Working Capital Management - Sri Ramakripa Firewood Depot Case

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- Cyclical Changes & Demand

The demand for the wares of the enterprise are cyclical and seasonal in nature, which means that the demand is not constant in nature. Such extreme cyclical changes can affect the business adversely which can be seen in the loans taken by the entrepreneur after extreme lean periods.

- Over capitalization

The enterprise, in current time is clearly going through a period of cash shortage. A period of low liquidity is harming the enterprise’s ability to grow and maintain basic business relations. Such a process is known as over capitalization, which is exactly what the enterprise is going through.

In layman’s terms, the enterprise has grown or expanded at an unsustainable rate, which will cause short term and long term adverse effects on the business.

- The working capital cycle

The working capital cycle starts when stock is purchased on credit from suppliers and is sold for cash and credit. When cash is received from debtors it is used to pay suppliers, wages and any other expenses. In general a business will want to minimise the length of its working capital cycle thereby reducing its exposure to liquidity problems. Obviously, the longer that a business holds its stock, and the longer it takes for cash to be collected from credit sales, the greater cash flow difficulties an organisation will face. In managing its working capital a business must therefore consider the following question. 'If goods are received into stock today, on average how long does it take before those goods are sold and the cash received and profit realised from that sale?

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- INVENTORY MANAGEMENT

Identify the level of inventory which allows for uninterrupted production but reduces the investment in raw materials - and minimizes reordering costs - and hence increases cash flow. Inventory is a list for goods and materials, or those goods and materials themselves, held available in stock by a business. Inventory are held in order to manage and hide from the customer the fact that manufacture/supply delay is longer than delivery delay, and also to ease the effect of imperfections in the manufacturing process that lower production efficiencies if production capacity stands idle for lack of materials.

Adequate Liquidity

The term 'liquidity' refers to the capability of a firm to meet short term financial obligations [i.e. Current Liabilities (CL)] by converting the short term assets [i.e. CurrentAssets (CA)] into cash without suffering any loss. Here current assets refer to those which are readily convertible into cash within one accounting period. Current liabilities, on the other hand, are those, which are to be met within one accounting period. The liquidity of a firm actually depends on the effective management of the composition of CA vis-a-vis CL. In fact, the components of CA other than cash have varying degree of liquidity depending on the time taken for conversion of assets into cash. The components of CL also have varying degree of the span of time made available to the firm by the short term creditors. A business enterprise making no profit may be considered as sick but one having no liquidity will die soon. As a matter of fact, liquidity is a necessary condition (or a pre-requisite) for the very survival of the firm. The liquidity position of a firm is generally analysed with the help of some important ratios computed on the basis of different constituents of working capital either in isolation or in aggregate or both.