Q. Example on Controlling working capital?
Describe how a manufacturing company could control its working capital levels and impact of the suggested control measures.
Solution:
Controlling working capital
Some of the practical aspects that could be taken to achieve this include:
1 Reducing average raw material inventory holding period
- Ordering in small quantities to meet immediate production requirements though could lose quantity discounts.
- Reducing the level of buffer stocks if these are held however this will increase the risk of production being halted because of a stock out.
- Reducing the lead time allowed to suppliers, but could also increase risk of a stock out.
2 Increase the period of credit taken from suppliers
- If credit period is extended then company may lose discounts from prompt payment. Financial effect of this must be calculated and compared with the cost of funds from other sources.
- If credit period is extended then goodwill may be lost, which is significant in the event of goods being required urgently.
3 Reducing the time taken to produce goods and inventory holding period or finished inventories
- Efficiency results in cost savings hence finding an efficient way to produce goods (i.e. in economic batch quantities) though the company should ensure than quality is not sacrificed.
- Savings arising from inventory holding reduction should be evaluated against the cost of inventory out, together with the effect on customer service.
4 Reducing average debt collection period
- Administrative costs of speeding up debt collection and effect on sales of reducing credit period allowed should be evaluated.