Managing and Reporting Working Capital

Reasons for Business Failures

  • accounting issues = 3/10 top reasons why businesses fail

  •   - Lack of management systems, such as financial controls.
      - Lack of financial planning and review.
      - Inadequate level of financial resources (lack of money).

6.1 Working Capital

  • Focus: Management and reporting of four critical balance sheet items:
      - Cash
      - Accounts Receivable
      - Inventory
      - Accounts Payable

  • Importance: How a business manages these items affects its cash flows, financial performance, and financial reporting.

Working Capital Definition

  • Working Capital: Calculated as
      extWorkingCapital=extCurrentAssets−extCurrentLiabilitiesext{Working Capital} = ext{Current Assets} - ext{Current Liabilities}

Example of Working Capital Calculation:
Company A:

  • Cash: $60,000

  • Accounts Receivable: $40,000

  • Inventory: $50,000

  • Accounts Payable: $50,000

  • Total Working Capital: $100,000

Company B:

  • Cash: $20,000

  • Accounts Receivable: $10,000

  • Inventory: $30,000

  • Accounts Payable: $50,000

  • Total Working Capital: $10,000

Importance of Managing Working Capital

  • Businesses need to maintain an appropriate balance between:
      - Having enough working capital to operate and manage unexpected cash needs.
      - Not holding excess cash, inventory, or credit that could reduce profitability.

  • Example: Café Revive and their transactions with DeFlava Coffee Corporation illustrate working capital flows, including purchasing coffee on credit, paying invoices, and monitoring inventory for restocking.

Internal Control in Working Capital Management

  • The purpose of Internal Control is to:
      - Safeguard assets.
      - Maintain detailed records for accurate reporting.
      - Provide reliable information.
      - Prepare financial reports per established criteria.
      - Enhance operational efficiency.
      - Ensure compliance with laws and regulations.

6.2 Cash Management

  • Definition: Cash includes anything that a bank accepts as a deposit.

  • Simple Cash Controls:
      - Controls over cash receipts and cash payments.
      - Bank Statement: Summarizes banking activities during the month.
      - Bank Reconciliation: Analyzes the difference between the cash balance in accounting records and the bank's reported balance.

  • Petty Cash:
      - A fund controlled by one employee for small cash payments. Useful when bank payments are cumbersome.

6.3 Accounts Receivable Management

  • Definition: Accounts Receivable are amounts owed to a business by customers from previous credit sales.

  • Credit Application Information:
      - Applicant's employer and income.
      - Applicant's bank details and balances.
      - List of assets and debts.
      - Directors' names and addresses (for companies).

  • Credit History Check: Conducted through independent companies.

Controls and Terms for Accounts Receivable

  • Controls:
      - Credit should only be extended to approved customers.
      - Monitor accounts receivable balances.

  • Common Credit Terms:
      - Example: '2/10, net/30' means 2% discount if paid within 10 days; otherwise, full payment due in 30 days.

  • The balance reported in accounts receivable is the cash expected from customers, stated net of any provision for doubtful debts.

6.4 Inventory Management

  • Definition: Inventory refers to merchandise available for resale.

  • Simple Inventory Controls:
      - Control ordering and acceptance of inventory.
      - Physical controls during storage.
      - Regular physical counts to ensure accuracy.

Determining Cost of Ending Inventory

  • Determined by understanding:
      - Cost of Goods Available for Sale.
      - Cost of Goods Sold.
      - Year-end inventory concepts.

Inventory Flow Example:
Café Revive Inventory Calculation:

  • Beginning Inventory: 50 packs

  • January Purchases: 240 packs

  • Goods Available for Sale: 290 packs

  • Goods Sold: 240 packs

  • Ending Inventory: 50 packs

  • Calc Example:
      - Cost for Pack: 50 @ $26 = $1,300, 190 @ $26 = $4,940, 50 @ $27 = $1,350
      - Total = $7,590

Inventory Valuation Methods

  1. Specific Identification: Tracking items individually (e.g., Café Revive stamps dates on their coffee).

  2. FIFO (First In, First Out): The oldest inventory costs are the first to be recognized as cost of goods sold.

  3. LIFO (Last In, First Out): The latest inventory costs are recognized first.

  4. Weighted Average: A recalculated unit price after each transaction.

6.5 Accounts Payable Management

  • Definition: Accounts Payable are amounts owed to suppliers for credit purchases.

  • Controls:
      - Control over who can obligate the business financially.
      - Control over payment processes.
      - Monitoring total accounts payable amounts.

6.6 Working Capital: Business Issues and Values

  • Discussion on how aggressive a business should be in managing working capital.

  • Ethical considerations in aggressive working capital management.

  • Importance of managing working capital for both liquidity and long-term sustainability of the business.

Key Takeaways

  • Understanding the importance of working capital management.

  • Awareness of cash management practices.

  • Knowledge about bank reconciliation processes.

  • Importance of monitoring accounts receivable for cash flow management.

  • Understanding inventory impact on payments and costs.

  • Significance of timely accounts payable management.