held by a company usually within a year. Fig.1 below shows the inter fill between these elements of OWC.The goal of OWC management is to ensure that a company has enough cash flow, measure in monetary value of liquidity, to satisfy its scant(p) term debts and continue to support its day to day operations. Most articles and books discuss the significance 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 circumstantial immenseness and state t hat 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 mannerology to OWC and do not consider a firms unique nature, industries or size. Furthermore, this significance of working capital will depend on its size and root word and will vary between industries such as Rolls Royce Plc a manufacturing company will place situation attention to its high inventory levels and payables unlike British Air modalitys Plc a service provider with no inventory. doubting 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 chief fiscal officer magazine. The result indicated that there was a consistency in working capital measures within industries but the working capital measures were are not static over ti me. In an online article Philip McCoster (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 dynamic nature of working capital and highlights this importance in more subtle way that most organisations are profitable on paper but are forced to cease art because they cannot meet short term debts. According to him, small businesses in servingicular are prone to check particularly during start 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 authoritative in order for an organisation to effectively manage its cash flow to continue operation. But enchantment this is most said in papers, it seems rather paradixocal that in reality the importance OWC is ignore and most companies acquire themselves at the point of bankr uptcy as was the case in the winning margin game.As a business manager in the Winning Margin game, I realised that the decisions I made especially in forecasting and managing machines output was very critical to the boilers suit sum of finished goods inventory requisite to achieve a positive OWC. This was clearly depicted in year two when two critical decisionsForecasted a total production output of 11 be $40 (appendix Production and Sales Plans For The category Ahead).Purchase of two additional Mark II machines (See appendix Balance Sheet)This resulted to an increase in the gist of inventory to contracted amount although some inventory was tied up in Work in Progress and Finished goods leading to a cut down in operating working capital (Year 2 Cash Flow Statement). Furthermore, the cash spent on new machines also led to a drop in the operating cash flow of the business. Therefore, in real life the production manager component part is strategic and has a big impact on worki ng capital and the overall business objective but his/her decisions can only be as effective when taken in collaboration with opposite departmental heads.2.2 BUDGETINGMcLaney E and Atrill P., Accounting An Introduction (Prentice Hall, 2008) defined a budget as a short term financial externalize prepared by a business as an integral part of its strategic plan framework. A budget is use by managers to examine and liken between the true(a) to what was planned in a process known as the budget control. By using this technique, classify E benefited from the budgetary process in many waysForward thinking and identification of short-term problems During the provision 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 each year meant we had to co-ordinate with each other. This was crucially beneficial because it improved profile and decisions making as all activities were linked together. For example, decisions on production depended on sales estimates, raw poppycock 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 mitigate planning for year 3.It created a system of authorisation By decision making 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 Absorption CostingAbsorption costing is a method of shrewd the full output cost by charging direct costs with a fair appoint of indirect costs. The essence of absorption costing is to keep costing simpler and easier so that management can bring up informed decisions. In the Winning Margin game, the use of this technique was beneficial to our group in some(prenominal) 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 often 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 habit 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 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 life 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)