INTRODUCTION
Working capital is defined as the funds required to meet the  day to day or operational needs of an organization. Accountants define it as that current asset which means the difference between current asset and current liabilities. Working capital is the turning wheel of a business.

COMPONENTS OF WORKING CAPITAL
In financial management, emphasis is the separate components of working capital which are

• Stocks
• Debtors.
• Cash
• Creditors.

The management of these various components of working capital involves the following decisions:

• What level do we maintain for each component?
• How do we finance the optimal level defined in (a) above
• What ratio do we maintain between current asset and current liabilities?

The following factors will inform management in making the above decisions:

• The nature of the product on service of the company.
• The practice in the industry in which the company operates.
• The sales pattern of the company’s product e.g. seasonal sales.
• The company’s relationship with its customers, suppliers, bankers etc.
• The short term inveastment opportunities available.
• The financial management style of the company.

Apart from the above qualities factors, working capital management will also involvean analysis of certain ratios, among others, the following ratios and indicators can be utlised:

• Current Ratio = Current Asset/Current Liabilities
• Quick/Liquidity/Acid test =(Current Asset – Stock)/Current Liabilities
• Working capital Ratio/working capital Turnover = Sales/Working capital
• Turnover cycle/operating cycle/Working Capital Cycle – This is defined as the length of time between paying for you raw materials and recovery date from your own customers. i.e. it is the length of time between expenditures on stocks and the inflows of cash from sales.

The longer the cycle or period, the more fund a company will require for its daily operations.
Efficient management of working capital will ensure that this turnover cycle is not too long. Substantial derivations from previous turnover cycle should be investigation and explained.

MANAGEMENT OF STOCKS
Management  of stock involves striking a balance between the the be costs and benefits of  working stocks.
This basic issues are involved in stock management

• the size and timing of stock replenishment
• the action to take where supply orders are not met.

a model has been developed which enables the financial mangers to calculate the  optimal quantity to order. the model has the objective of determining the quantity that should be ordered any time we are ordering such that the cost associated using stocks will reduce to the minimum.
the cost associated with stocks are as follows.

• purchase cost
• ordering cost
• holding/ carrying cost
• stock out cost

In developing the EOQ model, the following assumptions are made:

• purchase cost is constant
• annual demand is certain and known.
• lead time is constant and
• there is instantaneous b built up of stocks i.e. no delay in supplying orders.

• Assumption involve rendering irrelevant the purchase cost, while assumptions no 3and4 dismiss the possibility of a stock out of s cost. It then follows that  total relevant cost associated with holding stock as determined by the EOQ model are the ordering cost and the holding cost

Therefore, Relevant cost = total ordering cost = total holding cost
I.e. T C = = O/Q X O = Q/2X H.
T C = OD/Q = HQ/2
Where T C – total relevant cost
D = Annual Demand
O = Ordering cost per order
Q = Quantity to order
H = Holding cost per unit.

INVENTORY CONTROL SYSTEMS
The main inventory control systems exist.
Scientific methods

1. The Re-order level system.
2. The periodic review system
3. 80/20, ABC & Pareto Analysis

RE-ORDER LEVEL SYSTEM (setting of stock levels)
The main features of this control technique are:

• A predetermined re-order level is set for each stock item.
• When stock falls to this Re-order level and order is initiated
• The order placed is the EOQ.

For control purposes, under this system, 3 possible stock control levels are entered on the stock card viz.

• The Re-order level = max usage x max. lead time
• Minimum level = Re-order level – (Ave. usage x Ave. lead time)
• Maximum level = EOQ + Re-order level – (min. usage x min. lead time)

The Re-order level is the point at which new orders will be placed. As soon as the stock falls to the level order is plan

The minimum level is the level at which stock should not be allowed to fall below. It is also called the sufficient stock.

The maximum level is the level at which stock must not be allowed to be over.

PERIODIC REVIEW SYSTEMS
The main features of this system are:

• Stock levels for all items as reviewed at fixed intervals e.g. every week, every month etc.
• Where necessary, a replenishment order is placed.
• Re-order quantity is not predetermined but is based on the followings:
• The current stock level
• Estimated demand until next review period, and
• Lead time.

MANAGEMENT OF DEBTORS /CREDIT MANAGEMENT
As in all other component of working capital, the key factor in debtors management is the decision as to the optimal level to maintain. This also means striking a balance  between the advantages of increasing sales, profits by giving credit and the administrative cost and the finance costs of  giving credit including the risk of bad debts and legal cost taking action against debtors.

In setting a credit policy for accompany the following points should be addressed:

• Who do we sell to on credit
• Terms of trade which includes
• The credit period,
• Credit limit depending on the rating of the customers
• Penalt6y for late payment
• Cash discount for early payment.

• Debt collection methods including
• Correspondence i.e. letters of reminder
• Usage of debt collection agency
• Taking legal actions.
• Financing of book debts – this includes all actions that may be taken by the company to get money faster . such actions will include:
• Invoice documenting
• Factor financing (Factoring)
• Use of bill of exchange.

MANAGEMENT OF CREDITORS
This covered exactly the same as under trade credit (Debtors) as a source of short term finance. The golden rule is to fake as much credit as possible so long as you appreciate the cost of abusing the facility, namely:-

1. It may lead to a poor credit rating
2. Suppliers may include their own finance cost as hidden prices of suppliers.
3. Damages on inferior goods may be supplied.

Finally, trade creditors can be a very expensive form of financing if a cash discount is offered and the cash discount is not taken.
Take as much credit as possible.

MANAGEMENT OF CASH
The basic objectives of cash management are in two folds:

1. To meet the cash disbursement needs, and
2. To minimize funds committed to cash balances.

These two objectives are contradictory and the task of cash management is to reconcile them. In other words, it is the task of the finance manager to strike a balance between holding excess cash and not holding sufficient cash.
The objectives are basis but contradictory.
The major tool for determining optimal cash level is the cash budgeting system or technique. It is important that the forecast for cash are made with realistic assumptions. Note also that the more frequent the cash forecast, the less the deviation of actual from forecast.
In determining the cash levels to be held, the finance manager should also recognize an established model known as J. M. Keyne’s motives for holding cash.
These motives are:

• Transaction motive:- This refers to the holding of cash to meet the operational or day to day requirements of a company e.g. to purchase, stocks, pay salaries, meet operating expenses etc.
• Precautionary motive:- In the case, additional cash should be held to meet unexpected cash needs of short notice may be the result of:-
• Sharp increase in cost of raw materials
• Unexpected slow down in collection of accounts receivable.
• Cancellation of order by a major customer.
• Speculative motive: - This refers to the desire of a firm to take advantage of opportunities which present themselves at unexpected moments. The speculated motive helps to take advantage of:-

• An opportunity to purchase raw material at reduced price with the expectation that their prices will rise in the future.
• An opportunity to purchase securities when their prices are low but with their prices will rise in  the future.

Where it has been determined that there is surplus cash, it must be invested using the following guidelines.

• Short Term Investment opportunities available.
• An acceptable minimum required rate of return.
• The future requirement for cash.

The guiding princip0le is that short term in vestment must be readily realizable with minimum cost and minimum cost of capital.

Prepared By Alh. Y. O. Olajide
Managing Partner
Olajide And Associates
www.olajideassociates.com