Marketing with an un-safe product

An important phrase, as written by Kotler & Armstrong (2010) is “Responsible marketers must consider whether their actions are sustainable in the longer run”. When faced with the dilemma of having marketed an unsafe product, you will need to consider the fact that if the product is already on the market and it is known to be unsafe – it is probably safe to assume that the fact that it is an unsafe product will come to surface and, in my opinion,  the aim should be to cope with the bad press in a way that curves the negative image and hopefully builds a sustainable result.

Kotler & Armstrong (2010, p.609) outline this exact dilemma with it’s example on McDonalds and the bad press received due to their food being cooked in oils filled with trans-fats. McDonalds in turn has found a new source of food oil that is trans-fat free and does not sacrifice the taste of their french-fries (Kotler & Armstrong, 2010). Along with this they have also released additional product lines that cater for healthy eating (salads, etc).

While we also have the example as outlined by Kotler & Armstrong (2010, p. 613) of Hardee’s, a fast food chain that, at the time of a particularly health conscious media age (with focus on obesity and fast foods), released a new, incredibly high in calories (1410 calories) burger – with the attitude that their target consumer is able to choose between right and wrong; I personally do not see this as being a wiser decision than that of McDonalds.

The development of the safer alternative should be marketed well, and if the “unsafe” product is not a consumable product, I would consider allocating some of the budget towards allowing a discounted or free trade in for owners of the older models. With the devleopment of the safer, newer alternative, improvements on its eco-friendliness above and beyond it’s safety improvement should also be considered; if not, I would also consider the option of going the CSR (corporate social responsibility) route and donating a percentage of profits to a cause. While this may hurt current profits, the positive and honest image portrayed as “caring for the consumer” should aide in improving long term relationships.

I do not think that trying to ignore the fact that an unsafe product was released to the market would be beneficial in the long term, as that comes across as being un-trustworthy/underhanded – and trust is an important facet of any relationship, which definitely includes business.

References

Kotler, P. & Armstrong, G. (2010) Principles of Marketing. 13th (Global) ed. Boston: Pearson Education, Inc.

Competition in the Global Market

There are a number of factors influencing todays global competition, both positive and negative. The global market has expanded tremendously in the past 20 odd years, according to Kotler & Armstrong (2010, p.578) the number of multinational corporations has grown from 30 000 to over 60 000.

One of the factors that contribute to the global competition is that of foreign legislation and taxes on entering their markets. A particularly extreme example is outlined by Kotler & Armstrong (2010, p.580) where China has imposed restrictions on foreign entities opening banking institutions in China. The Chinese government has put requirements on foreign entities only to have US$ 50 million in operating capital each year per branch as well as limiting the number of branches that are opened to one per year. These limitations have made the idea of expanding into the Chinese banking industry something that is not feasible for a foreign entity.

On the contrary to the above situation which is a negative implication on globalising one’s business, there are also a number of trade agreements that encourage cross-border trade by lowering or removing duties/taxes on import and export or the entry of foreign business into a local sector.

However, these are not considered positive by all; Global Exchange (2011) describes their fight against “bi-lateral trade agreements” as a move towards the vision of “global economic integration that values worker’s rights, fair trade, and environmental protection over corporate profits”. The trade agreements currently in place according to Global Exchange (2011) are:

NAFTA – North American Free Trade Agreement which includes Canada, Mexico and the United States

FTAA – Free Trade Area of the Americas; this is planned to expand NAFTA to include a new zone from Argentina to Alaska.

CAFTA – Central American Free Trade Agreement. This is the same model as NAFTA but for Central America.

AFTA – As above but for the Andean nations of South America.

With organizations trying to stop the free trade agreements due to their claims on job losses and a negative impact on the economy this also increases the risks of moving towards globalization, if the free trade zones are discontinued many globalized businesses will be adversely affected.

Another free trade zone is that of the European Union (EU), Kotler & Armstrong (2010) have described this union as reducing the barriers between member countries on products, services, finances and labour. Another positive movement for the EU has been the recent adoption of the Euro currency across numerous EU member states.

Other factors covered by Kotler & Armstrong (2010) are those of cultural barriers. Cultural barriers include language barriers and there have been a number of cultural and language faux pas from even the largest companies, for example: Nike’s depiction of a famous basketball player “crushing” a number of Chinese cultural figures (Kotler & Armstrong, 2010, p.585).

It is important to understand all of the markets you are entering into, cultural borders and language borders are often very important and firms that include this in their market research and product strategy are definitely intensifying the competition (such as LG distributing their brightly coloured fridges to the Indian public, Kotler & Armstrong (2010)).

References

Global Exchange (2011) Global Trade Agreements [Online]. Available from:  HYPERLINK “http://www.globalexchange.org/campaigns/globaltrade/”http://www.globalexchange.org/campaigns/globaltrade/ (Accessed: 16 July 2011).

Kotler, P. & Armstrong, G. (2010) Principles of Marketing. 13th (Global) ed. Boston: Pearson Education, Inc.

The JIT / Just In Time Technique

JIT or Just-in-Time is focused on rapid throughput as well as reducing inventory to provide improvements on operations. JIT provides “lean operations” that supply or receive only the materials needed, only at the time they are needed (Heizer & Render, 2009).

The techniques involved in JIT are outlined by Heizer & Render (2009) and can be outlined as follows:

1)     Suppliers – JIT involves reducing the number of vendors and focuses on good relationships between suppliers. Focused on quality products and making sure that goods are delivered when needed.

2)     Layout – JIT focuses on maximising usage of space. By grouping similar products together you can ensure a larger amount of production gets done in a smaller space (aided by machinery capable of doing tasks for more than one product). JIT also focuses on reducing the distance required for transportation of products/materials therefore the requirement for storage is also reduced (also due to the fact that JIT aims to reduce inventories to only what is required).

3)     Inventories – As mentioned above, JIT aims to reduce the amount of inventories on hand (ideally eradicating inventory all together except for what is needed to fulfil the current demand). This includes producing in smaller lot sizes thus allowing production cycles to be shorter.

4)     Scheduling – JIT techniques make sure that the schedules are communicated across all suppliers and focuses on performing tasks exactly to their required scheduling time. Using the “kanban” technique is also a feature of JIT, this is where inventories are moved through the process on a pull basis (in other words, only when they are needed by the next phase/step, will they be “pullded” to the next step).

5)     Preventative Maintenance – by maintaining systems and checking on systems on a daily basis, future problems are caught before they get to the point where they become serious.

6)     Quality Production – By making quality a top priority, JIT aims to make sure all suppliers, processes and personnel are of the highest quality therefore eliminating the chances of quality control issues.

7)     Employee Empowerment – By empowering employees to do multiple functions / “jobs” within the business, this allows for fewer employees as well as more flexible employees being able to perform multiple tasks.

8)     Commitment – All aspects of the organisation must be committed to the JIT process. Management, employees and suppliers should all be supported and committed to their functions within the process.

The diagram by Heizer and Render (2009, p.539) shows that by following these guidelines for JIT, assets are freed up due to the rapid movement, waste is decreased because of the high quality and due to the reduced costs involved in the whole process the savings can be passed on to the consumer. This, of course, results in a competitive advantage due to higher quality being achieved at lower costs and at faster times.

References

Heizer, J. & Render, B. (2009) Operations Management. Ninth Edition. Prentice Hall: New Jersey.

Material Requirements Planning (MRP), what is it and how do we perform it optimally?

MRP (material requirements planning) is a technique of assessing dependent demand by using a BOM (bill of material), inventory, expected receipts and a MPS (master production schedule) to determine the material requirements (Heizer & Render, 2009).

When we say “dependent” demand, we are referring to the production of an item that is dependent on certain parts. For example, the production of a motor car is dependent on parts like the engine, wheels, windows, body etc. Heizer and Render (2009) also note that, broadly speaking, “for any item for which a schedule can be established, dependent techniques should be used”.

In a paper by Anderson and Schroeder (1984) points out that MRP can and shouldn’t operate in isolation from the rest of the business (i.e. only in manufacturing). MRP Systems should expand to the other functional areas of a firm and information must flow freely between these areas.

The main functions included by Anderson and Schroeder (1994) include:

1)     Manufacturing
As we have discussed above the main focus behind MRP is on manufacturing. The MRP system is based on the type of product being manufactured, identified by using the Master Production Schedule and Bill of Materials (MPS and BOM). Manufacturing is the core process of developing the products.

2)     Engineering
The engineering function of the firm is where the BOM mentioned above comes from. Anderson and Schroeder use an example of a firm implementing MRP where the BOM from Engineering did not match up with the Manufacturing bills – It is important to make sure all data is correct and this is another reason why all areas of the firm should be involved in the system.

3)     Marketing
Marketing is important to MRP systems because this is where the main demand forecasts are coming from. As mentioned in Anderson and Schroeders (1994) example, marketing “provided the information on firm orders and a forecast for the system”.

4)     Finance
As we know the main point of just about any organisation is to maintain profitability and the MRP system is a tool used to optimise the materials required for production. Finance provides accurate reporting on the performance of the implemented MRP system.

5)     Personnel

At the heart of any organisation is its’ personnel. All personnel should be well educated in and understand the purpose of the MRP system.

Expanding on the last point, the study by Anderson and Schroeder (1994) outlined the implementation of an MRP system across two organisations; one successful and one not. The main reason for the unsuccessful implementation was the “degree of commitment to a system rather than to a concept” (Anderson & Schroeder, 1994).

Educating and training employees to understand the importance and exact steps and procedures involved in the MRP system is very important across the organisation as it affects all functions. 

References

Anderson, J. & Schroeder, R. (1994) ‘Getting Results from your MRP System’, Business Horizons, 27 (3), pp.57-64, ScienceDirect [Online]. DOI 10.1016/0007-6813(84)90028-4 (Accessed: 28 May 2011).

Heizer, J. & Render, B. (2009) Operations Management. Ninth Edition. Prentice Hall: New Jersey.

 

How does higher quality lead to lower costs?

The answer to how higher quality can lead to lowered costs may seem fairly obvious. To explain the details behind this idea we should look at the details behind quality. Heizer & Render (2009) outline the costs of quality, or rather the costs that can occur if you have poor quality, as follows:

  • Prevention costs – training your staff to perform their tasks better and having programs to educate staff on improving quality.
  • Appraisal costs – the costs of “quality testing” the products produced. These appraisals can include, but aren’t limited to: product testing, product/service inspectors, quality assurance labs etc.
  • Internal failure – this is when a product or service is produced and fails or is defective. The internal aspect is that this is when the defective/failed product is detected before delivery to the customers. The product/service then needs to be scrapped or reworked.
  • External costs – similar to the situation above, usually a defective product or part of a product which occurs after the sale of the product or service. The costs involved in recalling, refunding and/or replacing the product or service.

Heizer & Render (2009) go on to show an example of General Electric’s recall of 3.1 million dishwashers due to a defective part, this recall ended up costing GE more than the value of all the washing machines. Another example provided by Heizer & Render (2009) show how Mercedes Benz’ lack of focus on quality led to a $600 million cost to company spent on warranties for faulty parts in their vehicles in a single year.

Fortunate to the consumer and perhaps not so fortunate to the organisation is that products and services can and generally are required to carry some sort of warranty or guarantee (such as the Consumer Protection Acts in many different countries – Wikipedia, 2011). If products are faulty or defective then consumers will return products which need to be repaired or replaced. In the cases where a warranty/guarantee is not available the lower quality will potentially damage the reputation of the organisation, which can end up in lost return and future customers. Heizer & Render also point out that poor quality delivery can also result in injuries, lawsuits, and increasing government legislation (which can be costly if processes are required by law).

One of the popular methodologies behind quality management is Six Sigma, which has the goal of “flawless performance” (TechRepublic, 2003). Six Sigma was developed by Motorola in the 1980s to deal with consumer complaints and increasing competition. To outline the processes behind Six Sigma, very broadly, we can consider them as follows (Heizer & Render, 2009)

  • Define the purpose, scope and outputs and required processes. Maintaining the idea of the customers definition of quality
  • Measure processes and collect data on the processes.
  • Analyse the collected data and ensure the results are repeatable as well as reproducible.
  • Improve the processes by modifying and/or redesigning them
  • Control the new processes and maintain performance and quality levels.

–        DMAIC

Another popular quality assurance protocol is HACCP (Hazard Analysis & Critical Control Points) used in food safety (FDA, 2011) in countries like the US, UK and for certain food stores here in South Africa (eg: Woolworths). HACCP can be summarised as food quality management “through the analysis and control of biological, chemical and physical hazards from raw material production” (FDA, 2011). My personal experiences dealing with food stores using HACCP and food stores that don’t use HACCP are like night and day. The quality is unrivalled and I feel quite safe that I’m practically guaranteed (term is used lightly) good quality, unspoiled and unmarked foods when using a HACCP controlled food store. The benefits of this can be equated to those mentioned above – lower returns (of items), lawsuits and health hazards.

References

FDA (2011) Hazard Analysis & Critical Control Points (HACCP) [Online]. Available from: http://www.fda.gov/food/foodsafety/hazardanalysiscriticalcontrolpointshaccp/default.htm (Accessed: 21 May 2011).

Heizer, J. & Render, B. (2009) Operations Management. Ninth Edition. Prentice Hall: New Jersey.

TechRepublic (2003) Six Sigma: High Quality can lower costs and raise customer satisfaction [Online]. Available from: http://www.techrepublic.com/whitepapers/six-sigma-high-quality-can-lower-costs-and-raise-customer-satisfaction/95607 (Accessed: 21 May 2011).

Wikipedia (2011) Consumer protection [Online]. Available from: http://en.wikipedia.org/wiki/Consumer_protection (Accessed: 21 May 2011).

What are the roles of an Operations Manager in addressing the major aspects of quality?

OperationsManager.com (2010) explain the roles of an operations manager to “ensures smooth operation of various processes that contribute to the production of goods and services of an organization”. The following tasks, centred on managing the quality of the service the organisation is providing, are those that are required of an Operations Manager:

  • Ensuring that the tools used to produce goods and/or services are acceptable and are capable of delivering the required quality of service that is acceptable.
  • Liaising with the Quality Assurance personnel to maintain positive feedback on the quality of the produced service or goods from the clients.
  • Assuring that quality tools and equipment are bought/maintained according with the allocated budgets.
  • Managing the support services of the organisation to ensure the most efficient management of support. For example; making sure high quality servers are purchased to store large amounts of confidential data in the most secure manner.
  • Management of any third party relationships the organisation has. Making sure that the agreements with the third parties are sound and that the third parties are performing their duties to the quality expected, as well as keeping to the required procedure standards of the organisation to maintain the highest quality possible.

The Open University (n.d.) explains that “decision making is a central role of all operations managers”. The decisions that the operations manager are involved in are in the design, management and improvement of the operations of the organisation; all of these are directly related to the quality of the service or goods that the organisation provide. If the ops manager makes a poor decision on improving services – the quality that was attained prior to improvements could fall and potentially drive away potential and existing customers, the same goes for the design of a new product/service. If the management of operations are lacking then this could also result in poor service delivery (lower quality).

Heizer & Render (2009) explain the importance of forecasting by the use of forecasting metrics. An operations manager may use the forecasting tools to predict future patterns in service delivery requirements by using trend projections based on historical data (Heizer & Render, 2009). With these forecasting models the operations manager can pre-empt quiet or busy periods (for example: shopping spikes during Christmas holidays) thus ensuring the required resources are available to cope with the demand or lack thereof while maintaining a profitable operation.  Heizer & Render (2009) also point out that these forecast methodologies are not perfect and should always be monitored and maintained according with “new” historical data.

In summary and conclusion the roles that an operations manager play in addressing the major aspects of quality is comparable with their job function as a whole; they must ensure processes are kept to the required quality for the organisation while maintaining a profitable and manageable operation.

References

Heizer, J. & Render, B. (2009) Operations Management. Ninth Edition. Prentice Hall: New Jersey.

OperationsManager.com (2010) Operations Manager job description: daily tasks, roles, duties and responsibilities [Online]. Available from: http://www.operationsmanager.com/operations-manager-roles-in-the-company/jobs-roles-duties-and-responsibilities/ (Accessed: 21 May 2011).

The Open University (n.d.) The role of the operations manager [Online]. Available from: http://openlearn.open.ac.uk/mod/oucontent/view.php?id=397333&section=2.3 (Accessed: 21 May 2011).

When is the Objective Function more important than the Constraints, and vice versa?

Let’s start by identifying the two parts to this question, as explained by Heizer & Render (2009):

1)     Objective Function:  “A mathematical expression in linear programming that maximizes or minimizes some quantity (often profit or cost, but any goal may be used)”

2)     Constraints: “Restrictions that limit the degree to which a manager can pursue an objective”

Circumstances where the objective function is more important than the constraints:

A scenario where the objective function is more important can be where the objective is critical to the success of the project in the development phase. Heizer & Render’s (2009, p.591) example of “OM in Action” for Homart Development company illustrates such a situation (book not required, continue reading). For Homart to develop their new mall their objective of attaining 3 “anchor” stores is an important factor in the success of the mall. The anchor stores are the largest stores that will no doubt attract the most customers. It is based on these anchor stores that many other stores will decide to rent in the mall and where they will position themselves in relation to the types/positions of the anchor stores. If the objective function is to get 3 anchor stores as tenants and the constraints are the required square meters floor size and required monthly rental income then if a highly popular anchor store offers to be a tenant with a higher required floor size and a lower required rental, Homart may very well consider taking the offer due to the popularity/benefits of having that anchor store in their new mall.

To state this rule in general terms I would say that where the benefit of the objective outweighs the constraints, or the future success of the project relies upon the objective being met then the constraints may be overlooked.

Circumstances where the constraints are more important than the objective function:

A situation where I would consider the constraints being more important than the objective function would be where the constraints are a valuable commodity that has a limitation that can be considered not-optional. Referring to Heizer & Render (2009, p.599) in their example of Cohen Chemicals (book not required, continue reading) where the organisation had an inventory of highly perishable raw materials that had to be used within the next 30 days to avoid wastage. While there may be situations where wastage of inventory is not an option it should be made high priority to use the raw materials the organisation has already purchased; more so than achieving the objective. In this situation, I am assuming that the outstanding orders have a certain leeway in which production is able to extend beyond the deadline; whereas the deadline for the raw materials to perish is non-negotiable.

The above example can be generally explained as; where the project has constraints that constitute to a greater loss than if the objective is not fully met (eg: needing to get rid of existing stock/inventories).

 

References

Heizer, J. & Render, B. (2009) Operations Management. Ninth Edition. Prentice Hall: New Jersey.

 

Integrating Finance with Operations Management

Heizer & Render (2009, p.33) explains an organisations strategy as its “action plan to achieve the mission”. The mission can be defined as “the purpose or rationale for an organisation’s existence” (Heizer & Render, 2009, p.32).  The mission of the operations management department of an organisation would be to make production consistent with keeping to the organisations overall mission statement, it is focused on the internal processes to do this so maintaining profits and cutting costs is of utmost importance to continue operations.

Production needs to therefore deliver their goods or service cheaper, better (or different) and more responsive (Heizer & Render, 2009, p.33).

Operations strategies are likely to be more successful when they are integrated with other areas of the organisation’s function, not only limited to accounting and finance but also HR, IT, marketing etc. (Heizer & Render, 2009, p.45)

Integration with accounting / finance is something that should be done to achieve the answers to almost all of the “Ten strategic OM Decisions” (Heizer & Render, 2009, p.37), the decisions I would say would require this are

1)     Goods/Service design: As described by Heizer & Render (2009), “design usually determine the lower limits of cost and the upper limits of quality”. Operations must know the financial capabilities of the organisation and the affordability ranges for the level of product they are able to produce. The design must be feasible.

2)     Process/Capacity design: Specific levels of production requires specific levels of labour, management, technology, human resources (qualified and/or unqualified) as well as maintenance; these all come at a cost and make up most of the organisations cost structures (Heizer & Render, 2009).

3)     Location selection: The size and the area of the desired location for the operations strategy to succeed can vary greatly in cost and affordability must be ascertained. If operations required a large plant in a high cost area this may not be feasible and should be consulted against the financial department. Coming to a decision to change areas or have a smaller plant may be required in this situation.

4)     Human resources: People are an integral part of an organisation and, as stated by Heizer & Render (2009), people are expensive. The amount of qualified and unqualified personnel will make up high costs for an organisation and integration with finance/accounting to decide on the affordability of the required personnel as well as salary levels would be required.

5)     Supply chain management: To get good terms and maintain trust with suppliers, keeping a good payment schedule and credit terms is highly important.

6)     Intentory: This ties in to all of the above, the inventory levels must be monitored and considered based on their costs, accounting can provide good reports on the costs behind the levels of inventories that are kept on hand (storage etc.).

7)     Scheduling: With an increase or decrease in schedule time will come additional/decreased costs.

8)     Maintenance: Maintenance can be an expensive or lucrative part of a business depending on which side of the table you are sitting on. Product reliability and  quality are to be considered with maintenance and both of these factors can and mostly are influenced by costs.

Without integration with accounting/finance I would go far as to say that operations would not be able to function effectively.  Finance is what keeps the organisation going and poor operational strategies and decisions without considering finance will cause problems and may even end up in bankruptcy.

References
Heizer, J. & Render, B. (2009) Operations Management. Ninth Edition. Prentice Hall: New Jersey.

Marking, Finance and Operations

The three basic functions of a firm, as Heizer and Render (2009, p.4) have outlined, are applicable to all firms and organisations; whether private, government, non-profit or any other type of organisation. These basic functions can be outlined as follows

1)     MARKETING

Marketing is the part of the firm that is concentrating on generating client demand for the product or service that the firm is producing or providing.

Heizer & Render (2009, p.5) provide some good examples of marketing departments in different businesses, some examples can be:

  1. Commercial Bank – Marketing of loans (mortgage, personal, commercial etc.) which brings in the demand for which the latter two points of this discussion are involved in (mainly 3 – Productions/Ops.).
  2. Internet Service Provider – Marketing of Internet connectivity, shared website hosting, dedicated website hosting, backup services.
  3. Food Store Chain – Marketing opening of new branches, weekly/monthly specials on food products etc.

2)     FINANCE / ACCOUNTING

As I have covered in previous posts, accounting is a vitally important function of a business. Accounting measures the performance of the organisation as well as makes sure the income is collected and the debts are paid (Heizer & Render, 2009, p.4).

Thomas (n.d.) sums the importance of accounting as a function in business as

  1. Allowing business owners to see where profit and losses are being made (Profit and Loss)
  2. Allows business owners to see where and how cash is being spent (Cash Flow)
  3. Shows whether profits are large enough to cover expenses (Balance Sheet)
  4. Helps aid financial decisions.
  5. Required to adhere to tax legislations

All of these areas of accounting apply to all types of businesses.

3)     PRODUCTION / OPERATIONS

This is where operations management comes in to play. Whether the organisation provides manufactured goods or intangible services, or a combination of both the processes are part of the production/operation function.  As Heizer & Render put it (2009, p.4), this function “creates the product”.

There are some notable differences between services and goods but as Heizer & Render show (2009, p.11); even organisations which seem very much “goods” (eg: automobiles), they still require a level of service (vehicle finance, vehicle delivery). The same goes with service heavy organisations (eg: consulting), which mostly have an element of goods as well (eg: printed reports). Heizer & Render  (2009, p.11) point out that one of the only “pure service” providers are those that provide counselling.

Some examples of operations in different organisations are:

  1. Commercial Bank – Tellers, transaction processing, cheque clearing, facility design and layout, vault operation, maintenance and security (Heizer & Render, 2009).
  2. Software Development – facility design and layout (placement of personnel), communications, training, client liaison, quality assurance and control, product development, product design and maintenance.

All of the above 3 functions are imperative to the operation and success of an organisation.

References

Heizer, J. & Render, B. (2009) Operations Management. Ninth Edition. Prentice Hall: New Jersey.

Thomas, C. (n.d.) Why is accounting important in business? [Online] eHow. Available from: http://www.ehow.com/facts_5003375_why-accounting-important-business.html (Accessed: 7 May 2011).

Representing Working Capital

Working capital (WC) can be represented as follows:

Working Capital = Current Assets – Current Liabilities

It can be said that WC measures a company’s efficiency as well as their short-term financial health (Investopedia, n.d.).

A company should always have a positive WC value. If there are less assets than there are liabilities then this means that the company is unable to repay all of their liabilities, this should be considered a “red flag” when assessing the financials of a business (Investopedia, n.d.). It should also be compared with previous WC amounts to assess a decline in profits/sales and should also be cause for concern (Investopedia, n.d.).

Management of Stock-in-trade:

It is important to consider the costs behind holding and not holding your inventories (stock-in-trade). Holding stock incurs costs such as storage space, insurance, loss of interest on the cash used to purchase stock as well as the potential losses in the case that stock becomes obsolete (Atrill & McLaney, 2011).  On the contrary, not holding stock on hand poses risks of losing sales, reordering costs, production being slowed down, and potential time critical opportunities for large quantities of stock being missed (Atrill & McLaney, 2011).

Companies should therefore manage their inventories wisely. When managing inventories a company should identify the most efficient amount of stock to be ordered by using assessment models and methods to find out the best frequency and quantity to order stock, it is important to keep accurate inventory logs so that historical data can be used in this (Atrill & McLaney, 2011), taking into consideration future forecasts of required stock.

“Just in Time” (JIT) inventory management can also be considered (Atrill & McLaney, 2011). JIT is used by most online stores today and, as the name implies, stock is ordered or re-ordered only when it is needed (often after the purchase has been made in the scenario of online stores).

Management of Trade Debtors:

This can also be referred to as “trade receivables”. Careful consideration should be made when deciding which customers should receive credit. Atrill & McLaney (2011) outline the 5 C’s of credit, as explained by Investopedia (2011):

1)     Character – The reputation of the borrower (eg: via credit check)

2)     Capacity – Compare the borrowers income to their recurring debts to work out their capacity to repay more debt

3)     Capital – Consider the amount of capital (deposit) the borrower is going to put down on the purchase, the higher the deposit the less chance of default.

4)     Collateral – Does the borrower have collateral (eg: property) that can be used to recover bad debt.

5)     Conditions – Interest rates and the term of repayment should also be considered.

The costs behind giving credit are also a factor. These are costs such as losing interest from having cash on hand in investments, as well as the lost purchasing power due to the lack of cash on hand, administration costs for maintaining customer accounts and the additional costs involved in vetting potential trade debtors must also be considered; perhaps the biggest concern would be the risk of bad debts (Atrill & McLaney, 2011). If potential clients are refused credit then the potential of a poor reputation, or losing clients is also there.

All of these above issues should be carefully evaluated and policies on all possible risks and situations as well as contingency plans should be drawn up to maintain trade debtors.

Cash

When managing cash it is important to evaluate the benefits behind keeping cash on hand as well as the best amount of cash to keep on hand. If cash is on hand, the company is losing out on interest that could be gained from the cash being in investments, also, purchasing power due to bank statements reflecting a lower balance (Atrill & McLaney, 2011).

The potential losses from not having enough cash on hand can be that of losing “supplier goodwill” (Atrill & McLaney, 2011) if there are not enough funds to keep up to date on payments. As well as missed opportunities for purchasing in cash and receiving cash discounts. Another major issue to consider is the cost of borrowing money needed (interest charged) if there is not enough cash on hand.

As with trade debtors, it is important to plan, using historic records to base your plans on. Make contingency plans and policies and find the lowest source of funding if needed (overdrafts etc.).

Trade Creditors

Also referred to as “trade payables”, is the amount of credit the company itself has (for purchasing inventories etc.) Costs to consider when managing trade credits are that of purchases on credit generally being of a higher cost than purchasing in cash (due to interest, or just simply a higher price); additional administration costs are also required to manage trade creditors for the company (Atrill & McLaney, 2011).

Trade credit can also favour the company as some suppliers may allow for borrowing without charging any interest, some suppliers may also require the company to have credit (or at least, be “credit worthy”) to be able to get discounts or be able to make large orders (helps build goodwill) (Atrill & McLaney, 2011).

As with the previous areas it is important to develop policies and plans around trade creditors. If the company is able to get interest free credit then they should take advantage of this to increase cash flow in the business (Atrill & McLaney, 2011).

Conclusion

Accounting ratios should be used where ever possible to help evaluate and assess the best possible option in managing working capital.  The working capital ratio can be used to calculate the efficiency of a company when it comes to managing stock in trade, trade debtors and creditors (MoneyTerms.co.uk, n.d.) – the calculation is as follows:

Working Capital Ratio = (stock-in-trade + trade debtors – trade creditors) / sales

MoneyTerms.co.uk (n.d.) give an example that if the ratio is 0.20 then that means that the company requires 20p (cents) of working capital for every 1GBP of annual sales, which can be put as : “If annual sales increase by £100,000 of then the company will have to invest £20,000 in working capital to be able to meet this.”.

References

Atrill, P. & McLaney, E. (2011) Accounting and Finance for Non-Specialists. 7th Edition. Prentice Hall.

Investopedia (n.d.) 5 Cs of Credit [Online]. Available from: http://www.investopedia.com/terms/f/five-c-credit.asp (Accessed: 30 April 2011).

Investopedia (n.d.) Working Capital [Online]. Available from: http://www.investopedia.com/terms/w/workingcapital.asp (Accessed: 30 April 2011).

MoneyTerms.co.uk (n.d.) Working capital [Online]. Available from: http://moneyterms.co.uk/working_capital/ (Accessed: 30 April 2011).