Question

Write a 350- to 525-word paper in which you complete the following:

Explain the difference between permanent and temporary working capital, and describe what a firm could do to minimize risk.

Evaluate how small adjustments made to total cash conversion can have a large impact upon the financial health of a company.

Describe Economic Order Quantity (EOQ Using the EOQ formula and an example product for your business, determine the optimal quantity of the item to purchase that will help to minimize the annual total costs of keeping that item in inventory.

Describe what a Just-in-Time (JIT) inventory system is and its significance in reducing inventory costs.

Answer 1

1. Permanent investment does not change with the fluctuations occurring in the business activity and it represents the minimum amount that has to be invested as working capital within an organization. On the other hand temporary working capital is the additional working capital requirement that arises out of seasonal demand for a product or out of special events and circumstances that are difficult to predict beforehand. In order to minimize its risks a firm should keep the options of additional financing open. This will help the firm to fund the gap between the time it takes to convert its assets into cash and cash equivalent instruments. When the gap is filled the risk is automatically minimized. Also a firm will have to keep in hand sources of additional working capital always ready.

2. Cash conversion cycle of a company is nothing but the sum of days inventory outstanding (DIO) and days sales outstanding (DSO). From this sum the days payable outstanding (DPO) is deducted. The shorter the cash conversion cycle is the better it is for a company. Now small adjustments can be made to total cash conversion and this can have a significant impact upon the financial health of a company. For instance a company can reduce its DSO by giving an additional 1% discount to debtors who pay promptly. This will reduce the company’s accounts receivables balance. This will led to a fall in DSO and the eventual lowering of the cash conversion cycle.

3. EOQ is the ideal order quantity that a company should buy, at one time, in order to minimize its variable inventory costs. EOQ = [(2*annual demand*cost per order)/(holding cost)]^0.5

My business is a carburetor manufacturer and for this I order a float chamber from a vendor. The applicable numbers for my business is: annual demand = 4,000 chambers, cost per order is $60 and holding cost is $2. Thus my EOQ = [(2*4000*60)/(2)]^0.5

= 489.90. This will be rounded off to 490 float chambers. Thus to minimize my inventory related costs I will have to order 490 float chambers per order.

4. JIT inventory system is an inventory system that intends to increase efficiency and minimize waste by receiving the inventory only when they are required in the production process. The system is based on a ‘pull’ system and under this system all components that are required for the production of the finished goods are delivered to the production department exactly on time when they are required. This enables the JIT inventory system to reduce the amount of inventory that an organization has to hold. This leads to optimization of costs through minimization of working capital requirements, reduced production runs and reduced holding costs.

(451 words)