Question

A) Identify the components of working capital and the accounting issues related to these components.

(B) The IASB has issued pronouncements on some of the issues affecting working capital; Discuss two of these pronouncements and state if, in your opinion, the issues have been resolved.

Answer 1

A) Gross Working capital means total current assets and net working capital is difference between current assets and current liabilities.Current assets usually consist of cash,marketable securities,receivables, inventory and current liabilites consist of Payables. There are main 4 components of working capital:

1.Cash Management-Cash is one of the important current asset. There are three motives of holding cash Transaction,Precautionary,Speculatve.One of the main models for cash management is Baumols Model.

Baumols Model=(2*A*O/C)^1/2

^{Where A= Annual cash disbursement O= Fixed cost per transaction C=opportunity cost of one rupee per annum}

2. Receivables Management- The term receivable is any claim for the money owed to the firm from customers arising from sale of goods or services in due course.The total volume of accounts receivable depends on its credit sale and debt collection policy—these two significantly influence the requirement of working capital. Liberal credit policy increases the vol­ume of sales but at the same time it also increases the investment in receivables.

3.Inventory Management-Inventory constitutes a major part of total working capital. Efficient management of inventory results in maximization of earnings of the shareholders. Efficient inventory management consists of managing two conflicting objectives: Minimization of investment in inventory on the one hand; and maintenance of the smooth flow of raw materials for production and sales on the other.Therefore the objective of a finance manager is to calculate the level of inventory where these conflicting interests are reconciled. There are two types of inventory cost ordering cost and carrying cost.The following are the important inventory control techniques:Economic order quantity,Fixation of stock levels,ABC Analysis,Just in Time (JIT).

4.Accounts Payable Management:Payables or creditors are one of the important components of working capital. Payables provide a spon­taneous source of financing of working capital. Payable management is very closely related with the cash management. Effective payable management leads to steady supply of materials to a firm as well as enhances its reputation.It is generally considered as a relatively cheap source of finance as suppliers rarely charge any interest on the amount owed. However, trade creditors will have a cost as a result of loss of enjoying cash discount on cash purchases.