Question

In at least 200 -300 words, explain the cost-benefit analysis involved in working capital management decisions involving cash, accounts receivable, inventory, accounts payable and short-term financing.

Answer 1

A cost-benefit analysis can be defined as a process that is used in the businesses to analyze the management decisions. It is an analysis as to whether the cost of working capital applied is worth for the benefit we get from the project.

The business analyst aggregate the benefits of the project and then deduct all the costs associated with taking that option of the project. Some consultants or analysts also build models to assign the value on particular items such as the benefits and costs associated with cash, accounts receivable, inventory, accounts payable and short-term financing.

The company evaluates the cash needed for the project and later makes an anaysis of how much the project will fetch the company. If the profit generated from the project is meeting the target set by the company than the project is taken other wise the search for better project options is done.

With respect to the accounts receivables the company evaluates if the credit sales and accounts receivables value is kept in check. Whether selling goods on credit is beneficial or on cash is in favour of the company. If the profit generated from the option 1 is more then the company adopts to sell goods on credit otherwise selling goods on cash is taken as option.

With respect to the inventory the company evaluates the stock needed at all the time with the entity. An analysis with respect to margin of safety, sales value and opening and closing stock is taken into account. The cash needed for increasing or decreasing the inventory is taken into account and an anaysis of how much the project will fetch the company. If the profit generated from the project is meeting the target set by the company than the project is taken other wise the search for better project options is done.

For accounts payable the credit period allowed by the creditors and the discount allowed on cash purchases is evaluated. The company evaluates how much the project will fetch the company in both the cases and if the profit generated from the credit purchases is in benefit or  is meeting the target set by the company than the project is taken other wise the search for better project options is done.

For short term financing the company evaluates the cost of arranging finances from the various sources of finances for the company.