Explain-why-working-capital-management-has-become.doc

Explain why working capital management has become increasingly important in the current business environment.In a competitive business world, successful organizations understand the importance of critical-thinking in the decision-making process. To make sound business decisions, organizations must combine strategic planning with comprehensive data analysis, which includes the evaluation of financial and non-financial records and processes. Management and those involved with maintaining the companys financial health use a variety of tools, methodologies, and performance metrics to gain a better understanding of the companys current financial state, create reliable forecasts, and formulate and implement solutions for the company. Organizational leaders realize that to make the most optimal decision, the company has to fully evaluate all aspects of the companys operations including policies and procedures. The working capital policy is imperative to a companys success because the policy serves as a strategy on how the organization can maximize its resources. “The working capital policy is the firms policy about its working capital level and how its working capital should be financed decisions about how much to keep in its cash account, what level of inventory to maintain, and how much to allow receivables to build up” (Danh, 1999). The working capital policy also includes handling creditors, debtors, inventory, and possible sources of additional working capital. The working capital policy will assist companies in making sound business decisions on how it shall finance its existing assets. Good working capital management is important. According to the Treasury of New Zealands (2007) website, if a company is “operating with more working capital than is necessary, this over-investment represents an unnecessary cost.” The website further added that excess working capital means “operating inefficiencies.” Even with excess assets, it is considered inefficient because the assets can be used, invested, and generate additional income for the company. The following are just some of the various components of a working capital:Current Assets Liquid Assets (cash and bank deposits) Inventory Debtors and Receivables Current Liabilities Bank Overdraft Creditors and Payables Other Short Term Liabilities Provide at least two examples of organizations that have good working capital management policies, and two examples of organizations with poor working capital management policies. Be sure to explain why the policies of your selected organizations are effective and ineffective.Some of the companies that have been successful at managing their working capital are Ford Motor, Dell, Kitty Hawk, General Motors, Texas Instruments, Prometheus Print, etc. On the other hand, companies that have been unsusccessful at managing their working capital are Larrys Market of Seattle and Dephi.SuccessfulTexas Instruments Factoring of Receivables (Factoring) Invoice factoring, also known as factoring or accounts receivable factoring, is a financial option available to organizations. By factoring, businesses are able to liquidate outstanding receivables to financial institutions, referred to as factors, for immediate cash funding. Business organizations that factor out their receivables sell their outstanding receivables to factors. The organizations are able to have quick access to cash; however, the cash received for the receivables sold is less than the face value of the total receivables sold. In turn, the factors (financial institutions) perform the collection for these outstanding invoices and potentially receive the full amount when the receivable is actually due. Business organizations factoring out their receivables do not have to wait until the invoices are past due. Although still considered unconventional form of financing, many organizations opt to factor out their receivables because of the convenience factoring provides. Organizations can shorten the billing cycles, improve cash conversion cycles, and increase liquidity by factoring accounts receivables. According to Invoice Financials (2006) website, some of the benefits of factoring are: Obtain funding for your outstanding receivables within 24 hours. Accelerate cash flow, make payroll, and fulfill new orders. Offer better terms to large customers and increase sales. Extend credit to large customers without asking for COD. No new debt is created. Factoring is not a loan. Pay your suppliers faster; take advantage of early pay discounts. Improve your business cash flow and credit rating. Eliminate long billing cycles and the hassle of collecting money. Instant credit guarantees for new customers. No obligations and no binding contracts. The factors decision to offer or accept financing will be based on the customers credit worthiness (open receivables) as opposed to the companys financial statement. Therefore, eliminating the need for audited financial statements. Organizations just need to prepare invoices and supporting documents for the outstanding invoices that will be sold. Texas Instrument (TI), designer/supplier of digital signal processing solutions and more popularly known as the manufacturer/distributor of scientific calculators, have been factoring its outstanding receivables since 1990 (Quickel, 1993). According to Quickel, Texas Instruments sold receivables around the 1990s were averaging between $150 million o $175 million per year. By selling a percentage of its total receivables as opposed to individual receivables, Texas Instrument can ensure access to needed cash as well as “maintaining contact with its customers” (Quickel, 1993). Prometheus Print Invoice DiscountingPrometheus Print is a printing company that uses invoice discounting as a means of protecting cash flows. (Meade, 2006). Prometheus uses The Royal Bank of Scotland Group (RBS) for their invoice discounting after giving the customer 90 days to pay in full and RBS then collects on the bad debt or turn it over for legal action (Meade, 2006). Prometheus switched to invoice discounting from factoring after factoring provided the necessary flow of working capital to establish the company (Meade, 2006). Invoice discounting offers the real cash flow benefits that factoring offers but without the loss of control of the sales ledger and existing methods of credit control within the company (The Banking Liaison Group Ltd, 2006). This system can be used by companies to improve cash flow, but it can also be used to reduce administration overheads (Moore, 2006).Dell, Inc. Cash Conversion Cycle (CCC) The cash conversion cycle, also known as cash cycle and working capital days, is one form of early warning system for organizations financial health. Cash conversion cycle is an important financial tool or approach in determining the companys financial position because it allows organizations to “measure the length of the cash-to-cash cycle” (Bierley, n.d.). Organizations are able to calculate the time their working capital (cash) is unavailable for use. Bierley explains that “the speedier your cash-to-cash cycle, the few days your cash is unavailable for use in propelling your value stream.” Mathematically, the cash conversion cycle is calculated using this formula: Inventory outstanding (DIO) + Days sales outstanding (DSO) - Days payable outstanding (DPO) = Cash conversion cycle“The cash conversion cycle is the number of days between paying for raw materials and receiving the cash from the sale of the goods made from that raw material” (Wikipedia, 2006). In the cash conversion cycle, the number indicates the availability of the cash for the organizations use. “The higher the number, the longer a firms money is tied up in operations of the business and unavailable for other activities” (Wikipedia, 2006). American computer hardware manufacturer, Dell, Inc., primarily sells direct-sales model of its personal computers and accessories via the Internet and telephone sales network. Dell has always considered students and regular home users as part of its target consumers; however, it has always been regarded as a company which sells its product to businesses and information technology professionals. In 1995, Dell evaluated its overall operations and found that its increased inventory and accounts receivables were affecting the companys growth rate and profitability (Harper, 2005). The company had to make some changes within its operations and take serious efforts to reengineer its financial operations. Since Dell launched reengineering efforts in the fourth quarter of 1996, the company was able to reduce its cash conversion cycle to negative/minus five days by the fourth quarter of 1997 (Banham, 1997). Prior to making these changes, Dells CCC was averaging at 40 days. Dells short conversion cycle was an indication that Dell had a well-managed working capital. Dells negative conversion cycle meant the company was able to receive payments from customers prior to paying vendors. Additionally, Dell employs just-in-time (JIT) inventory management system which helped the company better manage its inventory. “Dells five days of inventory allows it to pass on component price declines faster than anyone in the industry” (Gurley, 2001). Gurley adds “Dells business advantages is its negative cash conversion cycle because it keeps only five days of inventories, manages receivables to 30 days, and pushes payables out to 59 days.”UnsuccessfulLarrys Market: Poor Inventory Management Larrys Market based in the Seattle area did not adjust for changes within the area. Increased inventory and higher inventory costs have created significant challenges. The company is now faced with reducing corporate staff by 70 percent with the possibility of future cuts. The inventory control issues have created lower buying power and slow vendor payments. Poor decisions and a lack of inventory management have placed the company in jeopardy (Zwieback, 2006).Delphi: Lack of Cash Flow Management.Delphi, a supplier of automotive parts and accessories to manufacturing companies, in recent years has been crippled from long gaps in the operational cycle (the period between accounts receivable to accounts payable) and the cash cycle ( the period payment of raw materials and accounts receivable) (Ross, Westerfield and Jaffe, 2005). The operational cycle and cash cycle are dependent variables in the companys cash flow time line (the combination of both operational cycle and cash cycle); thus impacting a companys decisions on short-term financing options (2005). Delphis financial profile contains a strong cautionary tale of the need to properly manage and shorten certain aspects of these business cycles. According to Delphis 2004 annual reports, two cash flow time line elements can be identified as needing further scrutiny, inventory and accounts receivable. In 2004, Delphis raw material inventory exceeded 132 million dollars with a completed inventory of 146 million dollars; moreover, Delphis accounts payable had ballooned to 367 million dollars (Delphi, 2004). Delphis accounts receivable did net a positive return of 91 million dollars; compared to 2003s loss of 452 million dollars in 2004. The main issue for Delphi becomes how to financially support such gaps between operational and cash cycles. Delphis Achilles financial-heel was the method by which Delphi attempted to solve the gaps in the cash flow time-line by using loans. As of December of 2005, Delphis long-term debt was in excess of 3.1 billion dollars, comprised of a combination of revolving credit and long term loans (Mergent, 2006). Furthermore, 2004 Delphi had about 92 million dollars in outstanding payments from sales and in 2005 this figured climbed to 365 million dollars for 2006. Delphis inability to close the gap between operational and cash cycle has caused increased financial stress on the company and has increased the companys debt, both short and long-term.References:Anonymous. (2007). Working capital management. New Zealand Department of Treasury. Retrieved April 4, 2007, from t.nz/ publicsector/workingcapital/chap2.asp.Banham, R. (1997, December 1). Upgrading cash flow at Dell. Retrieved August 12, 2006, from /article.cfm/2987362/c_3046568? f=magazine_featured.Banking Liaison Group Ltd. (2006). Factoring and invoice discounting. Retrieved August 14, 2006, from http:/www.bankexperts.co.uk.Bierley, J.J. Jr. (n.d.). Cash-to-cash cycle. Retrieved August 12, 2006, from /learn/cash_to_cash.php. Delphi, (2004). Delphi: Driving Tomorrows Technology. Retrieved December 31, 2006 from Mergent database.Danh, V.T. (1999, October 22). Working capital policy. Retrieved August 19, 2006, from .vn/coursewares/kinhte/qttc/abstract/ch10.htm.Gurley, J.W.