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.

3  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.