Introduction
Liquidity is a huge issue – especially now. In many cases we don’t really think about it – until it becomes an issue. It usually becomes an issue when liquidity is too low. And when it becomes an issue it can escalate alarmingly and cause considerable damage and distress.
- Liquidity issues can affect countries. There have been recent major economic and political issues in Venezuela [2017] and Lebanon (2023). See also here from the International Monetary Fund (IMF) blog.
- It can affect individual companies, for example here.
- And it can affect individuals and be close to home, see personal insolvencies.
For individual businesses the efficient management of short term assets (current assets) and short term liabilities (current liabilities) is crucial for the survival and growth of a business. This week we’ll be looking at the management of these items (working capital) and will see the process as a series of interlinks and trade-offs.
Lecture slides
The lecture slides for today are here.
If cash is the ‘lifeblood’ how much is needed? Like animals the amount of working capital needed may depend on the size of the business. Big businesses generally need more working capital. However, it may be too high or too low (perhaps like blood pressure). So what’s right?
Discussion question
Discussion question from a previous exam paper:
a) Businesses need to balance the trade-offs between holding too much cash and holding too little cash.
Discuss the costs to a business of holding too little cash and the costs of holding too much cash.
(15 marks)
b) A business intends to increase its profit by increasing its sales.
Discuss the pressures that increasing sales can put on a business’s working capital.
(10 marks)
Supportive reading
Philip McCosker, The Importance of Working Capital, ACCA (2000)
– available online
Working Capital: Meaning and Formula: a basic introduction – available online
Cash Management: online at Kaplan Financial Knowledge Bank
D. Chandra Bose: Fundamentals of Financial Management, Prentice-Hall, 2006, chapters 9, 10, 11, and 12 – available on Google Books
Firth: Management of Working Capital, Macmillan, 1976
– a bit dated, but still remains a useful introduction. It’s in the university library.
Dhiraj Sharma: Working Capital Management, 2014, New Delhi : Himalaya Publishing House
– an electronic resource, available in the university library.
Hi Donald,
When we calculate the turnover ratio we should use the average amount or closing balance?
Many thanks
Hi Ray
I would use the end of year figure unless asked to do otherwise. What you need is a ‘typical’ figure for the year. As there can be seasonal variations (e.g. in inventory levels) during the year, adding the opening and closing figures and dividing by 2 does not necessarily get you any closer to the average level during the year. So I would tend to stick with the end of year figure.
Hope this helps.
Best wishes
Donald
Hi Donald,
https://ecourse.co.uk/materials/qneorite.pdf
I’ve tried using the days and months but I don’t get the same answer.
For receivable: receivables/cost of salesx12: 851580/3,406,320×12=3. For payable : payable/ turnoverx12 567720/4257900×12=12
Thanks
Hi Vanessa
Receivables should be compared with turnover not cost of sales.
Payables should compared with cost of sales not turnover.
Best wishes
Donald
Hi Donald,
Thank you got that mixed up. One more question in regards to the discussion in part c. Is it okay to do it just like you did or would we have to go into more details?
Thanks
Hi Vanessa
The text answers given are sometimes a bit on the brief side and may be in bullet form. You will have to make your own judgement as to what an appropriate text answer is. It should, of course, be clear, accurate and to the point.
Best wishes
Donald
Hi Donald,
Im unsure how you worked out
Credit to customers (months) and
Credit from suppliers (months) in Neorita. I used the Ratios Receivable days and Payable days but I got a different answer.
Thanks
Hi Vanessa
I am having trouble tracing the case study you are referring to. Can you add a link? A possible issue is that you have measured in days and my suggested solution uses months.
Debtor days = trade debtors / sales x 365
Debtor months = trade debtors / sales x 12
Does this take you any further?
Best wishes
Donald
Hi,
Is cross-sectional analysis worth 20 marks or 60 marks? (Boxton)
A question like Boxton could be set as either a 20 mark or a 60 question in an examination situation. Obviously, the level of analysis, presentation and commercial awareness would be expected to be much higher if there were 60 marks. 60 mark questions often contain extra parts that explore other, connected parts of the syllabus.
Best wishes
Donald