Question

Question 4 - In your own words explain what working capital management is and give an example of one way Organic Produce Corporation’s financial managers could improve the company’s working capital position.

Answer 1

Working Capital Management

A Gist

It is an accounting method of managing the two components of the working capital namely, current assets and current liabilities. Working Capital Management is used by investors to assess the short term performance of the firm. This is in terms of short term debt repayment, efficiency in operational cycles of the firm.

Working Capital = Current Assets / Current Liabilities

Ideal ratio = 1.2 to 2

However if this ratio is high it may also show that the firm is not making an optimum use of it's resources. Contrary, if the ratio is low, it shows that the firm will have problems servicing it's short term debts and might have a crunch of resource to carry out its day to day activities in future period.

How is it done

There are various components that make up the entire working capital. These are sub parts of current assets and current liabilities.

1. Accounts Receivables: This includes amount that is yet to be received by us from parties who bought goods or services on credit. The manager needs to ensure that debtors pay the firm as quickly as possible. For this purpose, the firm may provide discounts to parties who clear their payment in certain time period prescribed by the firm Accounts Receivable policy/

2. Accounts Payable: The other component is the amount the firm owes to its creditors. It is better to pay off the amount at the earliest. This reduces the debt component thereby clearing more amount for day to day operations.

3. Inventories Management: This is one of the crucial components of working capital management. Inefficiency can lead to bottleneck in operations. A manager should focus on selling the inventories. This helps in increasing the speed of sales at the same time, the stocks do not remain for a longer period. This is also serves part objective of reducing cost of storage of inventories.

Organic Produce Corp.

Organic Produce Corp. is involved in activities to bring the organic food products from the farmers to customers. The corporation needs to have a good amount of positive working capital. As it is an intermediary link between customers and farmers. They have to pay out to farmers at the same time they have to manage huge inventory of pulses and Agro- Commodities for processing and trading. The finance manager needs to have abundant cash and cash equivalent to keep the debt at bay and ensure the timely supply of farming products from it farmers (creditors). Since the product is consumed rapidly, timely management in processing the product and trading should involve the efficient method of inventory management which could be mostly FIFO (First in First Out) as we are talking about food product even if it is pulses.