Presentation Transcript

1. Working Capital Cash is the life blood of a business. Businesses need cash or money on hand to keep a business running. Working Capital is the money available to pay for everyday things a business needs. The word cash refers to current assets. It is money a business receives for their goods or services. Money held in a bank or in actual cash form are two types of current asset. Also Stocks and money owed by debtors. Current assets = Cash + Stocks + debtors
2. Liquidity –means how easily an asset can be turned into cash Money at a bank is highly liquid A load of lumber used to build a house is not very liquid.
3. Businesses that do not keep up with cash flow issues can become insolvent and my go out of business. As soon as a business has this problem it can cause a spiral effect that will cause a business to not operate the way it should. When this happens a liquidation of the business assets will occur. This can happen to businesses that have been profitable for years but fail to get through short term cash flow problems.
4. Working Capital can also be referred to as net current assets. Working Capital = Current assets – Current liabilities
5. Working Capital needs to be used to pay for running costs for a business. Current assets are to be used to pay for costs within a year. Also known as liquid assets.
6. Types of current assets Cash - money at hand or in the bank Debtors – money that is owed by a customer of the business. (Someone who bought on credit) Stocks/inventories - raw materials, semi-finished goods or finished goods. (The closer to the market something is the more liquid it is considered)
7. Current liabilities Money that is owed and needs to be paid back within a year. Types of liabilities Overdrafts – short term loans that need to be paid very quickly Creditors – suppliers who sold a business something on credit Tax – Money that is owed to a level of the government
8. Most business will have a delay in-between spending money and receiving money back. (Think of a building a house) This is a major reason why business work so hard to manage their working capital. The working Capital cycle is important to understand page 363
9. Most businesses don’t want to have to much liquid assets on hand because they feel that money should be working for the company instead of being very liquid. (Although this lack of ready cash was damaging to many companies during the financial crisis. )
10. Current ratio – measure of liquidity of a firm. Shown as a ratio Current Assets: Current liabilities. Any firm under 1:1 has liquidity problems that can cause liquidation.
11. Cash vs profits Profit = revenue – cost When a firm makes enough to reach the breakeven point then all other money is considered profit. Customers have several options when making purchases. Cash in hand, check, direct debit or trade credit
12. If a business sells on trade credit the sale will count as profit but it will not be considered cash until the actual payment is made. Ex Because of this profit is not considered cash
13. Sales revenues vs Cash inflows Sales revenue is always from making a sale to a customer but cash inflows can be from any number of sources that bring money into a business. Ex loans, grants, interest payments and selling assets
14. Other cash flow problems for businesses stem from the fact that some businesses are seasonal and others expand to fast. Businesses that don’t worry about these problems can have trouble paying suppliers and employees It is also a problem for businesses to not use the money they have coming in to expand into areas that they may need to for survival. Finally some businesses that have lots of cash on hand may not actually be profitable.
15. Cash flow forecasts Cash inflows/receipts - money that usually comes in from sales revenue from customers. Predicting sales forecasts is very difficult but very important for a business. Also payment from debtors, loans, interest, sale of assets and rental income all go in cash inflows. Cash outflows/payments/ expenses/ outgoings – money that leaves a firm from bills such as labor, purchase of stocks (material) rent, taxes, payment to creditors, advertising, interest repayments and dividends. Net cash flow – The difference between cash inflows and cash outflows. Is very important to keep this positive.
16. Two other parts to the cash flow forecast Opening balance – The amount of cash at the beginning of the trading period. Is the same amount as the closing balance of the preceding month. Closing balance – amount of money in an account at the end of a trading period. Closing balance = opening balance + net cash flow
17. Cash flow forecast tend to operate according to the previous year. Although new customers may be anticipated.
18. Reasons for cash flow forecasts Lenders want to see cash flow forecasts before they give a business external finance. Businesses can anticipate times when they might have a cash flow problem and make adjustments to timing of cash coming in and cash going out. Businesses can plan better for the future when they have reliable predictions about their cash flow needs. Comparing actual results to forecasts help Turn to page 366
19. All businesses need to have good cash inflow in order to have working capital to pay expenses. Businesses that wait to bring in working capital need to worry about having enough money so they do not have a liquidity problem.
20. Causes of cash flow problems Overtrading – businesses try to expand to quickly. They take orders that they can not possibly fill than do not have enough working capital to spend on operating costs. Over borrowing – businesses that are highly geared will spend lots of their outflow money on paying back loans. Extremely dangerous in times of rising interest rates. Overstocking – keeping to much product around because that is a waste of resource money that should be used else where.
21. Causes of cash flow problemscon. Poor credit control – giving to long for debtors to pay back loans as well as giving credit to businesses that are a risk and don’t pay off their debt. Unforeseen changes – things that happen that can not be known to happen ahead of time. Note some business that deal in cash and low inventory carrying periods will not need to worry about working capital nearly as much as a business that carries inventory for a much longer period of time. A SHIP PRODCER COMPARED TO A grocery store
22. Businesses need to make sure current assets can always cover their current liabilities. There are many different ways to deal with working capital problems.
23. Option 1: Seek other sources of finance Overdrafts – temporarily take more money out of and account than a business has. Downside are fees and it can be hard if a business is known as a credit risk. Sale and leaseback – involves selling off fixed assets and then leasing them back. Selling off fixed assets - in case of a real emergency a business can sell its assets. Dangerous because they may need these to do business.
24. Option 1: Seek other sources of finance con. Debt factoring – passing on debt to a collection agency so they can have immediate access to the funds. Fees are associated. Government assistance – governments will sometimes help a businesses that is trouble because they do not want to see a business fail and with that have job loss Growth strategies - strategic alliances, joint ventures, mergers and takeovers happen many times because a business is in trouble.
25. Option 2Improving cash inflows Tighter credit control – sometimes businesses may need to reduce or reduce the amount they can buy on credit. Cash payments only - eliminate trade credit Both options will bring in money faster but it can lead to customers switching businesses. It will negatively affect those businesses cash flow.
26. Option 2Improving cash inflows con. Change pricing policy – if you lower prices it can increase sales on some products making it easer to convert stock to cash. Improved product portfolio – offering a greater range of goods can help to increase sales. The downside is that this could increase costs and risks without increasing net cash flows. Improved marketing planning – more market research can help to understand customers needs and increase cash inflows.
27. Option 3Reducing cash outflows Seek preferential (good) credit terms – negotiating better terms with current or potential suppliers. Downside is it can have administrate costs with no benefit. Seek cheaper suppliers – Can lower costs but run the risk of inferior supplies Better stock control - Some businesses will wait for orders to come in before they make whatever they are selling Reduce expenses – businesses will spend lots of time figuring out how they can save money by reducing non essential costs.
28. Most firms will do some combination of these methods to help increase the working capital. Following the Pareto principle many businesses will spend 80% of their time figuring out how to increase cash inflows and 20% of their time on how to cut costs. A contingency or emergency fund will usually set aside money for unexpected expenses. Page 372 table.
29. There are also things a business can do to keep cash flow problems from happing Having a broader range of customers can help by reducing risk in case a customer changes suppliers. For large projects that take a long time some businesses ask for partial payments to help cash flow problems. Paying large bills in installments can help cash flow problems. Ensure quality management systems are in place help to keep customers are happy.
30. Reasons that it can be very hard to make a proper cash flow forecast Marketing – Bad market research may give improper sales forecasts. Also a bad marketing campaign will sometimes make customers not like a product. Human resources – If a workforce does not get along or if they are unhappy with management then more and more customers may complain or use other businesses. Operations management – Some things that go wrong with production can really hurt cash flow when businesses can not produce their products on time.
31. Reasons that it can be very hard to make a proper cash flow forecast con. Competitors – Market leaders can be unpredictable and can effect other businesses very negatively. Changing fashion and tastes – People change what they want and what they like all the time. Because of this making predictions can be very hard. Economic changes – Low interest rates tend to increase spending because people will borrow more which will boost the overall economy. The opposite happens with higher interest rates. Because of this making predictions become very hard. External shocks – war, stock market crashes and natural disasters. Make making predictions very hard.
32. Predictions are never set in stone. They need to be revised constantly. Because things changed most businesses try to not make predictions for the very long term.
33. Managing cash flow is very important. It is important to not mistake cash with profits. More businesses fail because of bad cash flow management than a lack of profitability.
34. Working capital is important for Human resources – Staff needs to be paid on time or there can be serious trouble. If a firm is profitable but does not have the capital to pay their staff then employees will be unhappy. Marketing – letting people know about a product and doing research requires large amounts of cash. Production – businesses that build things for a long time need to make sure that they will have enough working capital to finish their projects.
35. Businesses need to be careful about how much they rely on cash flow analysis. It is important to understand where that information is coming from and how reliable it is to cover costs. Businesses need to make sure to have a balance between giving their customers credit and making sure they have working capital. In the short term working capital is more important than profits for a business because with working capital a business will not survive.