Role of Inventory in Working Capital
Inventories are a component of the company's working capital and make up a current asset. Some characteristics are crucial in the broad circumstance of working capital management, including:
It is presumed that inventories will be changed over to cash in the current accounting cycle, which is normally, one year. In some cases, this is not entirely true, for example, a vintner may expect that the wine be aged in bottles for many years. In spite of these and likewise problems, investor will view all inventories as being convertible into cash in a single year.
Inventories are considered as a origin of near all cash. For most products, this verbal description is accurate. At the same time, most business firm hold some slow-moving items that may not be traded for a long time. With economic retardation or changes in the market for goods, the aspects for sale of entire product lines may be decreased. In these cases, the liquidity aspects of inventories become extremely crucial to the manager of working capital. At a minimum, the analyst must distinguish that inventories are the to the lowest degree liquid of current assets. For business firm with extremely uncertain operating environments, the analyst must discount the liquidity value of inventories significantly.
Working capital is utilized to pay for inventory and strategic material supplies. Short term working capital is in general payroll, operations and plant expenses. In general these are looked at fixed costs as they do not depend upon sales.
Economically yielding material profit is attained by increasing sales and efficiency is increased by increasing inventory turnover. (less inventory at any given time)hence less working capital spent on materials and inventory.
Inventory and Operating cycle
Operating cycle has the specified consequences:
ñ Cash changed over into inventory
ñ Inventory changed over into accounts receivables
ñ Accounts receivables changed over into cash
ñ Cash again re-changed over into inventory
The above is the case of a normal wholesale or retail business. In case of making up businesses, the inventory passes through 3 stages and operating cycle will be as mentioned below:
ñ Cash changed over into Raw materials
ñ Raw materials changed over into work-in-progress
ñ Work-in-progress changed over into finished goods inventory
ñ Finished goods inventory changed over into accounts receivables
ñ Accounts receivables changed over into cash and
ñ Cash re-changed over into raw materials.
In all the above mentioned cases, accounts receivables get along to picture in case of credit sales. In case of cash sales, inventory will be directly away rechanged over in to cash.
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