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  1. Profile photo of ksaisonga says

    Hi,
    I dont really understand when you say working capital does not earn profit, investing in machinery is what is profitable. ( am looking at inventory, you paurchase and sale it brings in profit). Kindly elaborate for me please.

    • Profile photo of John Moffat says

      A manufacturing company makes profit by manufacturing goods and selling them at a higher price. The ideal situation would be to be able to sell them as soon as they were produced rather then keeping them in inventory. Keeping them in inventory does not make more profit – it means it takes longer to realise the profit, means more money lost in interest while waiting to sell them, and increases the chance of never being able to sell them (because they become obsolete etc.)

  2. avatar says

    Hi fahim how cash will be doubled automatically?john indicated in his lecture that if sales double receivables might be get doubled as you need to allow customer credit period to compete with others..That’s why to manage working capital you need to take overdraft.

  3. avatar says

    Sir,
    Could you little bit help me?
    Am I correct if I say that current liabilities financed by 200$ from long term(example 1)?
    Is a long term capital always better than overdraft?

    Thanks

    • Profile photo of John Moffat says

      No. We don’t finance current liabilities!

      In the current year, all of the finance for the company is coming from long-term capital (700) – the total borrowings (from equity and from long-term debt borrowing) is 700.

      In the next year, however, a total of 1,300 is being borrowed. 1200 is borrowed from long-term capital and 100 is borrowed short-term as overdraft.

      There is no ‘best’ way of borrowing.
      Long-term borrowings are likely to be more expensive that short-term borrowing (overdraft money is borrowed only as needed, which can mean less interest). On the other hand short-term borrowing is more risky (because the banks can insist on the overdraft being repaid at any time). (This is on pages 13 and 14 of the Lecture Notes).
      As I write in the notes (and say in the lecture), the standard ‘recommendation’ is to finance the average long-term working capital needs from long-term borrowings, and to finance short-term extra needs from short-term borrowing.

      The problem with over-trading is that the company is forced into short-term borrowing because they have not planned ahead properly.

      • avatar says

        But at the end you make 1400 instead of 1300 total ..because 700 old long term capital +500 he introduced new one and 100 short term which we get from bank overddraft it bcome 1300 instead of 1400

      • avatar says

        Short-term finance is often cheaper (although not always – interest rates on overdrafts can be very
        high, and delaying payment to payables can involve the loss of discounts). this is from your notes we pay high intrst on short term loan

      • Profile photo of John Moffat says

        aliimranacca007:

        I don’t make 1400 at all – I don’t know what you are trying to say.

        With regard to short-term finance being cheaper. Certainly the rate of interest may be higher or lower than long-term finance, but with overdraft finance we only pay interest on the amount borrowed (which changes from day to day). With long-term finance we pay interest on the full amount whether we need it day by day or not. I do make this clear in the lectures on working capital.

      • Profile photo of John Moffat says

        I know exactly which example it is, and I don’t make it 1400 at all.

        It comes to 1300 and that is what I say in the lecture and that is what I explained earlier in this thread.

        The only place I mention 1400 is that if the business had planned properly they would have raised 700 long-term capital (and therefore had a total of 1400) and then they would not have been forced to have the overdraft.

        I also make it clear that overdrafts (short-term finance) are not necessarily bad, but what is dangerous is when they are forced into having an overdraft because of not planning properly, which is what happens with over-trading.

      • Profile photo of John Moffat says

        It is because they had not raised enough new money.
        The receivables, inventory, and payables are likely to double.
        If they had planned properly and raised enough money then cash would be able to double also. However, because they did not raise extra money to finance the extra working capital needed it meant that they were forced into an overdraft.

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