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

2. This Lecture... Following this session you should understand: l What Working Capital is? l Factors that affect the requirements for Working Capital? l How to evaluate the requirement for Working Capital? l How evaluate a Cash Flow statement? l How to manage Working Capital? l How to prepare for Decisions 2 2

3. Team Questions? l What is the main cause of new businesses failing? l What do we mean by Capital? l What do we mean by Working Capital? l What do we mean by Fixed Capital? l What do we mean by Liquidity? l What is Liquidation and why are businesses liquidated? 3

4. 4 Working capital… l 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

5. 5 Working capital… The working capital cycle: l What can be done to reduce working capital required? delay start of the cycle bring forward completion of the cycle reduce scale of the cycle

6. 6 Working capital Working capital can be estimated: 1. from the balance sheet: current assets - current liabilities eg stocks (raw materials, work-in-progress, finished goods) + debtors + cash less (minus) overdraft + creditors

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8. 8 Adequacy of working capital? Adequacy can be estimated by: Looking at Balance Sheet Liquidity Ratios (%) (crude, at one point in time) 1. current ratio - Current assets > than 2 or 200% Current liabilities Current liabilities 2. acid test ratio - cash + debtors > than 1 or 100% Current liabilities Current liabilities

9. 9 l What is the Current Ratio? 322,578 x 100% = 578% 55,861 l What is the ‘Acid Test’ 256,736 x 100% = 460% 55,861

10. 10 Working capital Working capital over a production (accounting) period can be estimated: l by drawing up a cash flow budget l for the whole business the maximum anticipated overdraft is shown by the monthly cash flow forecast – 12 months forward – further forward for investment projects

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12. 12 Working capital shortage? Scenario 1 - new business Scenario 2 - declining market Scenario 3 - overtrading/developing too fast

13. The Life-Cycle Model The Market Development Dilemma?

14. 14 Working capital shortage l Generating working capital – There are only 4 options....? l increase liabilities l reduce assets l increase cash flow from trading l inject more equity capital

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16. 16 Working capital shortage Best preventative measure: l Sound budgetary control using rolling annual cash flow forecasts.... l monitoring actual against budget and using variance analysis to understand major discrepancies... l If failure is predictable but unavoidable at least you may be able to withdraw from business in an organised way with some capital and good name intact

17. 17 Cash Flow Budgeting & Variance Analysis

18. 18 Can you answer this question : Why do women live longer than men?

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20. 20 Three Main Financial Statements – Historic? l Cash Flow & Flow of Funds l Trading & Profit / Loss Account incorporating a Manufacturing Account l Balance Sheet/Statement of Assets & Liabilities l Why do we need them and what do they tell us?

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22. 22 Cash Flow l measures money flows into & out of the business bank account over the accounting period and shows how the bank balance changes as a result l solvency/ feasibility l Cash Flow during accounting period: Cash Receipts - Cash Payments = Net Cash Flow Opening Bank Balance + Net Cash Flow = Closing Bank Balance

23. 23 Net Cash Flow l Cash Receipts = £284,274 minus l Cash Payments = £283,118 = Net Cash Flow = £1,156 l Opening Bank Balance = (£44,418) (-) Plus l Net Cash Flow = £1,156 = Closing Bank Balance = (£43,262) (-)

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25. 25 Minus Cost of Sales £193,552

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27. 27 Minus Cost of Sales £193,552

28. 28 Trading & Profit / Loss Account l Wealth/value creation (profit)/consumption (Loss) by the business over the accounting period l effectiveness of management l efficiency of use of resources especially capital l Revenue – matched Expenditure = Profit (Loss) Note: not Receipts & Payments (cash terminology)

29. 29 Trading & Profit / Loss Account l Revenue – matched Expenditure = Profit (Loss) l Revenue = money received/owed to the business/increase in value of business stocks; for goods produced/sold during the period minus l Matched Expenditure incurred/owed / resources consumed during the period to achieve the Revenue Thus profit involves subjective judgement because not always based on money measurement. l Accounting Conventions to guide – see textbook

30. 30 The BIG picture The Business Health Check To determine business viability evaluate the extent to which the Net Profit + Depreciation (added back) meets the needs for: 1.Private drawings (non-corporate) 2.Taxation commitments 3.Repayment of loans when due 4.Normalised business re-investment 5.Expansion to remain competitive or Surplus funds to invest in or outside the business

31. 31 The BIG picture The Business Health Check 1.Strong Business – meets all 5 criteria. Looking for business development / investment opportunities. 2.Secure Business – meets first 3 criteria. Viable in short term. Needs to develop scope to invest in modest growth to survive in the long term. 3.Insecure Business – just falls short of meeting first 3 criteria. Not quite viable but looking for business turn around strategies

32. 32 The BIG picture The Business Health Check 4. Serious Business Problem – falls well short meeting first 3 and debt is likely to increase. serious action required but possibly time to turn business around. A realistic appraisal and severe restructuring/asset sales are likely to be necessary to remedy the situation 5.Acute Business Problem – a very major shortfall in 1 - 3 & weak balance sheet. Needs realistic appraisal of turn- around prospects & immediate & drastic action to avoid bankruptcy Likely that the business needs intensive care or winding up

33. 33 What you need to do… Team Leader - responsibility for administration for your team: l Review budgeting spreadsheet and use as template for calculating decisions? l Put Results 1 onto Bosscat Business Management Simulation Trend Analysis Data Sheet Blank l post e-decision sheets on time - as e-mail attachments to rjwilliams@plymouth.ac.uk (see timetable) l Ensure that you use new team number & give names of all team members

34. What you need to do… l Period 2 decisions by 12.00 & Period 3 by 15.00 l In e-mail ‘subject’ put new team number, team name and decision number (D2) l Results will be e-mailed back to Team Leader l keep your own e-file of all Decisions (D) & Results (R) for your team l Put all Results onto Bosscat Business Management Simulation Trend Analysis Data Sheet Blank and try to understand what they tell you about your business? 34

35. 35 Bosscat e-Decision Sheet – Periods 2+

36. 36 EUE43E: ‘Trade & Commerce’ The End Robert Williams