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Managing working capital.

[check] This checklist is aimed at managers who have responsibility for managing working capital.

For most businesses the control of working capital is fundamental to their finances, and good working capital management can improve their cash position. Working capital management involves the control of stock, debtors and creditors and may involve a number of employees in the process.


The term "working capital" refers to the current assets of the firm, ie, cash, and those items that can be converted into cash within the next 12 months, such as stock and work-in-progress and debtors. Debtors are amounts owed to the organisation. Net working capital is defined as the difference between current assets and current liabilities. Current liabilities consist of amounts that are owed by the firm that will be paid within 12 months. The major proportion of current liabilities are often, but not always, trade creditors, ie amounts owed to suppliers.

Advantages of good working capital management

These can include:

* helping to earn interest or reducing interest payments

* assisting in producing a realistic annual budget

* helping managers take financial responsibility

* helping managers to think about the future and plan accordingly

* helping managers to measure their own performance and the performance of their team

* helping managers in different parts of the organisation to co-ordinate their activities.

Disadvantages of poor working capital management

These can include:

* cash shortages

* an inability to pay suppliers

* overstocking

* the failure of the organisation.

Action checklist

1. Establish systems to measure working capital

Check that levels of working capital can be measured accurately and regularly, ideally on a daily basis, and certainly on a weekly basis. You need systems that will allow you to state the amount of cash, debtors, stock and work-in-progress, and creditors.

2. Record past and current levels of working capital

Knowing your current and past levels of working capital is a useful starting point. This helps with setting a realistic budget and will enable you to establish times of the month/year when elements of working capital are higher/lower. For example, some businesses will hold higher levels of stock as Christmas approaches.

3. Benchmark your levels of working capital

Although it can prove difficult, it's very useful if you can compare your levels of working capital with similar organisations. Some of these may be willing to share information with you on a regular basis. At the very least you may be able to obtain their annual financial accounts and calculate useful ratios:

* Stock days (Cost of sales divided by 365, multiplied by stock). This shows how many days stock the organisation holds at its financial year-end. A stock-days figure of 40 would mean that the organisation could continue trading for 40 days, without buying or manufacturing more stock, before it runs out. A lower figure is usually better as it means that lower levels of stock are held, i.e. there is relatively little money tied up in stock.

* Debtor days (Sales divided by 365, multiplied by debtors). This shows the average number of days that elapse before a customer pays for goods. A lower figure is better as cash is being received faster from customers.

* Creditor days (Cost of sales divided by 365, multiplied by creditors). This shows the average number of days that elapse before the organisation pays its suppliers. A higher figure is better as cash remains in the organisation for longer. However, recent legislation gives small businesses the right to charge interest for late payment. Delayed payment, particularly to small businesses, could cause them cash flow problems.

4. Look for improvements

There are a number of ways in which lower stocks and debtors, and higher creditors, can be achieved:

a) stock and work-in-progress

* forecast sales accurately

* improve stock control systems to identify over- or under-stocking

* where appropriate, get suppliers on a "Just-in-Time" system (where, in effect, they hold the stock for you)

* minimise your holdings of finished goods by accelerating the dispatch process

* eliminate slow moving lines

* where appropriate, hold one central store, rather than several.

b) debtors:

* agree trade terms with customers

* carry out checks to verify that prospective customers can pay

* establish an effective credit control system with a sensible collection policy

* ensure that statements and invoices are issued correctly and promptly

* offer early payment discounts and charge interest on overdue debts

* follow up late invoices in person

* resolve disputed invoices quickly

* pay commission to sales people on receipt of cash from customers, rather than when the sale is agreed/invoiced.

c) creditors

* agree trade terms with suppliers or lenders, eg, banks

* delay payment to suppliers until the last day of trade terms

* calculate whether it is worth paying suppliers early in order to qualify for discounts.

d) cash

* predict cash surpluses and make investment plans

* predict cash shortages and make prior arrangements with banks and other lenders

* ensure that you borrow from the cheapest source, but be aware of penalties for late payment

* deposit cash at the bank every day if practicable.

5. Set targets and incentives

Targets and incentives can be set in each of the areas above. A bonus could be paid for the achievement of a lower debtor days figure.

6. Establish cash and working capital budgets

You may need the help of an accountant to establish realistic cash and working capital budgets. These should give predictions for the levels of cash, stock, debtors and creditors on a weekly or monthly basis.

7. Monitor against budget and take appropriate action

On a regular basis you should compare actual performance against budget and take appropriate action. For instance, if stock levels are higher than budget you may need to review the list of slow moving product lines and possibly discontinue some.

Do's and Don'ts for managing working capital


Be realistic.

Take last year's working capital trends into account.

Be aware of seasonal fluctuations within the year.

Monitor on a regular basis (daily, weekly, monthly).

Delegate responsibility for each part of working capital to an appropriate individual.

Constantly strive for improvement.


Be over-optimistic.

Leave too little time for planning.

Draw up a working capital plan without involving key people, including, for example, your bank manager.

Useful reading


The real cost of capital: a business field guide to better financial decisions

Tim Ogier, John Rugman, Lucinda Spicer

London, Prentice Hall, 2004 (Financial Times series)

Finance for strategic decision making: what non financial managers need to know

M P Narayanan and Vikram K Nanda

San Francisco Calif., Jossey Bass, 2004

Financial management textbook, 4th ed

Geoffrey Knott

Basingstoke, Palgrave MacMillan, 2004

Planning and controlling physical and financial resources

National Extension College Trust

Prime Training, Cambridge 2002

Finance for non financial managers in a week, 3rd ed

Roger Mason

Chartered Management Institute

London, Hodder and Stoughton, 2003

Principles of corporate finance, 6th ed

Richard A Brealey and Stewart C Myers

Boston Mass, McGraw Hill, 2000

Tolleys businesswise: financial planning for the small and medium sized


Peter Lyons

Croydon, Tolley, 2001

Thought starters

* Do your financial systems give you regular and accurate figures for cash, stock and work-in-progress, debtors and creditors?

* Have you analysed past performance in order to set realistic targets for the future?

* Have you considered some quick and simple improvements, such as trying to get money in from a major debtor, or reducing stocks of slow moving items?
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Title Annotation:Checklist 182
Publication:Chartered Management Institute: Checklists: Small Business
Geographic Code:4EUUK
Date:Oct 1, 2005
Previous Article:Investment appraisal.
Next Article:Reading a profit and loss statement.

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