WORKING CAPITAL

Working Capital

Working Capital

Question 1

a) The amount of current assets that is in excess of current liabilities is called the working capital. Working capital is frequently used to measure a firm's ability to meet current obligations. A high level of working capital indicates significant liquidity.

In the given condition, the production costs and the sales revenue both are very close to the budgeted figures.

The raw materials in the stocks are more than the budgeted which means that the company is unable to achieve the budgeted sales targets. Due to this reason, there was less production leading to higher stocks in the inventory.

Finished goods/stock is also on the increasing trend if we compare it to the budgeted figure. Again, the reason for higher levels of finished goods/stocks is decrease in the level of sales as expected. Supply is very high and demand is not so high, so McCallum Ltd. ends up with a low price. People are willing to sell their finished products at huge losses (some return is better than none) and so McCallum Ltd will never be able to make a profit on these early crafted items.

Increase in debtors from the budgeted level indicates that McCallum Ltd. Is concentrating more on the credit sales and issuing credit in the market. The reason behind this strategy is to maximize the sales and so that company can earn something on its manufactured goods whenever it cash its debtors.

The assets i.e. cash held at bank were estimated to be 3,000 which is too far from the actual balance. The actual balance is -26,000. The reason for this huge gap might be that company has invested heavily in the production of goods due to which inventory levels (both stocks and finished goods) have increased. But McCallum Ltd. is unable to turn its credit sales in cash in the short run.

Creditors of McCallum Ltd. have decreased from the budgeted levels. It makes sense to say that company has over-drawn cash from the bank and invested heavily in production and removing the burden of liabilities.

In any case, the strategies followed by McCallum Ltd. are not wise enough to take out the company from financial crisis, as shown from the working capital statement. McCallum Ltd. have enough working capital on hand which is not feasible. It shows that the resources of McCallum Ltd. are not being utilized effectively for maximizing the revenue. Managers are just taking short-term approach and are not thinking of future.

b)

Managing inventory is a juggling act at McCallum Ltd. Excessive stocks can place a heavy burden on the cash resources of a business. Insufficient stocks can result in lost sales, delays for customers etc.

The key is to know how quickly the direction of overall stock movement or, put another way, how long each item of stock sit on shelves before being sold. Obviously, average stock-holding periods will be influenced by the nature of the business. Nowadays, many large manufacturers operate on a just-in-time (JIT) basis whereby all the ...