Working Capital Management
Working capital is the cash needed to pay for the day
to day operation of the business
Working capital calculated like below
Short term Loans
When Working Capital mismanaged? Cash Flow
Main Causes of Cash flow problems
Low profits or Losses
Over- Investment in Capacity
Too Much Stock
Allowing Customers too much Credit
Mr. Silva has set up a business 2 years ago. His annual turnover is Rs.200,000
and annual profit is Rs.18,000. He operates with a bank OD of up to Rs.25,000.
His working capital is sufficient to steadily expand the business.
Then he get a contract to supply Business A.(with d excitement of increasin
sales) The order is for Rs.40,000 a month for two years. He will be paid 75 days
The first month
Business runs smoothly. Suppliers start delivering as promised. The only
problem is that he is short of space.
The second month
Things still look good. He has made the first delivery to Business A. He
increases her overdraft.
The third month
Silva has problems. He has made more deliveries to Business A but His
overdraft is at the limit. He is getting calls from unpaid suppliers.
The fourth month
Silva in hot seat. Can’t pay all His suppliers. Some stopped delivering and
some are threatening legal action. He thinks that he will be fine because he is
still supplying Business A.
The fifth month
His overdraft is Rs.40,000 over the limit. 3 suppliers start legal action. The
bank refuses to pay cheques. Then first payment from Business A arrives on
The sixth month
The next Business A payment does not arrive on the due day. He cannot fulfill
any more orders. The bank demands that the overdraft be repaid within seven
Increasing credit sales volume
Extended credit sales period
Increasing and excessive reliance on trade payables
Increase in short term borrowings
Increasing sales without corresponding increase in
Lack of cash in hand or at bank
Symptoms of Over Trading ……
Stocks are ordered earlier and need to be paid for before
they are sold
Extended trade payable periods
Increasing inventory days
More stock required to meet sales demand
Increasing the length of working capital cycle!!
Investigation of overtrading….
Stock (inventory) days
Debtor (trade receivable) days
Creditor (trade payable) days
Gross profit margin
Net profit margin
Return on capital employed
Examples for Over Trading …..
o Seylan Bank PLC
o Next Clothing Retailer
o Sock Shop
o Borrowing or increasing in capital to increase current assets - cash
o Sale of non-trading assets
o Tightening terms of credit granted to customers
o Negotiating longer credit terms from major suppliers
o Setting new payment terms
o Offering discounts for prompt payments
o Automated payments
o Invoice discounting or Factoring
o Negotiating terms with suppliers
o Improve inventory control
o Lease/hire purchase assets
o Introduction of new capital
o Reduce distribution of profit
o Cost cutting
Anyone can think that
overtrading sounds like a good
thing, but actually it isn’t – the
key to a healthy business is to get
a good balance between under
trading and overtrading
Depletion of Working Capital
Impact on financial Health and Business…..
Overtrading means trying to grow quickly without having the financial
Overtrading can be a very big problem for companies, especially SME.
This is common in start- ups and expanding businesses
Over-trading can be a problem for many firms when the economy moves
out of a recession.
If company is growing, It’s vital that you have excellent financial
management information in place to keep the business on track and
prevent problems arising.
Notas del editor
Tight/set new payment terms/offer discount..Negotiate longer credit period from supp/improve inventory control
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