Fundamentals of Credit Management -Working Capital

The only sustainability and ability for a company to stay in business is the amount of Cash and its equivalents which is like the supply of oxygen for the business to flourish. A company with a long overdue collection period is probably yet to decide on the maximum stretch in collectibles for the month to meet their working capital requirements. Cash is the interconnecting nodes in all the financial assets of the business somehow or the other as:

  • Profits reported are result of rules, assumptions. estimates
  • Assets reported in the balance may not be reality check which connects the financials
  • The Profit & loss to the Balance sheet are connected in terms of the credit sales in the P & L to the accounts receivable in the BS.

The basic of Credit is extended to:

  • Increased liquidity to the suppliers
  • Increased profits
  • Higher productivity
  • Increase in the purchasing power of the business
  • promoting the growth of the company

Credit control being an important function is an important and independent function which is existence and makes the marketing and sales functions diligently in the business to provide a positive result. The amount of cash tied up in the business trading assets is reflected in the working capital of the company. The three main components of the working capital requirements of a company are:

  • Day sales outstanding which are said to be the DSO or the amount of cash you have unpaid in the business tied up to the unpaid invoices from the customers. Most of the businesses offer credit to the customers to manage their own cash flow cycle and that the uncollected cash is the cost to the business.
  • Day’s payable outstanding or the DPO tells you how you are doing with the suppliers. The aim here is higher the number if your suppliers are lending you the money to buy their services; that’s the cash you can use elsewhere in the business.
  • Finally, your days of inventory or the DI tells how much cash you have tied up in stock and raw materials. Like DSO a lower DI is a better projection of the cash flow cycle in the business.

Almost all businesses have working capital tied up in receivables and inventory, however having a negative working capital sometimes reflects the cash available which can be invested to earn interest income.The business model to be successful demonstrates the importance of cash flow management.