Explanation of Different Elements in Working Capital Management

This document provides an explanation of different elements in working capital management, such as profit, cash flow, receivables, inventory, and payables. It also discusses the purpose of budgeting and the strengths and weaknesses of traditional and alternative methods. The document further explores the application of budgeting methods to plan future cost management. The case study of Mediterranean Delights Ltd and Second Sight Plc is used to illustrate these concepts.

Project 2

Table of Contents
PART 1............................................................................................................................................1
EXECUTIVE SUMMARY.............................................................................................................1
1. Explanation of different elements............................................................................................1
2. Application of all the concepts within the organisation...........................................................3
3. Steps to be taken to improve cash flow by better working capital management.....................4
PART 2............................................................................................................................................4
EXECUTIVE SUMMARY.............................................................................................................4
1. Purpose of preparing budget, traditional and alternative methods of budgeting along with
their strengths and weaknesses....................................................................................................4
2. Application of budgeting methods to plan future cost management.......................................6
3. Analysis of appropriateness of traditional and alternative budgeting approaches...................7

PART 1
EXECUTIVE SUMMARY
First part of this report is based upon basic concepts of profit, cash flow, working capital
etc. It is based upon Mediterranean Delights Ltd which is operating business in South of
England. While managing working capital it is very important for all the organisations to pay
attention towards major elements such as inventory, payables, receivables etc. The company is
recommended to take appropriate steps to improve the cash flow by managing working capital
properly.
1. Explanation of different elements
Explanation of profit: When an organisation perform operations and generate revenues
then the total income which is received by it after deducting all the expenses is known as profit.
There are various direct and indirect expenses which are deducted from total value of sales.
These are rent, salaries, insurance, legal, postage, commission, depreciation etc. All the incomes
which are added in the calculation of it are profit on sale of assets, discount received etc. In order
to determine actual amount of profit which is generated by a company profit and loss statement
is formulated. With the help of it, all the internal and external stakeholders analyse that the entity
is having higher or lower profitability (Aktas, Croci and Petmezas, 2015). In other words, it can
be defined as the amount which is required by an entity to survive in the market and perform
future activities in systematic manner. With the help of it stakeholders such as investors,
employees etc. could be retained as higher profits will build their interest within the entity.
Explanation of cash flow: Cash flow is the total amount of cash which is being
generated by an entity by deducting all the outflows from inflows. In order to maintain liquidity
of the business it is very important for a company to make sure that it is having proper cash flow.
While making decision regarding making investment in a company investors determine liquidity
of business and then finalise that they wish to invest or not. While computing it for the business
cash flow statement is generated. Total value of it is calculated it by adding cash, other
equivalents and bank balance. Slight mistake in it may lead the business towards huge losses
because it is result in inaccurate liquidity (Atrill, 2015).
Differentiation between profit and cash flow: Profit and cash flow both are different
for companies and several bases for it could be understood with the help of following discussion:
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Basis Profit Cash flow
Definition It is the total amount which is generated
by entities after deducting all the
expenses from incomes.
Cash flow is the annual flow of liquid
assets of company which is calculated
by deducting all the outflows from
inflows.
Statement Profit and loss statement is formulated to
calculate net profits for the year.
In order to analyse actual cash flow
cash flow statement of generated by
companies.
Analysis With the help of profit actual
profitability of an organisation is
determined.
Cash flow facilitate the investors to
analyse actual liquidity of a company.
Explanation of working capital: All the companies require funding to carry out day to
day activities and working capital is the finance which is used for the same purpose. While
calculating it the major elements which are taken in to consideration are current assets and
liabilities. The difference between both of them is known as working capital and it facilitates the
execution of trading operations. If it shows a negative balance then it means that company is not
able to perform the operational activities properly and positive results shows smooth execution
of all the activities (Atrill, McLaney and Harvey, 2014). When a favourable WC is calculated
then it represents good position of company because it reflects that entity is able to pay out all
the current liabilities properly. On the other hand an adverse WC shows that liabilities of
enterprise are higher than the sources which are used to pay them.
Explanation of receivables: The total amount which is owed by a client of an
organisation is known as receivable. When a company sell its products on credit to the customers
then the outstanding amount will be considered as receivables. If the amount of it is not
recovered by an entity then it will be treated as bad debts. Businesses provide credit facilities to
those patronages who are able to repay the amount on due date. In order to record the total
amount which is owed by the clients is recorded in the books and appropriate account so that an
entity can analyse the actual current assets.
Explanation of inventory: When an organisation is selling different types of products to
the customers then the items which are kept in warehouses are known as inventory. It is very
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important for entities to manage it properly so that desired goals could be accomplished. There
are various types of inventory management systems which could be used by companies for
maintain the level of stock. These are LIFO, FIFO and AVCO. Business enterprises can use any
of them for making sure that goods are managed by them in warehouses properly. Main purpose
of it is to assure that all the production related activities are performed appropriately so that long
term business goals could be accomplished (de Almeida and Eid Jr, 2014).
Explanation of payables: When an entity is buying goods or services on credit from the
suppliers then the total owed amount by the organisation will be recorded as payables. It is a type
of current liability which is required to be paid by company within one year. In order to maintain
good relations with external parties such as suppliers it is very important for companies to make
sure that the total owed amount is paid on time. Any default in payment may result in bad image
of company in the market which is not beneficial for the business.
While calculating working capital all the above described three elements are required to
be calculated and analysed properly. These are receivables, payables and inventory. Inaccurate
computation of them may result in negative or adverse results for working capital which may
affect execution of day to day trading operations.
Changes in working capital affect cash flow: For all the business entities it is very
important to analyse all the potential modifications in the working capital so that changes in cash
flow could be determined. For example, if an organisation is not able to recover its debtors then
it will create difficulties in managing cash flow because it will result in decreased current assets.
2. Application of all the concepts within the organisation
Mediterranean Delights Ltd is one of the entities which are operating business in South of
England. The organisation is managing its working capital by paying attention towards
receivables, payables, cash, profits and inventory (Drury, 2016). Total operating profits of the
entity for last year before interest and tax was 5 million pounds and total debts of the entity were
increased by 2 million pounds in current year. Due to this liabilities are increased which may
affect working capital. Total outstanding amount which is required to be paid by the entity is 1.5
million pounds which is considered as payables for the year. The total receivables of the entity
against San Pedro is around 2 million pounds. All these concepts are applied by the entity
properly which helps it to manage working capital.
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3. Steps to be taken to improve cash flow by better working capital management
Every entity ways to make improvement in cash flow which is possible with the help of
better working capital management. Several steps which could be taken by Mediterranean
Delights Ltd are as follows:
 The organisation should pay all the debts on time so that current liabilities could be
managed which will be beneficial to manage working capital and improve cash flow
(Kaplan and Atkinson, 2015).
 Inventory management is also important for all the organisations as it is a part of current
assets and by managing it working capital could be managed. It will be beneficial to
improve cash flow because when stock will be controlled properly then it could be
ordered when it is required which helps to maintain cash.
PART 2
EXECUTIVE SUMMARY
1. Purpose of preparing budget, traditional and alternative methods of budgeting along with their
strengths and weaknesses
Budget is a type of advance plan which is generated by an organisation for the purpose of
carrying out future activities in systematic manner. With the help of it, business entities allocate
funds to all the departments according to their requirements so that they can perform all their
functions. Main purpose of a budget is to make sure that all the planned activities are performed
in appropriately so that the desired goals of higher profitability and revenues could be achieved
successfully. Another purpose of preparing a budget is to fulfil monetary requirements of all the
divisions of company so that all the tasks which are allocated to them could be accomplished
(Oseifuah, 2016).
It is very important for all the entities to pay attention towards different approaches of
budgeting so that best suitable from all of them could be selected for allocation of funds to
different activities. There are two types of approaches which are traditional and alternative.
Description of different methods of them is as follows:
Traditional approach: It is a type of budgeting method in which data from previous
years is used for generating reports from present period. It is mainly based upon estimation of
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different expenses which may take place in future while carrying out operations. One of the main
type of it is incremental budgeting which is as follows:
Incremental budgeting: When organisations prepare budget for current year on the basis
of previous performance or old budgets then it is known as incremental budgeting. All the details
which are used for generating new records are based estimation. It is mainly focused with
making changes in existing budget to perform future activities. Some of the strengths and
weaknesses of this approach of traditional budgeting are described below:
 Strengths: It is a simple method which could be used by organisations generate budgets
for future. The records which are generated by following this approach is easy to
understand which helps to analyse business performance effortlessly (Otley, 2016).
 Weaknesses: The level of flexibility in this budget is very low as it does not allow to
make modifications in the reports according to changes in business expenses. The
information recorded in it is not accurate because it is based upon estimation.
Alternative approach: When organisations have different options which could be used
for preparation of budgets for future period then it is known as alternative method of budgeting.
There are various approaches of it which are described below:
Rolling budget: It can be defined as a budget which is updated on the basis of business
activities. It is highly flexible which helps the managers to analyse the actual expenses and
incomes for the accounting year. All the strengths and weaknesses of using this budget are
discussed below:
 Strengths: Changes in the records could be made on the basis of different expenses
which are taking place within the accounting year. With the help of it accurate funds
could be assigned to different activities as provides information about actual expenditures
which are related to operations.
 Weaknesses: The process of generating it is time consuming which may affect
engagement of management in operations. Specific knowledge is required to create
rolling budget for which the organisation will be required to hire experienced staff.
Zero based budget: When an organisation is generating its budget with nil balance then
it is known as zero based budget. It is very important for the managers to justify all the
transactions which are recoded in it for assuring accuracy. Strengths and weaknesses of this
budgeting approach for the organisations which are used it are as follows:
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 Strengths: All the figures that are mentioned in it is accurate ans related to the current
accounting year which helps to allocate funds to different activities according to their
requirements.
 Weaknesses: The records could be biased by the managers as information of previous
years is not considered as the base for present year's budget. Process of preparing zero
based budget is very complex which may result in errors in future.
Activity based budget: This budgeting technique is mainly focused with identification,
analysis and assessment of different activities. With the help of it, management will be able to
assign budgets to all the operations according to their requirements. Different strengths and
weaknesses of this budget are as follows:
 Strengths: It is beneficial for the organisations to assign funds to different operations
according to their requirements. With the help of it managers can differentiate between
direct and indirect costs as it facilitate to assign funds to activities according to their
needs (Watson and et.al., 2016).
 Weaknesses: In order to generate it, it is essential for the managers to make sure that
they have proper understanding of it because lack of knowledge may result in failure of
operations.
2. Application of budgeting methods to plan future cost management
Second Sight Plc is an internation company which is planning to expand its business in
Netherlands by signing a joint venture with an Indian company. In order to plan the future cost
management traditional and alternative budgeting techniques could be used. Discussion of them
is as follows:
Incremental budgeting could be used to prepare records in the basis of previous year
which will help to estimate the cost of expansion and allocate funds to different activities
according to their requirements. All the products and process for the business will be budgeted
on the basis of prior year's records.
Zero based budgeting can also be used for future cost management of Second Sight Plc in
the expansion plan. By using it managers can formulate records with a zero balance. If it will be
used then products and process will be analysed accurately because information regarding the
operations in Netherlands will be recorded in the budget.
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Rolling budget helps to make appropriate modifications in the records which could be
used to plan future cost management by Second Sight Plc while expanding business in
Netherlands. With the help of it, managers will be able to make changes in the budget or
transactions according to the expanses which are taking place continuously. It will facilitate the
budgeting of products and process as use of it will result in accurate costs of all the operations.
Activity based budget can also be used by Second Sight Plc while planning for business
expansion for future cost management because with the help of it actual expenses which may
take place while performing specific activities could be determined. It will be beneficial to
budget all the processes and products as it will help the mangers to allocate funds to the activities
according to their requirements (Weetman, 2010).
3. Analysis of appropriateness of traditional and alternative budgeting approaches
Second Sight Plc is planning to expand business in Netherlands therefore it is very
important for it to make sure that appropriate budgeting techniques used by it. It has been
recommended to the enterprise that alternative approaches such as rolling, zero based and
activity based budgets. With the help of them, accurate budgets could be generated and then
funds funds could be allocated to activities according to their requirements.
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REFERENCES
Books and Journals:
Aktas, N., Croci, E. and Petmezas, D., 2015. Is working capital management value-enhancing?
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Atrill, P., 2015. Financial management for decision makers. Pearson Education
Atrill, P., McLaney, E. and Harvey, D., 2014. Accounting: An Introduction, 6/E (Vol. 6).
Pearson Higher Education AU.
de Almeida, J. R. and Eid Jr, W., 2014. Access to finance, working capital management and
company value: Evidences from Brazilian companies listed on
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Drury, C., 2016. Management accounting for business. Cengage Learning EMEA.
Kaplan, R. S. and Atkinson, A. A., 2015. Advanced management accounting. PHI Learning.
Oseifuah, E. K., 2016. Cash Conversion Cycle theory and corporate profitability.
Otley, D., 2016. The contingency theory of management accounting and control: 1980–
2014. Management accounting research. 31. pp.45-62.
Watson, A. and et.al., 2016. When do franchisors select entrepreneurial franchisees? An
organizational identity perspective. Journal of Business Research. 69(12). pp.5934-
5945.
Weetman, P., 2010. Management accounting. Pearson Education.
Online
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