There are two different definitions of working capital namely net, working capital and gross working capital. Basically the gross working capital refers to the total current assets that the company has while the net working capital is the difference between current assets less the current liabilities, meaning net working capital are assets financed by a long term fund. It determines the company's current position in terms of risks and profitability, wherein profitability refers to profits less expenses and risks are the possibilities the company will get involved with especially when failing to meet debt obligations as they come due for payment.
Capstone project assignments are challenging, so if you are stuck and do not know what to do, or you are short of time, you can always reckon on help with Capstone project by Pro-Papers writers team.
Primarily, the finance manager needs to make appropriate finance mix that will help lessen the amount of risk and increase profitability. Financing mix is defined as the proportion of current liabilities and current assets financed by long term funds. There are two kinds of approach in determining finance mix the conservative and aggressive approach. In conservative approach, the long term resources are the one's financing the current assets while short term finance only applies to emergency situations which also defines the nature of aggressive approach (Rao, V.S. Rama. February 7, 2009).
All of this is connected to operating cycle because the company should maximize the stake holder's wealth so the need to generate sufficient profit is important. Calculating the working capital is sometimes tricky and confusing, but only has to remember the basics and the important elements that need to be considered in calculating. The simple equation is current assets - liabilities = working capital. This calculation when applied to CBI's financial statement will come out as the ff, equation (total current assets $1,606,817 - total current liabilities $300,200 = working capital $1,306,617). Evidently the company has an impressive working capital after current liabilities. It appears that the total liabilities only accounts for 18.68% of the current asset, which is a good sign especially for the investors, because a negative working capital would mean a red flag and it occurred in a continuous trend for a long period of time will result to bankruptcy.
The way CBI performed in their working capital is generally impressive in such a way that the company was able to minimize accrued expenses and able to pay-off short term liabilities including its payables. When a company is falling negative of its working capital means the company is having trouble paying its short-term liabilities. The idea is, the higher the working capital the less financial strain the company would experience, as with CBI having 81.31% of working capital means they have currently a strong financial position in the business. The main advantage of looking into working capital is to oversee any possibilities of financial difficulties.
Even large businesses with billions of dollars in fixed assets may also end in bankruptcy court because of their inability to pay for the bills. A disrupted working capital means the company is not doing well in managing cash flow, thus resulting to lapses in short-term payments (Kennon, Joshua N.D.). A low or negative working capital is only good for companies with high turnovers or the ones with high inventory like a grocery store, because they can make money every time they open their doors and the amount of inventory they have allows them to plow cash which can be used to pay-off liabilities, because current inventory and receivables primarily are not qualified to compensate liabilities, otherwise it has to be turned into cash first.
The way CBI performed is just as efficient considering that they are not a high turnover business, it’s just enough that they produce high working capital, efficient in balancing cash flows and ensuring up to date payments of short term liabilities. Working capital and cash basically represents available cash that the company can use on a day to day operations, it is because working capital can be used for operational improvement by means of financing the cash conversion cycle. Cash is very crucial in the daily basis of business operation because it supports short-term expenses. Normally the accounts payable works on particular terms, i.e. 30 days or 60 days depending on supplier and company agreements.
Now, if the company reached the due period for payment and still haven't accumulated cash yet due to low sales, definitely the company will have a hard time satisfying the payables, unless there is sufficient working capital then the business can use the cash to pay off short-term payables and the operations would not suffer. Another use of cash and working capital to improve operations is for equipment upgrades and expansion. Instead of repairing production equipment’s during failures, it is better to just purchase a much state of the art machinery that is capable of doubling the normal output, thus ensuring higher volume of production while reducing man-hours. This is because a much efficient machine can reduce human errors making it easier to maintain quality and in return will reduce quality control expenses.
When there is enough cash from working capital, the business can think of expanding the business subsequently to maximize the capital for profitability reasons. For example, add new features into the products to make it more appealing to the market such as blood pressure monitoring features on each bike or add shockproof mechanism to reduce stress and product breakage adding durability. Cash on the other hand can also be used to further improve operations, by paying up parts of long term debts to scrutinize interest rates and more commonly, cash can be used to buy more raw-material stocks for optimized productivity.
However, working capital needs to be at suitable level to maintain a smooth business operations, it has to be on the optimal average level to be beneficial because low level working capital causes struggle to cover liability creating solvency and liquidity, if the working capital reached an all-time low level the company will resort to liquidation to identify where the funds were used, whereas over level will cause misuse of funds, because working capital is getting any earnings, the shareholder will suffer the opportunity cost and over level also decreases the market share value of the company so it has to be in complete equilibrium or at average as possible.
There are several ways how to improve the working capital, one is the proper forecasting of cash flow. It should always be taken into account all things which affect the working cash flow such as market cycle, unforeseen events, competitor actions and loss of important customers. It is also important to have contingency plans to overcome unexpected events. Another working capital improvement way is to address issues about working capital on a corporate-wide basis because cash can be generated at one location only, like for example a chain of retail stores has areas where sales are piling up while others are not doing very well, then cash generated from high selling stores can be utilized to cover the slower ones. It can be done by means information access, good links between billing and production and efficient banking systems.
All of this can be done using a good internal system of moving cash applying efficient treasury practices should always be observed. Collaborating with customers will also help in creating sufficient working capital; by constantly helping customers to plan their required inventory will match production in relation to consumer demands will help to reduce levels of inventory (Gass, Davis. N.D.). In the case of Competition Bikes Inc. who has more than 80% of excess working capital, they can use it to a more productive way. Excess or idle working capital bears no profit nor is profitable when not utilized. To maximize that, the company has to look for ways on how to put it in good use.
Aside using the working capital to pay wages, purchase raw materials, office supplies and facilitate credit to the customer, an excess can be used for several purposes. In cases that there was excess in working capital, the company can use it to acquire more loyal customers and that is to extend credit due dates and or to upgrade credit limits. Increasing credit limits in particular does not only utilizes the working capital but also gives the customers an opportunity to acquire more products from the company and therefore, the company will have the chance to increase turnover rates and avoid excess inventory. The reason behind that is when the company has too much stocks on inventory, chances for spoilage and product disintegration is high, thus protruding risk to the overall profitability.
Another way of utilizing excess working capital is to use it to increase incentives of field sales personnel on a certain quota requirement. In this way they would be pushed to market the product knowing the amount of money they can get by selling more bike units (CBI for example). Excess working capital can be also used to intensify marketing efforts or perhaps advertising if budget would permit. In marketing efforts, the most effective way of using the funds is through buyer discounts. It appears from the balance sheet that Competition Bikes Inc. has a lot of excess working capital; it can actually be used by marketing to conduct system-wide discount opportunities. Distributors can bring down the price of each unit at a certain discount level to entice more bikers to choose CBI's products.
Have slightly no idea on how to start your poem analysis essay outline? There is one great essay writing service that can help you with that. It's called Pro-Papers – your reliable helper for any kind of educational papers.
Lastly, the company can use excess working capital to increase production of in-demand product lines; this is the most direct way of utilizing the funds for profit generating purposes. The more in demand products in the market the more feasible for the company to sell. Another way of improvement is to pay-off accounts and notes payable. When there is less payables on the balance sheet the lesser the liabilities will be, as we all know less liabilities means higher working capital in the future as well as net profit. This will also improve CBI's portfolio making it a lot easier to acquire funds through bank loans for future expansions if they have a positive credit score.
CBI can use the excess working capital to launch e-commerce, since the company has a website, they can use the working capital to improve the website and utilize it to make an online store which in return would mean additional profit, the modern age opened business opportunities through Internet and CBI can take it to their advantage. The current working capital can also be used to improve CBI's transportation cost which is at $30 each unit. If they are using a third party carrier for deliveries, it would be much better to purchase own vehicles for transporting goods. This will help lessen the current cost of transportation, which means the savings could contribute to net sales and lower operating expenses.
Leave a Reply
Your email address will not be published / Required fields are marked *