1 EUE43E: ‘Trade & Commerce’ Understanding Working Capital & Cash Flow Robert J. Williams.

11

EUE43E: ‘Trade & EUE43E: ‘Trade & Commerce’Commerce’

Understanding Working CapitalUnderstanding Working Capital

& Cash Flow& Cash Flow

Robert J. WilliamsRobert J. Williams

This Lecture...This Lecture...

Following this session you should understand:Following this session you should understand:

What Working Capital is?What Working Capital is?

Factors that affect the requirements for Working Factors that affect the requirements for Working Capital?Capital?

How to evaluate the requirement for Working How to evaluate the requirement for Working Capital?Capital?

How evaluate a Cash Flow statement?How evaluate a Cash Flow statement?

How to manage Working Capital?How to manage Working Capital?

How to prepare for Decisions 2How to prepare for Decisions 222

Team Questions?Team Questions?

What is the main cause of new businesses failing?What is the main cause of new businesses failing?

What do we mean by Capital?What do we mean by Capital?

What do we mean by Working Capital?What do we mean by Working Capital?

What do we mean by Fixed Capital?What do we mean by Fixed Capital?

What do we mean by Liquidity?What do we mean by Liquidity?

What is Liquidation and why are businesses What is Liquidation and why are businesses liquidated?liquidated?

33

44

Working capital…Working capital…

The working capital cycle:The working capital cycle:

buy raw materials

pay labour

pay overheads

store finished goods

store raw materials

pay supervisors

sell finished goods on credit

debtors pay

pay creditors

55

Working capital…Working capital…

The working capital cycle:The working capital cycle:

What can be done to reduce working capital What can be done to reduce working capital required?required?

delay start of the cycledelay start of the cycle

bring forward completion of the cyclebring forward completion of the cycle

reduce scale of the cyclereduce scale of the cycle

66

Working capitalWorking capital

Working capital can be estimated:Working capital can be estimated:

1.1. from the balance sheet:from the balance sheet:

current assets - current assets - current liabilitiescurrent liabilities

egeg

stocks (raw materials, work-in-progress, stocks (raw materials, work-in-progress, finished finished goods) + debtors + cash goods) + debtors + cash

lessless (minus)(minus)

overdraft + creditorsoverdraft + creditors

77

BALANCE SHEET STATEMENTEnd of: PERIOD 3

Actual£

SOURCES OF CAPITAL

31 SHARE CAPITAL £ 400,00032 RESERVES (P/L account) £ 18,71733 SHAREHOLDERS FUNDS £ 418,71734 BANK LOAN (Debt cap.) £ 140,00035 TOTAL CAPITAL EMPLOYED £ 558,717

APPLICATION OF CAPITAL

36 FIXED ASSETS

37 LAND/BUILDINGS @ COST £ 180,00038 MACHINERY @ COST £ 120,00039 LESS CUMULATIVE DEPN £ 8,000

TOTAL FIXED ASSETS £ 292,000

40 CURRENT ASSETS

41 RAW MATERIALS £ 87442 FINISHED GOODS £ 64,96843 DEBTORS (receivables) £ 256,73644 CASH £ 0

TOTAL CURRENT ASSETS £ 322,578LESS

45 CURRENT LIABILITIES

46 BANK OVERDRAFT £ 43,26147 CREDITORS (payables) £ 12,600

TOTAL CURRENT LIABILITIES £ 55,86148 NET CURRENT ASSETS £ 266,717

49 TOTAL NET ASSETS £ 558,717

88

Adequacy of working Adequacy of working capital?capital?

Adequacy can be estimated by:Adequacy can be estimated by:

Looking at Balance Sheet Looking at Balance Sheet Liquidity Ratios Liquidity Ratios (%)(%)

(crude, at one point in time)(crude, at one point in time)

1.1. current ratio - current ratio - Current assetsCurrent assets > than 2 or > than 2 or 200%200%

Current liabilitiesCurrent liabilities

2.2. acid test ratio - acid test ratio - cash + debtorscash + debtors > than 1 or > than 1 or 100%100%

Current liabilitiesCurrent liabilities

99

What is the Current What is the Current Ratio?Ratio?

322,578322,578 x 100% = 578% x 100% = 578%

55,86155,861

What is the ‘Acid Test’What is the ‘Acid Test’

256,736256,736 x 100% = 460% x 100% = 460%

55,86155,861


Actual£

SOURCES OF CAPITAL



36 FIXED ASSETS



40 CURRENT ASSETS







1010

Working capitalWorking capital

Working capital over a production (accounting) Working capital over a production (accounting) period can be estimated:period can be estimated:

by drawing up a cash flow budgetby drawing up a cash flow budget

for the whole business the maximum anticipated for the whole business the maximum anticipated overdraft is shown by the overdraft is shown by the monthlymonthly cash flow cash flow forecastforecast – 12 months forward – further forward for – 12 months forward – further forward for investment projectsinvestment projects

1111

CASH FLOW STATEMENT PERIOD 3Actual

£CASH IN Cash brought forward from last period £ 0

From last period's debtors (sales) £ 234,274New loan received £ 50,000

(A) TOTAL CASH TO ACCOUNT £ 284,274

CASH OUT Overdraft brought forward from last period £ 44,418Paid to last period's creditors (purchases) £ 10,500Loan repayment £ 0Labour costs £ 158,400Production overhead less depreciation. £ 59,061Premium material costs £ 4,320Sales & administration expenses £ 41,449Finance charges £ 9,388

(B) TOTAL CASH FROM ACCOUNT £ 327,536

CASH BALANCE (A - B) £ -43,262

1212

Working capital shortage?Working capital shortage?

Scenario 1 - new businessScenario 1 - new business

Scenario 2 - declining marketScenario 2 - declining market

Scenario 3 - overtrading/developing too fastScenario 3 - overtrading/developing too fast

The Life-Cycle ModelThe Life-Cycle ModelThe Market Development Dilemma?

1414

Working capital shortageWorking capital shortage

Generating working capital –Generating working capital –

There are only There are only 4 4 options....?options....?

increase liabilitiesincrease liabilities

reduce assetsreduce assets

increase cash flow from tradingincrease cash flow from trading

inject more equity capitalinject more equity capital

1515


Actual£

SOURCES OF CAPITAL



36 FIXED ASSETS



40 CURRENT ASSETS







1616

Working capital shortageWorking capital shortage

Best preventative measure:Best preventative measure:

Sound budgetary control using Sound budgetary control using rolling annual cash rolling annual cash flow forecasts....flow forecasts....

monitoring monitoring actualactual against against budget budget and using and using variance variance analysisanalysis to understand major discrepancies... to understand major discrepancies...

If failure is predictable but unavoidable at least you If failure is predictable but unavoidable at least you may be able to withdraw from business in an may be able to withdraw from business in an organised way with organised way with somesome capitalcapital and and good namegood name intactintact

1717

Business Management Simulation.

CASH FLOW BUDGET/STATEMENT PERIOD 7 PERIOD 8 PERIOD 8 PERIOD 8 PERIOD 8Actual Budget Actual Variance Variance

£ £ £ £ %CASH IN Cash brought forward from last period

From last period's debtors (sales)New loan received

(A) TOTAL CASH TO ACCOUNT

CASH OUT Overdraft brought forward from last periodPaid to last period's creditors (purchases)Loan repaymentLabour costsProduction overhead less deprn.Premium material costsSales & administration expensesFinance charges

(B) TOTAL CASH FROM ACCOUNT

CASH BALANCE (A - B)

Cash Flow Budgeting & Variance Cash Flow Budgeting & Variance AnalysisAnalysis

1818

Can you answer this question :Can you answer this question :

Why do women live longer than Why do women live longer than men?men?

2020

Three Main Financial Three Main Financial Statements – Historic?Statements – Historic?

Cash Flow Cash Flow & & Flow of Funds Flow of Funds

Trading & Profit / Loss Account Trading & Profit / Loss Account incorporating a incorporating a Manufacturing AccountManufacturing Account

Balance Sheet/Statement of Assets & LiabilitiesBalance Sheet/Statement of Assets & Liabilities

Why do we need them and what do they tell us?Why do we need them and what do they tell us?

2121








2222

Cash FlowCash Flow

measures money flows measures money flows intointo & & out ofout of the business bank the business bank account over the accounting period and shows how the account over the accounting period and shows how the bank balance changes as a resultbank balance changes as a result

solvency/ feasibilitysolvency/ feasibility

Cash Flow during accounting period:Cash Flow during accounting period:

Cash Receipts - Cash Payments = Net Cash FlowCash Receipts - Cash Payments = Net Cash Flow

Opening Bank Balance + Net Cash Flow = Closing Bank Opening Bank Balance + Net Cash Flow = Closing Bank BalanceBalance

2323

Net Cash FlowNet Cash Flow

Cash Receipts = £284,274Cash Receipts = £284,274

minusminus

Cash Payments = £283,118Cash Payments = £283,118

= Net Cash Flow = £1,156= Net Cash Flow = £1,156

Opening Bank Balance = Opening Bank Balance = (£44,418) (-)(£44,418) (-)

PlusPlus

Net Cash Flow = £1,156Net Cash Flow = £1,156

= Closing Bank Balance = (£43,262) (-)= Closing Bank Balance = (£43,262) (-)

2424








2525

PROFIT/LOSS STATEMENT (SUMMARY)

PERIOD 3Actual

£

21 TOTAL SALES £ 256,73620 GROSS PROFIT (CONTRIBUTION) £ 63,184

SALES EXPENSES & ADMIN

22 GENERAL ADMIN. £ 19,00023 ADVERTS & PROMOTIONS £ 17,50024 MARKET RESEARCH £ 3,00025 WAREHOUSING COSTS £ 1,949

41,44926 OPERATING PROFIT £ 21,73527 FINANCE CHARGES £ 9,388

28 NET PROFIT £ 12,34728 PROFIT B/F £ 6,370

30 PROFIT C/F £ 18,717

Minus Cost of Sales

£193,552

2626

QTY £ QTY £ QTY £*** **********************************************************************************************************************************************1 OPENING MATERIAL STOCK 850 2642 MATERIAL RECEIVED 54,000 16,9203 STOCK AVAILABLE 54,850 17,1844 CLOSING MATERIAL STOCK 2,788 874*** **********************************************************************************************************************************************5 MATERIAL USED 52,062 16,310 9,562 2,995 42,500 13,3146 LABOUR COSTS 158,400 38,250 26,400 127,500 132,0007 PRIME COSTS 174,710 29,395 145,314

8 SUPERVISION 17,2809 MATERIAL ORDER COST 1,00010 MATERIAL STORAGE COST 18111 DEPRECIATION 4,00012 OTHER PRODN. COSTS 40,600

13 TOTAL PRODN. O/HEADS 63,061 10,610 52,451

14 COST OF PRODUCTION 237,771 40,005 197,76515 UNIT COST OF PRODUCTION 1.04 1.55*** **********************************************************************************************************************************************16 OPENING FINISHED GOODS STOCK 20,750 0 0 13,755 20,75017 ADD PERIOD'S PRODN. 237,770 38,250 40,005 127,500 197,76518 LESS CLOSING FINISHED GOODS STOCK 64,968 0 0 41,998 64,968

19 COST OF GOODS SOLD 193,552 40,005 153,54720 GROSS PROFIT 63,184 21,195 41,989

21 PERIOD'S SALES 256,736 38,250 61,200 99,257 195,536

*** **********************************************************************************************************************************************

2727

PROFIT/LOSS STATEMENT (SUMMARY)

PERIOD 3Actual

£

21 TOTAL SALES £ 256,73620 GROSS PROFIT (CONTRIBUTION) £ 63,184

SALES EXPENSES & ADMIN

22 GENERAL ADMIN. £ 19,00023 ADVERTS & PROMOTIONS £ 17,50024 MARKET RESEARCH £ 3,00025 WAREHOUSING COSTS £ 1,949

41,44926 OPERATING PROFIT £ 21,73527 FINANCE CHARGES £ 9,388

28 NET PROFIT £ 12,34728 PROFIT B/F £ 6,370

30 PROFIT C/F £ 18,717

Minus Cost of Sales

£193,552

2828

Trading & Profit / Loss Trading & Profit / Loss AccountAccount

Wealth/value creation (profit)/Wealth/value creation (profit)/consumption (Loss)consumption (Loss) by the business over the accounting periodby the business over the accounting period

effectiveness of managementeffectiveness of management

efficiency of use of resources especially capitalefficiency of use of resources especially capital

RevenueRevenue – – matchedmatched ExpenditureExpenditure = Profit = Profit (Loss)(Loss)

Note: not Note: not ReceiptsReceipts & & PaymentsPayments (cash terminology) (cash terminology)

2929

Trading & Profit / Loss Trading & Profit / Loss AccountAccount

RevenueRevenue – – matchedmatched ExpenditureExpenditure = Profit = Profit (Loss)(Loss)

RevenueRevenue = money received/owed to the = money received/owed to the business/increase in value of business stocks; for business/increase in value of business stocks; for goods produced/sold during the periodgoods produced/sold during the period

minusminus

MatchedMatched Expenditure Expenditure incurred/owed / resources incurred/owed / resources consumed during the period to achieve the consumed during the period to achieve the RevenueRevenue

Thus profit Thus profit involves subjective judgementinvolves subjective judgement because because not always based on money measurement.not always based on money measurement.

Accounting Accounting ConventionsConventions to guide – see textbook to guide – see textbook

3030

The BIG pictureThe BIG pictureThe Business Health CheckThe Business Health Check

To determine business viability evaluate the extent To determine business viability evaluate the extent to which the to which the Net Profit + DepreciationNet Profit + Depreciation (added (added back) meets the needs for:back) meets the needs for:

1.1. Private drawings (non-corporate)Private drawings (non-corporate)

2.2. Taxation commitmentsTaxation commitments

3.3. Repayment of loans when dueRepayment of loans when due

4.4. Normalised business re-investmentNormalised business re-investment

5.5. Expansion to remain competitive or Surplus funds Expansion to remain competitive or Surplus funds to invest in or outside the businessto invest in or outside the business

3131


1.1. Strong Business Strong Business – meets all 5 criteria.– meets all 5 criteria.

Looking for business development / investment Looking for business development / investment opportunities.opportunities.

2.2. Secure Business Secure Business – meets first 3 criteria. – meets first 3 criteria.

Viable in short term. Needs to develop scope to Viable in short term. Needs to develop scope to invest in modest growth to survive in the long term.invest in modest growth to survive in the long term.

3.3. Insecure Business Insecure Business – just falls short of meeting first 3 – just falls short of meeting first 3 criteria. criteria.

Not quite viable but looking for business turn around Not quite viable but looking for business turn around strategiesstrategies

3232


4. Serious Business Problem 4. Serious Business Problem – falls well short meeting – falls well short meeting first 3 and debt is likely to increase. first 3 and debt is likely to increase.

serious action required but possibly time to turn serious action required but possibly time to turn business around. A realistic appraisal and severe business around. A realistic appraisal and severe restructuring/asset sales are likely to be necessary restructuring/asset sales are likely to be necessary to remedy the situationto remedy the situation

5.5. Acute Business Problem Acute Business Problem – a very major shortfall in 1 – a very major shortfall in 1 - 3 & weak balance sheet. Needs realistic appraisal - 3 & weak balance sheet. Needs realistic appraisal of turn- around of turn- around prospects & immediate & drastic prospects & immediate & drastic action to avoid bankruptcyaction to avoid bankruptcy

Likely that the business needs intensive care or Likely that the business needs intensive care or winding upwinding up

3333

What you need to do…What you need to do…

TeamTeam LeaderLeader - responsibility for administration for - responsibility for administration for your team:your team:

Review Review budgeting spreadsheet budgeting spreadsheet and use as template and use as template for calculating decisions?for calculating decisions?

Put Results 1 onto Put Results 1 onto Bosscat Business Management Bosscat Business Management Simulation Trend Analysis Data Sheet BSimulation Trend Analysis Data Sheet Blanklank

post post e-decision sheetse-decision sheets on time - as e-mail on time - as e-mail attachments to attachments to [email protected]@plymouth.ac.uk (see (see timetable)timetable)

Ensure that you use new Ensure that you use new team number team number & give names & give names of of all team membersall team members

What you need to do…What you need to do…

Period 2 Period 2 decisions bydecisions by 12.00 12.00 & & Period 3 Period 3 byby 15.00 15.00

In e-mail ‘In e-mail ‘subject’subject’ put put newnew team number, team team number, team namename and and decision number (D2)decision number (D2)

Results will be e-mailed back to Results will be e-mailed back to TeamTeam LeaderLeader

keep your own e-file of all keep your own e-file of all DecisionsDecisions (D) (D) & & Results Results (R)(R) for your team for your team

Put all Results onto Put all Results onto Bosscat Business Management Bosscat Business Management Simulation Trend Analysis Data Sheet Blank Simulation Trend Analysis Data Sheet Blank and try and try to understand what they tell you about your to understand what they tell you about your business?business?

3434

3535

Bosscat e-Decision Sheet – Bosscat e-Decision Sheet – Periods 2+Periods 2+

GAME REFERENCE NO. DECISION PERIOD NUMBER

EMas3 2DATE TEAM REFERENCE CODE.

8TOTAL NUMBER:

OPERATORS AVAILABLE THIS PERIOD (must = cell D7 from last period) Cell D6 4555

NUMBER: OVERTIME:(hrs/op/wk-max.10)ALLOCATION OF OPERATORS GEMA 20 8FOR THIS PERIOD LUCY 25 2

(must = cell D6 this sheet which = D7 from last period's sheet) TOTAL 45KILOGRAMMES:

MATERIAL PURCHASE BASIC RAW MATERIAL (to be delivered next period ie cell D7 + 1 Period) (1 Tonne =1,000 Kg) Kg. 40,000 Kg.PREMIUM RAW MATERIAL (to be delivered for this period) (at £360 / 1,000 Kg) Kg. 0 Kg.

£:FINANCIAL DECISIONS EXTRA LOAN REQUIRED THIS PERIOD (at 2.5%/period) (multiples of £10,000) £0

LOAN REPAYMENT THIS PERIOD (only if cash available now) (multiples of £10,000) £0SELLING PRICE/DOLL: (£.p) ADVERTS: (@ £500 each)

MARKETING DECISIONS GEMA £1.50 Number of adverts: 2MARKETING DECISIONS LUCY £2.50 Number of adverts: 5

RESEARCH REQUIRED ALL COMPETITORS' ADVERTISING @ £1000 (Embolden request) YES NO ALL COMPETITORS' MARKET SHARES @ £2000 (Embolden request) YES NO MARKET FORECASTS FOR NEXT 4 PERIODS @ £3000 (Embolden request) YES NO ALL COMPETITORS' PROFITS TO DATE @ £2000 (Embolden request) YES NO CONSULTANT'S REPORT (Period 3+ only) @ £2000 (Embolden request) YES NO

TOTALTO BE EMPLOYED NEXT PERIOD (ie cell D6 +/- ANY CHANGE; max change ± 50%) Cell D7

PLEASE COMPLETE ALL BLANK SPACESTEAM NAME

BOSSCAT DECISION SHEET

Brytney Bratz Please take care to complete ALL unshaded cells correctly.

3636

EUE43E: ‘Trade & EUE43E: ‘Trade & Commerce’Commerce’

The EndThe End

Robert WilliamsRobert Williams

1 EUE43E: ‘Trade & Commerce’ Understanding Working Capital & Cash Flow Robert J. Williams.

Documents

Transcript of 1 EUE43E: ‘Trade & Commerce’ Understanding Working Capital & Cash Flow Robert J. Williams.