UNIVERSITY OF IRINGA

FACULTY OF BUSINESS AND ECONOMICS

DEPARTMENT OF ECONOMICS AND FINANCE

COURSE NAME: BUSINESS FINANCE

LECTURER NAME: Ms. MTEWELE

NATURE OF WORK: GROUP ASSIGNIMENT

SUBMISION DATE: NOVEMBER 2022

S/N NAMES REG. SIGN
NUMBER
1. JEREMIA NYANSANDA BEF-34252
MANGARAYA
2. YUSTA FRANCIS MODESTUSI BEF-33873
3. SHUMBANA IBRAHIM SONGORO BEF-34638
4. DESDELIA BONIFACE NYASHARO BEF-33967
5. CLIFF GOODLUCK KAPOMA BEF-34211
6. ATURASH ALINDA ABDALATIFU BEF-34362
7. EDSON ERASTO ALOYCE BEF-34832
8. PIUS DEUS MAKWAYA BEF-34238
9. ISIAKA HASSANI KIMATILO BEF-33528

QUESTION:
Working capital management.
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INTRODUCTION

Definition of working capital management

Working capital management can be defined as a business strategy to manage working capital.
In other words, working capital management is nothing but all that takes to maintain sufficient
cash flow to meet various business obligations.

THE FOLLOWING ARE MAIN OBJECTIVE OF WORKING CAPITAL

MANAGEMENT

1. Minimizing cost of capital, if the cost of fund utilized in working capital should be
minimum, the management should negotiate well with financial institutions, select the
right modal of financial and maintain optimal capital structure Example long term
financial option are long term debit.

2. To smooth working capital cycle, this could be achieved only if the business able to
manage all component of its working capital in the best possible manner Example raw
material should be available when required and should not hinder production.

Maximizing the return on current assets investments, the return on investment infused on short
term assets must exceed the average cost of capital to ensure wealth maximization

CASH OPERATING CYCLE

The cash operating cycle (also known as the working capital cycle or the cash conversion cycle)
is the number of days between paying suppliers and receiving cash from sales.

Cash operating cycle =inventory days + receivable days –payable days.

In the manufacturing sector inventory days has three components;

1. Raw materials days

2. Work in progress days (the length of production process)

3. Finished goods days.

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The concept of working capital for a business is the main indicator of whether the working
management strategy of a business run its operation smooth and can also positively impact the
profit and earning of a business. Similarly, it ensure that the operation of business are running in
an ordered and efficient manner.

IMPORTANCE OF CASH OPERATING CYCLE

The nature of working capital is as discussed below ;

1. It used to purchase raw materials, payment of wages and expenses.

2. Working capital enhance liquidity, solvency, creditworthiness, and reputation of
enterprises.
3. It changes from constantly to keep the wheels of business moving.

FOMULA FOR CASH OPERATING CYCLE

Cash operating cycle =inventory holding period+ receivable collection period_ creditors
payment period or, raw material holding period + work in process period + finished goods
holding period + receivable collection period _ creditors payment period.

Example of operating cycle

Suppose $500 worth is purchased from a supplier on 20 days of credit, and it was sold after 40
days of purchasing it. The credit of 40 days is given to the buyer. The buyer paid on completion
of the credit period.

Here, the operating cycle =inventory holding period + receivable collection period

=40 + 40=80days.

Cash operating cycle = 80 days _20 days (suppliers credit) = 60days

LIQUIDITY RATIO

Liquidity is a very critical part of a business. Liquidity is required for a business to meet its
short term obligations. Liquidity ratios are a measure of the ability of a company to pay off its
short-term liabilities.

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Liquidity ratios determine how quickly a company can convert the assets and use them for
meeting the dues that arise. The higher the ratio, the easier is the ability to clear the debts and
avoid defaulting on payments.

This is a very important criterion that creditors check before offering short term loans to the
business. An organization which is unable to clear dues results in creating impact on the
creditworthiness and also affects credit rating of the company.

Let us now discuss the different types of liquidity ratios.

Types of Liquidity Ratio

There are following types of liquidity ratios:

1. Current Ratio or Working Capital Ratio

2. Quick Ratio also known as Acid Test Ratio

3. Cash Ratio also known Cash Asset Ratio or Absolute Liquidity Ratio

4. Net Working Capital Ratio

Current Ratio or Working Capital Ratio

The current ratio is a measure of a company’s ability to pay off the obligations within the next
twelve months. This ratio is used by creditors to evaluate whether a company can be offered
short term debts. It also provides information about the company’s operating cycle. It is also
popularly known as Working capital ratio. It is obtained by dividing the current assets with
current liabilities.

Current ratio is calculated as follows:

Current ratio = Current Assets / Current Liabilities

A higher current ratio around two(2) is suggested to be ideal for most of the industries while a
lower value (less than 1) is indicative of a firm having difficulty in meeting its current liabilities.

Also: Difference between Current Ratio and Quick Ratio

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Quick Ratio or Acid Test Ratio

Quick ratio is also known as Acid test ratio is used to determine whether a company or a
business has enough liquid assets which are able to be instantly converted into cash to meet short
term dues. It is calculated by dividing the liquid current assets by the current liabilities

It is represented as

Quick Ratio = (Cash + Marketable securities + Accounts receivable) / Current liabilities

The ideal quick ratio should be one (1) for a financially stable company.

Working Capital Turnover Ratio

Cash Ratio or Absolute Liquidity Ratio

Cash ratio is a measure of a company’s liquidity in which it is measured whether the company
has the ability to clear off debts only using the liquid assets (cash and cash equivalents such as
marketable securities). It is used by creditors for determining the relative ease with which a
company can clear short term liabilities.

It is calculated by dividing the cash and cash equivalents by current liabilities.

Cash ratio = Cash and equivalent / Current liabilities

Net Working Capital Ratio

The net working capital ratio is used to determine whether a company has sufficient cash or
funds to continue its operations. It is calculated by subtracting the current liabilities from the
current assets.

Net Working Capital Ratio = Current Assets – Current Liabilities

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Liquidity Ratio Formula

Here are the important liquidity ratio formulas in a tabular format.

Liquidity Ratios Formula

Current Ratio Current Assets / Current Liabilities
Quick Ratio (Cash + Marketable securities + Accounts receivable) / Current
liabilities
Cash Ratio Cash and equivalent / Current liabilities
Net Working Capital Current Assets – Current Liabilities
Ratio

Importance of Liquidity Ratio

Here are some of the importance of liquidity ratios:

1. It helps understand the availability of cash in a company which determines the short term
financial position of the company. A higher number is indicative of a sound financial
position, while lower numbers show signs of financial distress.

2. It also shows how efficiently the company is able to convert inventories into cash. It
determines the way a company operates in the market.

3. It helps in organizing the company’s working capital requirements by studying the levels
of cash or liquid assets available at a certain time.

This concludes the article on the concept of liquidity ratios. It will provide ample information for
the students to understand liquidity ratios which provides a solid basis for calculating the
liquidity position of a company.

DIMENSION OF WORKING CAPITAL MANAGEMENT

(A) Cash management

What Is Cash Management?

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Cash management is the process of collecting and managing cash flows. Cash management can
be important for both individuals and companies. In business, it is a key component of
a company's financial stability. For individuals, cash is also essential for financial stability while
also usually considered as part of a total wealth portfolio.

Individuals and businesses have a wide range of offerings available across the financial
marketplace to help with all types of cash management needs. Banks are typically a primary
financial service provider for the custody of cash assets. There are also many different cash
management solutions for individuals and businesses seeking to obtain the best return on cash
assets or the most efficient use of cash comprehensively.

(B) CREDIT MANAGEMENT

Credit management is the process of granting credit, setting the terms on which it is
granted, recovering this credit when it is due, and ensuring compliance with company
credit policy, among other credit related functions. The goal within a bank or company,
in controlling credit, is to improve revenues and profit by facilitating sales and reducing
financial risks.

(C) A credit manager is a person employed by an organization to manage the credit

department and make decisions concerning credit limits, acceptable levels of
risk, and terms of payment and enforcement actions with their customers. This
function is often combined with Accounts Receivable and Collections into one
department of a company. The role of credit manager is variable in its scope and
Credit Managers are responsible for:[1]
(D) Controlling bad debt exposure and expenses, through the direct management of
credit terms on the company's ledgers.
(E) Maintaining strong cash flows through efficient collections. The efficiency of
cash flow is measured using various methods, most common of which is Days
Sales Outstanding (DSO).
(F) Ensuring an adequate Allowance for Doubtful Accounts is kept by the company.
(G) Monitoring the Accounts Receivable portfolio for trends and warning signs.

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 (H) Hiring and firing credit analysts, accounts receivable and collections personnel.
(I) Enforcing the "stop list" of supply of goods and services to customers.
(J) Removing bad debts from the ledger (Bad Debt Write-Offs).
(K) Setting credit limits.
(L) Setting credit terms beyond those within credit analysts' authority.
(M) Setting credit rating criteria.
(N) Setting and ensuring compliance with a corporate credit policy.
(O) Pursuing legal remedies for non-payers.
(P) Obtaining security interests where necessary. Common examples of this could be
PPSAs, letters of credit or personal guarantees.
(Q) Initiating legal or other recovery actions against customers who are delinquent.

Credit managers tend to fall into one of three groups depending on the specific legal and
jurisdictional knowledge required:

(R) Commercial Credit Manager

(S) Consumer Credit Managers

C). INVENTORY MANAGEMENT

Construction Credit Managers

What is inventory management?

Inventory management is the tracking of inventory from manufacturers to warehouses and from
these facilities to point of sale

How does inventory management work?

Inventory is the goods or materials a business intends to sell to customers for profit. Inventory
management, a critical element of the supply chain, is the tracking of inventory from
manufacturers to warehouses and from these facilities to a point of sale. The goal of inventory
management is to have the right products in the right place at the right time. This requires

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inventory visibility — knowing when to order, how much to order and where to store stock. The
basic steps of inventory management include:

1. Purchasing inventory: Ready-to-sell goods are purchased and delivered to the warehouse
or directly to the point of sale.
2. Storing inventory: Inventory is stored until needed. Goods or materials are transferred
across your fulfillment network until ready for shipment.
3. Profiting from inventory: The amount of product for sale is controlled. Finished goods
are pulled to fulfill orders. Products are shipped to customers.

What is inventory visibility?

Multichannel order fulfillment operations typically have inventory spread across many places
throughout the supply chain. Inventory visibility is knowing what inventory you have and where
it’s located. Businesses need an accurate view of inventory to guarantee fulfillment of customer
orders, reduce shipment turnaround times, and minimize stock outs, oversells and markdowns.

Three reasons why you need a better view of your inventory

Why is inventory management important?

Inventory can be a company’s most important asset. Inventory management is where all the
elements of the supply chain converge. Too little inventory when and where it's needed can
create unhappy customers. But a large inventory has its own liabilities — the cost to store and
insure it, and the risk of spoilage, theft and damage. Companies with complex supply chains and
manufacturing processes must find the right balance between having too much inventory on hand
and not enough.

What are the types of inventory management?

Periodic inventory management

The periodic inventory system is a method of inventory valuation for financial reporting
purposes in which a physical count of the inventory is performed at specific intervals. This

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accounting method takes inventory at the beginning of a period, adds new inventory purchases
during the period and deducts ending inventory to derive the cost of goods sold (COGS).

Barcode inventory management

Businesses use barcode inventory management systems to assign a number to each product they
sell. They can associate several data points to the number, including the supplier, product
dimensions, weight, and even variable data, such as how many are in stock.

RFID inventory management

RFID or radio frequency identification is a system that wirelessly transmits the identity of a
product in the form of a unique serial number to track items and provide detailed product
information. The warehouse management system based on RFID can improve efficiency,
increase inventory visibility and ensure the rapid self-recording of receiving and delivery.

Key features of effective inventory management

 Inventory tracking
 Know exactly where inventory is across the supply chain.
 Order management
 Customize pricing, send quotes, track orders and manage returns.
 Transfer management
 Move product to where it's most valuable.
 Reporting and analytics
 Evaluate patterns in processes to forecast future demand and sales.
 Purchasing
 Create and manage purchase orders.
 Shipping capabilities
 Automate shipping to reduce errors such as late deliveries or delivering incorrect
packages.

What is an inventory management system?

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Spreadsheets, hand-counted stock levels and manual order placement have largely been replaced
by advanced inventory tracking software. An inventory management system can simplify the
process of ordering, storing and using inventory by automating end-to-end production, business
management, demand forecasting and accounting.

Optimize your maintenance, repair and operations (MRO) inventory

The future of inventory management

Globalization, technology and empowered consumers are changing the way businesses manage
inventory. Supply chain operators will use technologies that provide significant insights into how
supply chain performance can be improved. They’ll anticipate anomalies in logistics costs and
performance before they occur and have insights into where automation can deliver significant
scale advantages.

In the future, these technologies will continue to transform inventory management:

Artificial intelligence

Intelligent, self-correcting AI will make inventory monitoring more accurate and reduce material
waste.

(D) WORKING CAPITAL FINANCING

Working Capital Financing is when a business borrows money to cover day-to-day operations
and payroll rather than purchasing equipment or investment.

Working capital financing is a common practice for businesses with an inconsistent cash flow.

Types of Working Capital Finance

There are several ways of financing working capital. The most common are:

 Working Capital loans

 Overdrafts

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  Lines of credit
 Invoice Discounting

Each have their advantages and disadvantages.

However, some are easier to get approval than others as banks can ask for huge collateral
coverage depending on your businesses’ credit

Overdraft

An overdraft is always offered by the institution providing the corporate bank account.
Alternatively, any third-party institution can provide a revolving credit facility. For the bank
account holder, an overdraft behaves the same way as a line of credit. If your account balance
dips below zero, the bank provides you overdraft protection up to a certain amount. This
prevents your purchase from being declined and your cheque from being bounced. Overdraft
protection can be linked to a business account but is typically utilised by individuals. This is
because revolving credit facilities are only offered to businesses. While personal bank accounts
will come pre-equipped with an overdraft facility, businesses must apply for overdrafts on
commercial accounts. Overdraft very similar to a line of credit but this is a non-revolving form
of credit

Line of Credit

This is a loaning facility granted by a lending institution allowing a business to borrow and repay
as often as needed within a set limit. It is a long term and flexible working capital financing
solution. For example, a business is granted a line of credit for the year. The company borrows
and repays 60% of the allotted amount monthly. Let’s assume the business picks up in the
summer and needs to borrow a higher amount from its line of credit. A credit line allows the
business to: Use credit facility when needed Have a lower interest rate is compared to one off
bank loans this is because a line of credit only accrues interest when debt is taken out on it

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Invoice Discounting

Invoice discounting is the process by which a business sells its account receivables to a third
party institution. This working capital financing solution for small and medium-sized businesses
is easier to get compared to other financing methods.

Why? Because it is backed by an asset, the invoice.

For example, if a business has an invoice that is not payable yet, invoice discounting can help
bridge the gap and make the funds immediately available.

Gain a deeper understanding of how invoice discounting works through our conceptual article
that expands on the concept.

Importance of Working Capital Finance for Businesses

 Whether your business is facing cash flow issues or not, having extra cash in reserves is
always good to secure yourself during unexpected circumstances.
 Working capital financing lets firms fulfil their short-term or urgent cash flow shortfalls.
 Benefits of Working Capital Financing
 This financing option is beneficial for different business types and purposes. Below are
key benefits of working

Working capital loan

Very simply, a loan taken to finance the daily operations of a business.

For example, a business applies for a loan to cover the rental cost of the premises. Renting a
premise would indirectly generate enough yield to pay the loan by maturity.

One of the drawbacks of a working capital loan is that it must be taken out again each time.

Aggressive Approach - Conversely, an aggressive approach involves extensive utilization of

short-term financing options. An aggressive approach aims to speed up your business cycle and
reduce idle assets that generate unnecessary costs. Although there are efficiency advantages
associated with this approach, it is incredibly high risk compared to a conservative strategy.

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Conservative Approach – As the name speaks for itself, this strategy finances working capital
with low risk and profitability. Working capital financing will primarily be secured through long
term solutions in these instances. For example, equity funding, term loans or long-term securities
like debentures. This strategy also finances a portion of your temporary working capital.
Temporary working capital is the net working capital variation curve above permanent working
capital.

Hedging Approach – Perhaps the most sensible, utilitarian and most frequently adopted
approach. This involves using long term financing methods to account for fixed assets and
permanent working capital. The graphical representation below, gives you a better understanding
of how the three working capital strategies work. Long- and short-term strategies are used to
overcome temporary and permanent working capita

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