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Working Capital

Financial Management 200 (University of Johannesburg)

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Working Capital
• Working capital is made up of liquid assets like cash, debtors and creditors
• The aim is to shorten the operating cycle to save costs and convert stock to
cash faster
• There are 3 schools of thought to funding working capital:
1. Aggressive fund long term with risky short term assets
2. Conservative fund short term financing with long term long risk assets
3. Match finance periods to periods of operational needs
• The following factors are considered when assessing a customer’s
creditworthiness:
• Attitude to debt
• Credit History
• Financial Position
• Security
• Economic Environment

Analysing the change in credit policy

Profit = G + I + B + D

G = Gross Profit

I = Cost of receivables Credit sales x collection period in days/365 x market rate

B = Cost of bad debts Credit sales x % of people not paying early x % Bad debts
expected

D = Cost of discount Credit sales x %who pay early x %discount

Credit policy is expressed as follows 6/3 net 10

6 = discount percentage

3 = the amount of days you have to pay to get discount

10 = The amount days you have to settle debts

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Creditor Finance

Kf = D / 1-D x 365/t

Kf is the cost of not paying creditors early

D = discount %

T = days left after the early payment day

Days before the deadline are free credit an everyday after is savings sacrificed

Factoring of Debtors

• Selling the debtors book to a debt collector for a fixed fee

• Effective cost = Net costs / Net receipts

Advantages

• The financial institution can assess credit risk better

• Savings on admin costs
• Focus on core business
• Discount and payment incentives can be reduced
• Reduced staff cost

Invoice discounting

• The bank will not take up the admin functions of recovering debt
• Charges high interest

Inventory Management

• Economic Order Quantity

√ 𝑭𝑺/𝑪

• F = Fixed order cost

• S = Annual unit sales
• C = Carrying cost of one unit of stock per year

Reasons for holding cash

• Loan covenants
• Precautions
• Speculation

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• Operations

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