Question

Discuss the types of funding sources and inventory policies that can be used to improve working capital.

Answer 1

Working capital is the amount of capital required to meet the day to day needs of a business. Working capital needs can be fulfilled with the help of bank overdraft. Bank overdrafts are a good and cheap way of meeting working capital needs at a short notice. Revolving credit facilities are also available which give a pre approved fund that can be used when needed. The use of invoice finance is common source of funding working capital. Getting a higher credit term from the suppliers is a cost effective way of meeting working capital needs. Factoring is another method which is favoured by smaller companies wherein the receivables are factored via banks and Financial Institutions to unlock substantial amount of working capital. Finally short term loans from banks can be taken to meet working capital needs.

Besides the external sources the working capital can be reduced by improvement in inventory management. Inventory on hand should be kept at a minimum and ordering just in time is a useful approach for minimising working capital. The inventory turnover ratio is useful for this purpose. It reveals how efficiently and quickly the company's inventory is being sold. The inventory turnover ratio should be maintained at an optimum level. A very high ratio would indicate that the efficiency of inventory ordering needs to be improved whereas a very low ratio would indicate very high levels of inventory. A correct balance has to be struck between the two so that an optimum level of inventory is maintained in such a way that neither the ordering costs are too high nor there is excess inventory on hand.