USQ UNIVERSITY OF SOUTHERN QUEENSLAND

MBA - ACC5502

Accounting & Financial Management / S1 / 2013

M B G Wimalarathna

(ACA, ACMA, ACIM, SAT, ACPM)(MBA–USJ/PIM)

Financing through WC Working Capital (WC) (in an entity) refers to the total funds invested in current assets. Concept of Net working capital (NWC) is a key component of working capital. NWC calculated by eliminating Total Current Liabilities from Total Current Assets.

WC CA NWC (CA - CL)

Managing suitable level of NWC is essential in following aspects. 1. Maintaining a healthy liquidity position. 2. To earn required return on assets. 3. Analyze cost & risk of short term funding.

Appropriate level of NWC is the level at which entity able to meet its financial obligations without any delays.

Hedging

Many entities practice “hedging” in order to maintain proper level of NWC.

Hedging : matching the maturity of the sources of funding with their use.

Keys for effective hedging;

NCA should be financed through permanent funding.

CA & other assets must financed through temporary funding.

Note:

Permanent Funding. (Maturity Period > 1year)

Temporary Funding. (Maturity Period ≤ 1year)

Spontaneous Funding. (Unplanned, Unstructured finance- can either permanent or temporary)

Cash & Cash equivalents

C/Assets Trade Debtors

Inventories

Accrued wages & taxes

Trade Creditors

C/Liabilities Bank Overdraft

Commercial bills & promissory notes

Factoring/Trade finance

Inventory loans or floor – plan finance

An entity must manage its cash due to following;

Need to have sufficient cash

timing of cash flows

cost of cash

cost of not having enough cash

The need to have sufficient cash An entity must always maintain sufficient level of cash balance in hand in order to meet its financial obligations.

When determining the level, trade-off between risk & return should taken in to consider.

Risk - inability to meet financial obligations.

Return - return get by making an investment.

The timing of cash flows

An entity must ensure the timing of its cash requirement.

Cash Sales

Collection of money from debtors

Mode of cash- Sale of assets (idle)

inflows Capital injections

Short-term Loans

Long-term Loans

Purchase of inventories

Purchase of Labor, R/M & other services

Mode of cash outflows Purchase of assets

Payment of taxes

The Cost of Cash An entity might incur cost in following manner when managing its cash. Opportunity cost of (merely)holding money. Cost of providing physical Security.

The cost of not having (enough) cash An entity requires money in order to meet its financial obligations. When entity not having sufficient cash, it may not pay the debt at required time which even affect to the going concern. (prone to wind - up the business in long run or even in short period)

An entity must develop a sound system for the debtors’ management by addressing all key aspects. A Debtor create through the credit sales and following benefits and cost would involved; Enhance customer base Benefits Increase sales volume Attract new customers / markets Eliminate some cost of marketing & selling Opportunity cost of money Cost Bad & Doubtful debts Administration Cost(Handling, Collecting,

Recording)

Key factors of determining the suitable level of debtors within the entity.

I. Total Sales

Total Sales

Credit Sales

Trade Debtor

II. Credit Policies This refers to the internal policies & applications with respect to credit sales & trade debtors.

Sele

cti

on o

f suit

able

custo

mer

Credit Policy

Determinants of credit Sales

Deciding Payment terms

Sett

ing C

red

it L

imit

III. Collection Policies & Procedures

An entity must develop a system which entails clear policies & procedures with respect to collection of money from the debtors. This might directly affect to bad/doubtful debtors and working capital coupled with the liquidity position

of the entity. IV. The level of credit sales

As mentioned before, a trade debtor will create within the entity as a result of credit sales.

Inventory has become a most common and crucial element represents current asset in the entity. (especially in manufacturing entity)

Inventory is essential for the continuous production process. Raw Materials (RM) Form of Inventories Work in Progress (WIP) Finished Goods (FG) Benefits 1. Continuous Production - Sales - Profit 2. Retain & gain customers 3. Build good relationship with key players in the market 4. Create & maintain goodwill Costs 1. Ordering Costs ( Broker, Freight, Clearing) 2. Holding Costs - Storage Insurance Deterioration & Obsolescence Theft Financing Costs

Techniques available to manage the inventory. - Maintain minimum level of stock - Managing average turnover period - Economic order quantity (EOQ)

Maintaining a minimum stock level refers to the buffer stock keep by entity to make sure continuous operations. Average turnover period = Average inventory held x 365/52/12 Cost of Sales EOQ = 2 Do H Where, D Total demand for given period O Ordering Cost H Holding Cost Q Quantity

Just in time (JIT) is the technique introduced by Japan (Toyota) through which entity able to produce goods by placing the orders for inventories as and when requirement arise only.

Accrued wages & taxes

Entity keeps its employees salary for the particular month as an accrual until end of month which indirectly treat as short term source of finance for the entity. Same in the event of GST and other indirect taxes. Trade Creditors

Trade Credit is most common widely practice mode of short term funding in the business world. An entity purchases materials in the normal course of business while make the payment after 30 - 90 days. (not a norm) Average Settlement period = Avg. Trade Crs. x 365/52/12 Cr. purchases Bank Overdrafts Bank Overdraft (OD) is a facility granted by a bank (commercial) exceeding the current account balance as a result of corporate relationship having with the company without pledging securities (in most cases).

Commercial bills & Promissory notes

Both commercial bills & promissory notes are also become popular within the business world through which borrower receives funds less than the face value, with the face value paid in maturity. Factoring & invoice discounting Factoring - Formal arrangement of handing over the debtors administration to third party. Invoice discounting - Sell the debtor/invoice and receives the discounted value of money. Pledging receivables - Pledge the debtor balances as a security to obtain finance facilities. Inventory loans or floor - Plan finance Obtain finance facility by pledging inventory as a security. Floor plan finance, involvement of three parties; the lender, the manufacture and the borrower.

Sources of Long - term debt finance

In addition to the various types of short term funding/finance mode discussed above, following long-term debt finance modes are also become popular within the business world.

Fixed rate business loans Variable rate business loans Installment loans Interest - only loans Fully drawn advances Leasing

In addition to above, following mode of finance also could be seen in the business world.

Corporate bonds Floating rate notes Debentures & unsecured notes

Hybrid Finance A Mode of finance which has characteristics of both debt & equity.

Convertible notes / debentures Convertible Preference Shares

Equity Finance Very popular strong mode of financing available for the entity. This could work either issuing ordinary shares or preference shares or both. In addition to above, entities tend to use rights issue and options also as a mode of financing.

International Sources of Funding

International sources of funding occur when foreign investor make investments in the entity (within the local country). Both Direct & Portfolio investment could be seen in the practice.