There are many definitions of management accounting with academics such as Jagels et al (2007, p.2) defining it as being “concerned with providing specialised, internal information to managers who are responsible for directing and controlling operations.” Similarly, Adler (2013, p.1) offers a comparable description citing that management accounting aims to “provide information that is relevant and useful to the operational and strategic decisions that senior managers make.” Both of these definitions suggest that management accounting is used for internal purposes unlike financial accounting which focuses on providing information to external parties such as investors. Furthermore, we can also surmise that management accounting places much of its emphasis on planning, forecasting and future decisions rather than the historical financial performance of the organisation.
A key aspect of management accounting is managing working capital with Moyer et al (2008, p.542) stating that “effective working capital policies are crucial to a firm’s long-run growth and survival.” Raheman and Nasr (2007) corroborate this by outlining how it “directly affects the liquidity and profitability” of a company. This essay will seek to define and evaluate the various different features that make up working capital and how they can be successfully managed, with particular reference to the practices of the Clandeboye Lodge Hotel, a four star hotel situated in Bangor, County Down.
Working Capital is identified as the arithmetic difference between current assets and current liabilities (Sagner, 2010) with many authors including Proctor (2009) listing the main current assets as inventory, trade receivables, and cash. Following on from this, the main current liabilities are understood to be trade payables and bank overdrafts as outlined by Siddaiah (2010). It is the balance of these which will determine a firm’s liquidity, or in other words their “ability to pay in cash the obligations that are due” (Vijayakumar, 2001, p.146). Cash is the most liquid of current assets with it being readily available, whilst inventory is typically the least liquid as it generally takes the longest amount of time to convert into cash. There are a number of ratios used to establish how liquid an organisation is, however Baker and Powell (2005, p.48) state that the “most widely used” is the current ratio and it is calculated by dividing the firm’s total current assets by the total current liabilities. There are many arguments over what the ideal current ratio should be, with scholars such as Fabozzi (2001, p.480) disputing that the “general standard for this ratio (such as 2:1) is not useful.” However, many authors including Thukuram (2006, p.87) conclude that a ratio of 2:1 is “considered ideal as a rule of thumb.” Nevertheless, whilst aiming for a 2:1 ratio would suggest an encouraging solvency position, any higher than that is not necessarily considered positive. As Jackson et al (2009) point out, a current ratio that is more than 2:1 can only be considered good if you are a creditor of a company. From the company’s point of view, it may mean that they are holding too much stock or struggling to collect cash from customers. Alternatively, a ratio of less than 2:1 can indicate that the business will have difficulties in meeting their short term financial commitments. This is one area that the Clandeboye Lodge seem to completely ignore when attempting to manage their own working capital. The priority of the business seems to focus on looking ahead to the future, making plans and accurately forecasting, whereas with the use of liquidity ratios, in order to perform a meaningful analysis “one must have at least a few years of historical data” (Vinturella and Erickson, 2013, p.166) to accurately establish possible trends and industry norms.