Working Capital Control

1
Working Capital Control

• What is it?
• Essentially net current assets (but strictly
  speaking should exclude cash)
• Why is it important?
• Cash tied up in day-to-day operations
• The business cannot continue without it
• It has to be funded from somewhere
• If business runs out of cash, it will fail

2
Why do we need to control it?

• Use cashflow forecast to work out how much cash
  we need to borrow/invest
• To keep working capital to a minimum (and hence
  free up cash for other purposes)
• keep stocks low
• keep debtors low
• delay payment to creditors
• BUT if working capital too low (or negative),
  risk bankruptcy
• fail to meet liabilities as they fall due

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Cash Flow Forecast
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Cashflow Forecast Example - Carruthers
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Bank Reconciliations

• You can check the cash at bank (or bank
  overdraft) balance in the accounts by comparing
  it to the balance on your bank statement.
• The two figures are unlikely to agree exactly -
  this does not mean that the balance in the
  accounts is wrong.
• Acceptable differences are cheques that have not
  yet cleared (deposits and payments). Other
  differences should be adjusted.

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Bank Rec. Example

• Balance per bank statement 351.05
• Balance per cash book (accounts) 319.04
• Why are they different?
• 3 cheques you have issued have not cleared
• 1 deposit has not been cleared
• the bank has made an error with the amount of
  another deposit
• these are all acceptable differences

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Bank Reconciliation as at 30 Nov

• Balance per bank statement
• Less outstanding cheques
• Add outstanding deposit
• Less error on statement
• Balance per cash book

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Daphne Ltd Example

• Acceptable differences are cheques outstanding
  (not yet presented) and deposits not yet credited
  (cleared).
• But we must adjust for investment income, bank
  charges and standing order as we should have
  entered these in the books (accounts).
• Nb. typo statement date 30.6.01 not 00

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Insert ratio analysis diagram here
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Ratio Analysis

• Ratios of accounting numbers are useful to
  analyse the position and performance of a
  business.
• It is important to compare ratios over time
  (trends), or to budgets, or to other
  businesses/industry averages. By themselves they
  are meaningless.

11
Profitability Ratios

• Gross Profit Ratio Gross Profit ? 100
• Sales
• Net Profit Ratio Net Profit ? 100
• Sales
• ROCE PBIT ? 100
  Capital Employed

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ROCE

• ROCE is very important.
• Can split ROCE as follows
• ROCE Net Profit Ratio ? Capital Turnover Ratio
• as long as you use PBIT in Net Profit Ratio
• Capital Turnover Ratio Sales
  .
• Capital Employed

13
Liquidity (Working Capital) Ratios

• Use Stock Turnover Ratio to see whether the
  Current or the Quick Ratio is the most
  appropriate liquidity ratio to use.
• High/quick stock turnover - Current Ratio
• Low/slow stock turnover - Quick Ratio
• Also look at Debtor and Creditor Days to
  determine changes in payment/collection periods
  (affect cash cycle of business).

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• Stock Turnover Ratio Cost of Sales
• Inventory Held
• OR
• Inventory Held ? 365 days (no. of days)
• Cost of Sales

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• Current Ratio Current Assets .
• Current Liabilities
• Quick Ratio Current Assets Stock
• Current Liabilities
• the quick ratio is sometimes also called the
  acid test.

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• Debtor Days Trade Debtors ? 365 days
• Total Credit Sales
• (how long it takes your customers to pay)
• Creditor Days Trade Creditors ? 365 days
• Total Credit Purchases
• (how it takes you to pay your suppliers)
• if you dont have purchases, use C.O.S.

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Efficiency Ratios

• Tell you how well you use your assets to generate
  income.
• Capital Turnover Ratio
• Fixed Assets Turnover Ratio
• Sales .
• Fixed Assets Book Value

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Gearing Ratios

• Debt to Equity Long-Term Liabilities
• Capital Reserves
• Debt to Capital Employed
• Long-Term Liabilities
• Capital Employed

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Investor Ratios

• Dividend Yield Div Per Share ? 100
• Market Price per Share
• Note You need market price to calculate this but
  it may not be available.
• Dividend Cover
• Net Profit Before Ord Divs
• Ord Divs paid and proposed

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• Earnings per Share Earnings Before Ord Divs
• No. of Ordinary Shares Issued
• companies like Somerfield report this at bottom
  of the profit and loss account
• Price Earnings Ratio Market Price per Share
• (PE Ratio) Earnings per Share

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Writing Reports

• Title page
• Contents page
• Executive summary
• Terms of reference
• Introduction
• Several sections dealing with content
• Conclusion
• Appendices