So one has to be very careful in controlling inventories While on the one hand

So one has to be very careful in controlling

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So one has to be very careful in controlling inventories. While on the one hand excess inventories can lead to following costs: 1. Cost of Capital 2. Cost of holding (storage, insurance, damage etc…) 3. Cost of obsolescence (products getting unsalable either due to date expiry or newer versions coming in the market) We have also seen that nil stocks can have very serious loss consequences. Hence stocks have to be properly balanced. One must also know that in any trading operation, idle cash lying in the banks can also contribute to the cost of current assets. Hence collection account cash (which is normally kept in the current account) should be transferred to company’s operational accounts, where they can be put to productive use such as reducing bank overdrafts or repayments against interest bearing borrowings. 118
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WORKING CAPITAL Other heads of accounts that can contribute to increase in current assets and consequently working capital are prepaid expenses, advances given to suppliers and deposits to outside parties. Prepaid expenses are instances of payments to suppliers of goods or services, ahead of the due date of payments. These advances made to suppliers in effect result in blocking, the organization’s funds ahead of the business realization and are to that extent investments. So what should a good business manager do? The manager would look for opportunities to balance such investments by obtaining credit from suppliers. Thus getting suppliers of goods and services to extend credit to the company, would result in obtaining suppliers’ credit, whose effect would be to reduce to that extent involvement of own funds in the business. In a typical marketing organization, such suppliers can be, not only material suppliers but also service suppliers such as transporters, C and FAs, advertising/ media agencies. Interest free deposits from Distributors can also be source of such funds. 7.3 SUMMARY Working capital in simple terms means the capital required for day to day running of the business. In accounting terms the amount is the difference between current assets and current liabilities. Cost Associated with Credit Sales 1. Cost of capital. 2. Cost of control. 3. Cost of collection. 4. Cost of delinquency. 5. Cost of default. To reduce the risks of sales on credit one must very carefully evaluate the credit worthiness of the party to whom credit is being extended. 119
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WORKING CAPITAL Post evaluation of the credit worthiness of the party one must also set limits of credit to be extended. These limits can be both time limit and amount limit. Time limit will set, up to what length of time credit will be extended to that party and similarly amount limit will specify the maximum amount for which credit can be extended. Cost Associated with Inventory 1. Cost of capital.
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