Working capital management:
Working capital management is a very important concept in any business organisation as it relates to the management of short term liabilities and assets of the business that drives the day to day operations. Efficient working capital management ensures that business organisation is able to have sufficient assets to meet its short term operational expenses and debt obligations and hence the organisation operates continuously without interruptions. Working capital therefore refers to the difference between current assets and current liabilities in the business. Management of working capital entails the strategies employed in the business to manage cash, accounts payables, receivables and inventory.
Preve & Virginia (2010) describes working capital management as operational decision making strategies that link short term business financing strategies with the overall business strategies. In this regard working capital management relates to management decisions around the financing of short term business obligations with the short term sources of business financing to create value for business and match the long term business goals. Working capital management can be subdivided into the following categories of short term operational decisions:
Debtors form a fundamental part of short-term source of income for business hence there is need for proper strategies to ensure that the business handles its accounts receivables. Effective management of debtors will enable business to release cash for other business projects or acquisition of new stock hence the business will operate a smooth supply chain. The essence of efficient debtor management is to ensure that all credit sales that raise accounts receivables are promptly converted to cash.
Debtor’s management therefore involves all processes from the point of conducting negotiations with credit buyers to the actual receipt of the cash from such clients. The most important decisions in debtors management is how the business negotiates terms for credit sales and the kind of clients that such facilities are extended to. The management must ensure that terms of credit sales are well defined. Clients receiving such facilities must be properly appraised and as such the business must ensure that accounts receivables are paid within the shortest possible time. The business must also impose penalties for late payments that may affect the value that the firm receives. The key factor in debtor’s management is therefore time period that it takes to convert the account receivables to cash. (Morris,Mackay & Oates,2007 p.98).
This is another important area of working capital management and deals with availability of cash flows to meet daily operational demands without increasing the cash holding costs. This is a strategy that ensures that the business has sufficient cash which is the quickest current asset for all operational needs but at the same time reducing the costs attributed to the possession of excess cash in the business. In this regard the management must clearly identify their operational needs and the quick assets that will offset such needs and strike a balance such that the business does not hold excess liquidity but at the same time provide sufficient cash to ensure continuous operations. Proper cash budgeting can help an organisation reduce the costs and risks associated with holding cash but at the same time achieve efficiency in meeting its daily operational needs (Friedhof, 2006 p.3).
The term inventory is used to refer to stock which is one of the key components of current assets in business. Inventory management refers to the processes involved in moving stock in and out of the business to ensure that the business have sufficient levels of stock to meet the demands from customers but also achieve sufficient levels to reduce holding excess stock that incurs costs to the business. The essence of inventory management is to achieve proper levels of stock to ensure continuous operations. It also ensures that the business is able to minimise costs associated with handling and storage of inventories as well as tax obligations accruing from holding excess stock. Inventory management must pay attention to the time that it takes to acquire the products from the supplier and the time it takes for the inventory to move out of business due to sales. Determination of the two timings will allow the business to create a buffer stock to handle any emergencies and unusual demands hence the business will be able to keep track of its required levels of inventory in the business. Different strategies can be used to determine the appropriate levels of inventories in the business The Last In First Out method (lifo) and First In Fisrt Out (fifo) are commonly used to determine the optimal level of inventory in business.
These three decision strategies work hand in hand in ensuring efficiency in the management of working capital hence any business must set up strategies around the three to achieve working capital management. As discussed in the three strategies, holding excess cash and stock have some financial obligations on the part of the business. These can be inform of handling and storage costs as well as tax obligations as excess cash and stock adds on to the business assets. On the other hand a business that holds larger amounts of account receivables may find it difficult to meet its short term account payables as well as other operational needs and this can affect the running of the business. The bottom line is that a business must maintain an optimal level of working capital that helps in meeting short term operational needs but also minimises the costs associated with maintaining such working capital and as such this will constitute efficient working capital management (Kumar, 2001).
Sources of business finance in UK:
UK is one of the most advanced economies in the world and its dependence on the service sector makes financing businesses a key part of the economy. The financial sector therefore plays an important role in UK economy through financial intermediation by availing liquidity to companies and individuals who in turn invest in different service sectors. Due to its integrated nature and the current advancements in the financial service sector UK has a whole range of sources of financing for businesses which includes short term, medium term and long fincning.They are discussed below:
Long term sources of finances:
These are sources of business finance that are required for business expansion purposes and hence they are used to undertake projects that run for more than one year. These finances could essentially be used for purposes such as acquisition of new premises, purchase of a fixed asset for production purposes, development of new product, and establishmement of subsidiaries among others. Long term sources of finances involve large sums of money as the projects could go for a long period of time. The UK capital market has a whole range of sources for business. They include shares, long term loans from financial institutions, venture capital available from rich investors, retained earnings from the business debentures and bonds.
Shares and retained earnings:
This is the most common source of long term financing to any business and as such it’s done through the invitation of the members of the public to subscribe to the company by purchasing shares. This can be done in form of initial public offering or introduction. For ordinary shares the capital becomes permanent business capital but for preference shares the capital can be recalled or converted to permanent capital through ordinary shares. Retained earnings refer to the excess profits that shareholders gains in the business and as such the excess profits are ploughed back to the business to finance other projects (Medina, 2007).
- This is the cheapest source of financing as no costs apart from underwriting and share floating costs are the only costs associated with this source of finance.
- The business will be able to raise more funds through this source of funding as it’s available to all members of the public.
- The capital will permanently remain in business hence the management is able to properly plan on how to invest using equity capital
- Floating of shares may lead to dilution of the leadership and management of the business as shareholders becomes members of the business.
- Shareholders may demand for regular dividend payments and this can affects the business operations
- Companies that go public will have a lot of public scrutiny and this may spill out certain trade secrets to the competitors.
- Equity funding may lead to higher tax obligations to the business as the earnings on equity funds are taxable
This is a very important source of financing long term business projects and comes from wealthy investors with interest in certain sectors of the economy. They therefore provide the necessary capital to finance certain business projects.
- This sources of finance is less costly as the only obligation will be to share the proceeds of the business with venture capitalist
- Venture capitalists can help in the management of business hence the firm will achieve certain levels of efficiency under venture capitalists.
- The entry of venture capitalists leads to dilution of the control and management of the business
- Venture capitalists are real investors who will be looking for value for their money hence the management will be under pressure to perform and achieve higher levels of performance.
- Venture capitalists may dictate the areas of investments. This may lead to the abandonment of a viable project just to suit the needs of the capital providers.
Debentures and long term loans:
This is another source of long term capital for firms in the UK.Debentures and bank loans are extended by financial institutions for a period of 5 years and above and can be used for financing capital investments in the business. The business will be required to make repayments through installments that include both the interest and the principle amount loaned out (Medina, 2007).
- This is source of funding doesn’t dilute the management and leadership of the organisation as the capital contributors have no obligation of daily business management.
- The management may decide what kind of investment to undertake with the funds
- The two sources of financing provide a lot of tax incentives to the business as the interest payable on loans and debentures are tax deductible.
- The business is under obligation to make periodic payments in form of installments towards the loans hence the business must maintain sufficient cash flows to achieve this.
- Debenture and loan providers can easily take over the management of the business if the business fails to deliver on periodic payments
- This is a very expensive source of finance as the interest payable could be too much as the creditors needs to account for risk of default and the time it takes to recover the money.
Medium term sources of finance:
These are similar to the long term financing but the time period involved in their repayments is shorter. Most of the medium term sources of finance run for a period of one year. These sources of finance includes: short term bank loan, fixed deposit accounts, euro issues and foreign currency bonds among others.
- These are sources of finance allows the business to meet obligations that accrue within one year
- The sources of finance are cheaper and convenient as opposed to the long term finances
- They can allow business to make necessary repayment arrangements as they do not fall within a short period
- Most of these sources of finance will require the business to set aside adequate cash flows to make periodic repayments.
- They are expensive compared to other long term sources like shares that do not have interest payment obligations.
Short term sources of finances:
These are sources of finance that are used to meet short term business obligations and their repayments falls in a period below one year. Most business makes use of these arrangements to meet their daily operational needs. They include trade credits from suppliers, advances from customers, fixed deposit obligations among others (Medina, 2007).
- These sources of finance play an important role in ensuring continuity of the business in the absence of liquidity to meet urgent needs
- They allow for flexibility in utilisation of cash as the business can commit excess cash to other projects and acquire important goods on credit.
- Short term debt obligations may affect the management of working capital if not properly managed
- Short term debt obligations comes with significant amount of interest hence the business may be subjected to higher costs of acquiring commodities that could be acquired cheaply using cash.
Factors affecting the choice of financing sources:
Deciding the source of finance to use is a very important decision that is made in business and as the management has a look at a number of factors before arriving at a source of finance to be used. They are discussed below:
Amount of money required:
The business has to determine the exact amount of money required for a certain project. Certain amounts of money may only be available in a limited source of financing and this may limit the source of financing to use.
The period the money is required:
This will help in determining whether to use a short term or a long term source of funding. Money required for a long period of time will force the organisation to use long term sources.
Risk involved in the project:
Business ventures have different levels of risks and hence potential financiers will evaluate the risk associated with the project. This will limit or increase the opportunities for different sources of funding available to a business.
The cost of finance:
Business must analyse the costs associated with a source of finance as this will affect the eventual benefits that accrue from the finances. Some sources of finance may readily be available but the costs could be higher than what the business will gain from the project and in that case the source of finance will not be viable (Medina, 2007).
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