|
|
To avoid unnecessary collision with debtors a business can factor its receivables. This involves selling the debtors to a financial institution known as a factor. This entails an agreement on the basic credit terms of each customer. The customer sends payment directly to the factor that bears the risk of non-paying customers. The costs that will be incurred by the entity are factoring commission and interest on the advance granted. This means that the debts will be sold at a lower value than they are worth to cover for the risks that the factor will have. Other than costs, an entity will benefit from specialized services in credit management offered by the factor. This enables the entity’s management to concentrate more on manufacturing and marketing.
At the end of the day, sales will have increased due to attractive credit terms offered. Costs of credit management and bad debts will be significantly reduced.
A brilliant business tactic is ensuring that your debtors pay you as fast as possible as you delay payments to your creditors for as long as you can. This guarantees maximum use of the cheapest source of finance-credit. Precaution should be taken since harassing your debtors might scare off prospective customers and unnecessary delays of creditor’s money might earn you unlimited space in your creditor’s bad books.
Much care and skills must be taken in inventories. Unlike other classes of working capital, this class is exposed to more risk. Dishonest employees may decide to help themselves to the stock. Thieves may go over an electric fence, past the security guards and the surveillance cameras skip recording any movements. Due to the risks that stocks are exposed to, costs of holding stock have become a significant item in the profit and loss account of many business entities. The more stock you keep, the more storage space you will need and this will be more costly. Stock handling will require more people; this in turn inflates the wages expense. Insurance firms will want more premiums to cover the increased stock. To the unlucky few, fall in prices means capital loss. Worse still, one might end up not recovering the investment incurred. Consumers might change their tastes and preferences rendering your stock obsolete. The more stock you keep, the more the investment return you forego, is the solution keeping the stocks at the lowest levels possible?
Low stocks have their evils too. Incase of a break in supply of raw materials, production stops. Finished goods stock might run out forcing the customers to lose their confidence in you and take business elsewhere. Low stocks also mean frequent ordering. Costs of transporting ordered goods, insurance in transit and other significant clerical costs related to ordering will sharply rise. Business entities are faced with the problem of meeting two conflicting needs. The stocks are to be maintained at a high level for efficient and smooth production and sales operations. They are also to be maintained at a lower level to maximize profitability.
The problem has to be solved mathematically. All stock related costs have been classified as either stock ordering costs or stock holding costs. Stock ordering costs decrease with increase in inventory maintained while stock holding costs increase with increase in inventory maintained. When curves of the above functions are drawn on costs vs. inventory size axis, they intersect at a point where both costs are equal. This is the economic inventory quantity and if stock is maintained at this level, costs will be at their lowest.
Proper receivables management increases sales, creditor’s management increases financing and stock management reduces costs. Cash will start streaming in and with it comes another challenge-how do you manage your cash?
Pilling it in a bank account wont work. Sometimes the ledger fees and transaction costs exceed the interest that they offer for the money banked and who gains at the end? It’s the bank. Do you get some light to the source of their billions profit every year?
Entities that avoid dealing with liquid cash could be working it the right way but they are exposed to massive banking frauds and unnecessary costs associated to bouncing cheques. Many entities have therefore opted to deal with liquid cash despite the risks that they face. Robbers have reigned everywhere and if not, dishonest staff has taken their part. This has forced the entities to take fidelity covers for their cash at an extra cost.
For entities that deal with cash, they have to keep it to meet their transaction needs, take advantage of investment opportunities that come their way and meet any emergencies or unusual demand for cash. Like stock, keeping cash in large amounts has its costs. Its purchasing power might be lowered due to inflation and there is the investment return that has been foregone by holding the cash in its liquid form.
Insufficient cash leads to increased transaction costs incurred each time cash is raised. Cash discounts may also be lost over and above the loss of good credit rating. An entity may also fail to honour its obligations in time due to insufficient cash and this may attract penalty interest. So there comes the challenge of meeting two conflicting needs. Cash has to be kept in large amount for smooth running of business and in small amounts to avoid risks and maximize profits.
|
Tags
You must be logged in to add tags.
|
Writer Profile
Martin Tairo
As a very creative Architecture student at the University of Nairobi, i have had lots of interests in many forms of arts. These include performing arts, writing and drawing.
I have written many articles on issues ranging from humour, politics, religion and even the most controversial topics like human rights and abortion.
|
Comments
You must be a TakingITGlobal member to post a comment. Sign up for free or login.
|
|
