Management of working capital AO3
AO3 You need to be able to: Demonstrate synthesis and evaluation. Command terms these terms require you to rearrange component ideas into a new whole and make judgments based on evidence or a set of criteria. Compare, Compare and contrast, Contrast, Discuss, Evaluate, Examine, Justify, Recommend, To what extent
If cash flow is poor, how can it be improved?
Working capital management involves monitoring four important components of the working capital cycle:
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'What if' analysis - contingency planning
As with all business tools the output is only as good as the quality of the input. Cash flow forecasts are exactly what they say - forecasts of future events. It is good planning to consider 'what if' scenarios which might affect cash flow. For instance:
- Sales revenue is lower than expected as fashions change
- Customers do not pay on time or there are larger bad debts than usual
- Raw materials, components and energy costs increase rapidly
- New competitors enter the market and existing competitors cut prices
- Interest rates increase
- Market research is inaccurate
- Motivation falls leading to lower output and higher production costs
The firm can work out the worst case scenario and look at the effect on its cash flow. Would this be sustainable? It can then put procedures and contingencies in place to deal with emergencies. For instance it may build contingencies into its budgets and/or negotiate overdrafts on good terms before they are required. Computer software makes it easier to complete 'what if' analysis using spreadsheets with variable timings and amounts.