Example on controlling working capital, Financial Management

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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.

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.

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