Management of working capital

Published on August 31, 2017   20 min

Other Talks in the Series: Accounting Records and Accounts

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Hello. This is Huw Morgan from the Alliance Manchester Business School. This is the eighth talk in a series of lectures on accounting records, and this session introduces the Management of Working Capital, the net assets that are available for use in the short term.
We start with a recap on the elements that comprise working capital and then consider the importance of liquidity, the ability of a business to meet its obligations as they fall due, and operate on a day-to-day level. We consider the potential impacts that expansion may have on these short-term resources and the importance of ratios to identify and resolve potential problems before they get out of hand. We shall continue this topic in the next session, session nine, when we focus on valuation methods and the typical safeguards to minimise liquidity risk.
We first considered the importance of short-term finance in session 5 when reviewing Shaun's statement of financial position. The next two sessions focus on the middle section of this statement, the working capital of a business. Working capital denotes those resources that are available for more immediate use, normally considered to be convertible to cash within one year.
Here are the extracts from Shaun's financial statements for the year ended 31st December 2016 when he had been running a retail outlet and trading on credit terms with suppliers and certain local retail customers. The income statement extract will be useful for us to assess not only the performance of Shaun's business in generating gross profit but also to view how well Shaun is managing his working capital. Let's introduce some ratios. Shaun has earned gross profits, the profit from buying and selling his goods before the deduction of operating expenses and tax, of 80,000 on sales of 200,000. The gross profit percentage is 40%. This is calculated by dividing the gross profit by sales. One way of explaining this is for every 100 pounds of sales made, 40 pounds of gross profit is earned.