Working capital management – A case study of Ha Phong Export Garment Joint Stock company

NGUYEN VAN CHUONG UNDERGRADUATE THESIS TOPIC: WORKING CAPITAL MANAGEMENT: A CASE STUDY OF HA PHONG EXPORT GARMENT JOINT STOCK COMPANY Supervisor : Assoc.. WORKING CAPITAL MANAGEMENT: A

NGUYEN VAN CHUONG

UNDERGRADUATE THESIS

TOPIC:

WORKING CAPITAL MANAGEMENT: A CASE STUDY OF

HA PHONG EXPORT GARMENT JOINT STOCK COMPANY

Supervisor : Assoc Prof PhD Nguyen Thi Ha

WORKING CAPITAL MANAGEMENT: A CASE STUDY OF

HA PHONG EXPORT GARMENT JOINT STOCK COMPANY

Major : Corporate Finance

Supervisor : Assoc Prof PhD Nguyen Thi Ha

I hereby declare that this thesis is my own work and effort It has notbeen submitted anywhere for an award Where other sources of informationhave been used, they have been acknowledged

Graduation thesis author

Nguyen Van Chuong

Date: May 27th

I would like to express my deep gratitude to all those who have given

me the possibility to complete this graduation thesis In preparing thisgraduation thesis, I have had generous and advice from my teachers, mycolleagues, my family and my friends I would like to express my great thanks

to all of them

First of all, I would like to express my deepest gratitude to mysupervissor, Assoc.Prof PhD Nguyen Thi Ha, lecturer of Academy ofFinance, who has given immeasurable help, constant guidance with manycareful instructions, comments and valuable advice to me whenever I need.Without her support, I would not be able to complete my thesis And I reallyappreciate her patience in reading and correcting my thesis

Second, I wish to show my sincere thanks to all my teachers atAcademy of Finance, who have provided me with worthy lessons thoughoutfour years of study

Moreover, I would like to thank Chief accountant - Mr.Nguyen ThanhThuy, General accountant- Mrs Nguyen Thi Lan and the staffs of Ha PhongExport Garment Joint Stock company for their valuable supports during theinternship period Without their helps, it would be impossible for me to finishthis work

Last but not least, I would like to send my love thanks to my family,friends and classmates for their great love and care in both spirit and healthduring preparation for the graduation thesis

TABLE OF CONTENTS

DECLARATION i

ACKNOWLEDGEMENT ii

Table of contents iii

LIST OF ABBREVIATIONS vi

ABSTRACT vii

INTRODUCTION 2

CHAPTER 1: THEORETICAL BACKGROUND OF WORKING CAPITAL AND WORKING CAPITAL MANAGEMENT 5

1.1 Working capital and the sources of working capital 5

1.1.1 Definition and characteristics of working capital 5

1.1.2 Classification of working capital 7

1.1.3 Working capital policies 8

1.2 Working capital management of business 12

1.2.1 Definition and objectives of working capital management 12

1.2.2 The content of working capital management 13

1.2.2.1 Determining working capital requirements and organizing working capital sources 14

1.2.2.2 The allocation of working capital 18

1.2.2.3 Cash management 20

1.2.2.4 Receivables management 21

1.2.2.5 Inventory management 23

1.2.3 Measurement for working capital management efficiency 34

1.2.4 Factors affecting working capital management efficiency 40

CHAPTER 2: CURRENT SITUATION OF WORKING CAPITAL MANAGEMENT AT HA PHONG EXPORT GARMENT JOINT STOCK COMPANY 44

2.1 Overview of Ha Phong Export Garment Joint Stock Company 44

2.1.1 Foundation and development 44

2.1.2 Characteristics of business operations 46

2.1.3 An overview of financial situation 57

2.2 CURRENT SITUATION OF WORKING CAPITAL MANAGEMENT AT HA PHONG EXPORT GARMENT JOINT STOCK COMPANY 72

2.2.1 The situation and allocation of working capital 72

2.2.2 The situation of working capital financing policies 77

2.2.3 The situation of determining working capital requirements 83

2.2.4 Cash management 83

2.2.5 Receivables management 91

2.2.6 Inventory management 102

2.2.7 The situation of productivity and efficiency of working capital management 108

2.3 Discussion about the management of working capital 111

2.3.1 Achievements 111

2.3.2 Shortcomings and reasons 113

CHAPTER 3: SOME SOLUTIONS TO IMPROVE EFFICIENCY OF WORKING CAPITAL MANAGEMENT AT HA PHONG EXPORT GARMENT JSC 117

3.1 Orientations and objectives for future development at Ha Phong Export Garment JSC 117

3.1.1 Economic-Social context 117

3.1.2 Orientations and objectives for the future development of Ha Phong Export Garment Joint Stock company 120

3.2 Some solutions to improve working capital management at Ha PhongExport Garment Joint stock company 1223.2.1 Improving the efficiency of the use of funding sources, alwaysensuring solvency 1223.2.2 Determining the demands of working capital reasonably 1233.2.3 Determining a reasonable level of cash reserves and speed up therotation of cash 1293.2.4 Improving the efficiency of inventory management 1303.2.5 Improving the efficiency of receivables management 1313.2.6 Strengthening the management and improvement of personnelorganization 1323.2.7 Improving the management of cost 1333.2.8 Improving the rotation of working capital by promoting access tonew technologies in manufacturing 1333.3 The conditions for implementing the measures 133CONCLUSION 135REFERENCE

APPENDICICES

`

LIST OF ABBREVIATIONS

LIST OF TABLES

TABLE 2.1 : CHARACTERISTICS OF LABORS OF THE COMPANY ONMARCH 1ST ,2019 57TABLE 2.2: THE CAPITAL AT HA PHONG EXPORT GARMENT JSC

IN THE PERIOD FROM 2017 TO 2018 59TABLE 2.3: THE CAPITAL SOURCES AT HA PHONG EXPORTGARMENT JSC IN THE 62PERIOD FROM 2017 TO 2018 62TABLE 2.4: INCOME STATEMENT IN 2017 AND 2018 64TABLE 2.5: SOME OF MAIN FINANCIAL INDICATORS IN 2017 AND2018 68TABLE 2.6: THE ALLOCATION OF WORKING CAPITAL IN STAGE OF2017-2018 74TABLE 2.7: THE FLUCTUATION OF PERMANENT WORKINGCAPITAL IN 2018 78TABLE 2.8: THE FLUCTUATION OF TEMPORARY WORKINGCAPITAL IN 2018 80TABLE 2.9: DETAIL SITUATION OF CASH AND CASH QUIVALENTS

IN THE STAGE OF 2017-2018 85TABLE 2.10: LIQUIDITY RATIOS IN 2017 AND 2018 87TABLE 2.11: INDICATORS ABOUT THE SPEED OF CONVERSIONINTO CASH IN 2017-2018 90TABLE 2.12: DETAIL OF ACCOUNT RECEIVABLES IN THE STAGE

OF 2017 AND 2018 92TABLE 2.13: THE EFFICIENCY OF ACCOUNT RECEIVABLES

TABLE 2.14: THE SITUATION OF PAYABLES AND RECEIVABLES IN2018 99TABLE 2.15: INVENTORY STRUCTURE IN THE STAGE OF 2017 AND2018 103TABLE 2.16: THE EFFICIENCY OF USE INVENTORY IN THE STAGE

2017 AND 2018 107TABLE 2.17: SOME OF INDICATORS ABOUT THE SITUATION OFWORKING CAPITAL MANAGEMENT IN 2017-2018 109

LIST OF EXHIBITS, DIAGRAMS AND CHARTS

EXHIBIT 1.1: WORKING CAPITAL POLICIES 9

EXHIBIT 1.2: MODERATE FINANCING POLICY 10

EXHIBIT 1.3: AGGRESSIVE FINANCING POLICY 11

EXHIBIT 1.4: CONSERVATIVE FINANCING POLICY 12

EXHIBIT 1.5: COSTS OF HOLDING CASH 21

EXHIBIT 1.6: THE MILLER – ORR MODEL 23

EXHIBIT 1.7: TYPICAL INVENTORY CYCLE 28

EXHIBIT 1.8: EOQ AND INVENTORY COST 29

EXHIBIT 1.9: INVENTORY ABC CLASSIFICATION 31

EXHIBIT 1.10: JIT COST CURVES 33

DIAGRAM 2.1: COMPANY STRUCTURE 47

DIAGRAM 2.2 : ACCOUNTING APPARATUS OF THE COMPANY 50

DIAGRAM 2.3: TECHNICAL PRODUCTION PROCESS 53

CHART 2.1: COMPARING WORKING CAPITAL WITH FIXED CAPITAL AND TOTAL CAPITAL 72

CHART 2.2: THE STRUCTURE OF WORKING CAPITAL IN 2017-2018 75

CHART 2.3: THE FLUCTUATION OF RECEIVABLES 93

CHART 2.4: THE CHANGE IN ACCOUNTS IN 2017 AND 2018 101

CHART 2.5: THE CHANGE IN INVENTORY STRUCTURE IN THE STAGE OF 2017 AND 2018 104

This study investigated the factual state of working capital managementefficiency at Ha Phong Export Garment Joint Stock Company from theviewpoint of a fourth year student of Faculty of Corporate Finance, Academy

of Finance The paper aims at finding out the drawbacks in the company’sworking capital management and the reasons, and more importantlysuggesting main methods to improve the efficiency of working capitalmanagement in the company In achieving these aims, the graduation papersurveys the current situation of working capital management and assess thatwhether it is effective or not From received results, the study argues the mostpractical implications at Ha Phong Export Garment Joint Stock Company toimprove the efficiency of working capital of the company in the year to come

1 Rationale of the study

Currently, in the context of international economic intergration,Vietnam is promoting the development of market economy With the strongpromotion of start-up spirit from government, many firms with different types

of ownership have been formed, and the number of enterprises is increasing

It has created unwittingly the intense competition of businesses It forcescompanies to try to improve their manufacturing operation To perform theseactivities, every enterprise also needs to have its resources Because of thelimitation of sources, every decision in producing and using of economicagent make certain that resources are fully used and used efficiently.Internally, capital is a prerequisite which decides to the manufacturingprocess of firms Especially, with firms in the manufacturing sector, workingcapital is more necessary and realistic moral

Working capital has an important role in the financial structure offirms, it directly effects the efficiency and risk operation of firms Workingcapital not only help firms to seize business chance and to create competitiveadvantages, but also ensure that the process of manufacture is performedregularly and continuously Although firms have different sizes and differentaspect operation, working capital is always the most important part ofbusiness operation Nowadays, the integration trend of the Vietnameseeconomy in particular and internationally in general has placed Vietnameseenterprises facing to enormous challenges Market pressures, productioncosts, the violent competitiveness with many countries such as China,Bangladesh, Campuchia, Malaysia, Indonesia require businesses to payspecial attention to the management of their production and business capital

competitiveness in the market Therefore, after a period of practice andresearch at Ha Phong Export Garment Joint Stock Company, I realized thatthe company is one of the enterprises that has captured the socialdevelopment trend in the field of business, production and processing ofexport garments Businesses in the same industry are growing and affirmingtheir position in the market, competition takes place more and more fiercely,prices of inputs increase Besides, businesses operate in the field of importand export, the manufacturing enterprises in the industry constantly invest inmodern technology and equipment to use the most effective inputs In thefuture, the competition is growing more and more when foreign companies inall industries join in Vietnam This fact shows that Vietnamese enterpriseshave no other way to improve their own business efficiency by manysolutions, which promote the management of working capital placed on top.

To be aware of the importance of working capital and to be inspired ofthe necessity of effectively managing working capital of during training time

at Ha Phong Export Garment Joint Stock company, as well as based onknowledge and practical experiences I got during the internship, I’m going to

choose the topic: “Working capital management – A case study of Ha

Phong Export Garment Joint Stock company” as my graduate thesis title

2 Aims of the study

The aims of the study is to examine, analyze, and evaluate theefficiency of working capital management at Ha Phong Export Garment JSC.Then, based on the company’s achievements and limitations, suggestingpositive measures to stabilize, strengthen position and recommend somesolutions for improving the efficiency of working capital management at thecompany

3 Object and scope of the study

 Object: This topic learns in depth issues involved with working capitaland working capital management, in order to suggest solutions toimprove working capital management of firms.

working capital management of Ha Phong Export Garment JSC

 Source of information: The number is collected and analysed in financialstatements from 2017 to 2018 of the company

4 Methods of study

Based on knowledge at university, books and self-accumulation and toachieve these above objectives, several methods of studying the thesis are asfollows:

- Data collection: From website of the company, books, magazines andinternal information of the corporation

- Inductive, deductive and statistical method

- Figure comparison, data evaluation, judgement and conclusion

- Method of analyzing, summarizing, synthesizing materials and booksfrom the theoretical background

5 Organization of the study

Besides the contents, introduction, conclusion and references, the thesisconsists of 3 chapters:

* Chapter 1: Theoretical background of working capital and

working capital management.

* Chapter 2: Current situation of working capital management at

ha phong export garment joint stock company.

* Chapter 3: Some solutions to improve efficiency of working capital management at ha phong export garment joint stock company.

CHAPTER 1 : THEORETICAL BACKGROUND OF WORKING CAPITAL

AND WORKING CAPITAL MANAGEMENT

1.1 WORKING CAPITAL AND THE SOURCES OF WORKING CAPITAL

1.1.1 Definition and characteristics of working capital

1.1.1.1 Definition

Working capital is a part of capital, with commercial businesses, it islabour object of a company Firm uses WC to purchase reserve goods formoving process and tools for supporting this process carried regularly andcontinuously It is a direct capital part to generate revenue for a firm

Working capital may be defined by various authors as follows

According to Weston & Brigham: “Working capital refers to a firm’s

investment in short term assets, such as cash amounts receivables, inventories etc” (1)

J.S.Mill also acknowledged: “The sum of the current assets is the

working capital of the business” (2)

Last but not least, the accounting principles of board of AmericanInstitute of Certified Public Accountants has defined the working capital as

under:

“Working capital( WC ) is represented by the excess of current assets

or current liabilities and identifies the relatively liquid portion of the total enterprise capital which constitutes a margin or buffer for maturing obligations within the ordinary operating cycle of the business”

Thus, we can understand that, working capital is an advanced amount

of money that a firm spend to establish necessary, regular current assets formanufacturing operation Working capital is the amount a firm invests inshort-term or current assets that required for day-to-day operation

1.1.1.2 Characteristics of working capital

When joining in manufacturing business operation, working capitalincessantly changes morphological expression From the form of money todifferent forms and when finishing product consumption process, workingcapital comes back to the first form that is capital in cash

The movement of working capital through stage is described asfollows:

progress and finished goods

Work-in-Cash & Cash equivalent

This movement of working capital is called “capital circulation”

When joining in manufacturing business operation, since dominated bythe characteristic of current assets, working capital has followingcharacteristics:

- Working capital in the rotation process always changes the forms of

expression

- Working capital transfers all the values right in a time and get a full

refund after each business cycle

- Working capital completes a circuit after a business cycle.

- Working capital is very liquid for it can be converted as cash any timewithout losing anything

- Investments in current assets such as working capital come with lessrisk for it is just for short term.

Since these characteristics of working capital, so that, working capitalmanagement method is on quota, it means working capital quota for eachproduct unit, capital quota for each cycle of manufacturing businessoperation However, in market economy, it is usually difficult to determineworking capital requirement towards each cycle of manufacturing businessoperation Therefore, we usually base on important target: most economical ofworking capital

1.1.2 Classification of working capital

1.1.2.1 According to expression patterns and the possibility of capital swaps

 Capital in cash and receivables:

- Cash: includes cash on hand, bank deposits and cash in transit

- Accounts receivables: includes mainly accounts receivables andadvance payments

 Capital in materials and goods: includes materials, work inprogress, semi-finished products and finished products

This classification helps the business assess the level of inventoryreserves, the solvency and liquidity of the investment assets in enterprise

1.1.2.2 Based on the role of working capital in the production process

 Working capital in the reserved state includes the types of capitalsuch as material capital, additive material capital fuel capital, tool &instruments,…

 Working capital in the production process includes types of capital,such as: goods in process, homemade end-product, prepare items…

 Working capital in circulation includes finished product, cash,short-term investment and the capital during the payment process

This classification shows the role of each type of WC in the process ofproduction and business, from which to choose appropriate structure ofcapital to invest, ensuring the balance of production capacity among stages inthe process of production and business of enterprises

1.1.3 Working capital policies

Working capital management has two main decisions at twoconservative stages: Level of current assets (how much to invest in currentassets to achieve the objective) and financing current assets (how should theabove current assets investment be financed)

1.1.3.1 Working capital investment policies

- Relaxed policy refers to a flexible one that involves in maintaining alarge amount of cash, holding a high level of inventory and allowing agenerous customer credit terms for a given level of sale The greatinvestments in WC can reduce the risk in business but also results in lowerprofitability

- Aggressive policy is associated with low cash, inventory levels andrestrictive credit terms for a given level of sale Less cash and investment ininventory, meaning less money tired up in WC, this may help firms toincrease profitability Employing this policy can increase the risk of cashshortage for operation and the likelihood of inventory running out is alsoincreased

- Moderate policy is somewhat in the middle of relaxed and aggressiveone

Exhibit 1.1: Working capital policies

Within the three above approaches, no policy is the best for a firmbecause there are no absolute benchmarks These are primarily used inanalyzing ways that a company approaches operational problems of workingcapital management

1.1.3.2 Working capital financing policy

The management of WC financing concerns with decisions of choosing

an appropriate mixture of fund sources to invest in short term assets Thereare major fators needed to be taken into account when deciding the relevantsources to finance the right level of investment in WC, those are: Costassociated with the capital sources and risk of the finance There are threetypes of assets that need to be financed:

- Non current assets (NCA): Called fixed assets, are long-term assetsthat are used to derive benefit over several periods

- Permanent current assets (PCA): Are the minimum levels of CA firmsneed to hold to sustain normal levels of business

Short-term finance

Long-term finance

FCA

PCA

NCA

Time

- Fluctuation current assets (FCA): Or temporary current assets present

an extra amount invested in CA arose from normal business activities Theseassets are seasonal and increased due to temporary demand

There are three funding policy for working capital:

- Moderate financing policy: The maturity of structure of the financematches the maturity of the asset According to this principle, fluctuation CAare financed through short-term funds whereas permanent CA and non-current assets are financed with long –term sources

Exhibit 1.2: Moderate financing policy

- Aggressive financing policy: This approach uses short-term sources tofinance not only fluctuation CA but also a part of permanent CA All of NCAand a part of PCA are financed by long-term sources Using this fundingpolicy can increase the profitability of firms However, it entails more risksassociated with solvency

$

Short-term finance

Long-term finance

Exhibit 1.3: Aggressive financing policy

- Conservative financing policy: Is a lower risk approach In which,long-term sources are used to finance not only long-term assets andpermanents CA but also a part of fluctuation CA This can reduce the reliance

on short-term funds or reduce the frequency need of refinance to supportpermanent and fluctuation CA, resulting in lower level of risk that related tothe ability to pay back the obligation However, long-term funds are moreexpensive and consequently higher cost of financing and therefore, reducingprofitability

Long-term finance

Exhibit 1.4: Conservative financing policy

Each financing policy brings both advantages and disadvantages.Firms’ managers have to decide the balance between long-term and short-term finance based on the trade off between risk and profitability Managersshould take other important factors such as the variability of sales and cashflows into account in order to choose a suitable financing policy that canmaximize the firms’ owner wealth

1.2 WORKING CAPITAL MANAGEMENT OF BUSINESS

1.2.1 Definition and objectives of working capital management

1.2.1.1 Definition

In market economy condition, its mechanism sets up the requirements

of management and organization, which requires enterprises to findthemselves exists and grows direction To snap up bargain and overcome thechallenge, to keep firm’s foothold in the competition, firms need to makeright decision about creating and managing manufacturing business capital ingeneral and working capital in particular most efficiency and to make profitfor firms

According to Corporate Finance Syllabus, Academy of Finance,

copyright © 2014, page 208: “Working capital management is the process of

managing and monitoring activities related to working capital”

1.2.1.2 Objectives of working capital management

 First, effectively manage the day-to-day activities of the business to

firstly improve the firm’s profitability

The timely and sufficient mobilization of capital, savings on usingcapital help firms to seize business opportunity, increase revenues and profitsfor corporation Choosing the right form and method of mobilizing capital canhelp firms to decrease the cost of capital, contribute to increase profits andROE for firms On the other hand, with maximum mobilizing of amount WCfor manufacturing business operation can help firms to avoid loss by blockedfunds, increase inventory turnover, receivables, which contribute to grow upprofits after tax for firms

 Second, ensure the firm has sufficient liquidity to meet its term obligations

short-Working capital is prerequisite for business’s operation In operationprocess, firms frequently have the requirements of working capital for regularoperation like developing corporations If a enterprise doesn’t mobilize timelyand enough capitial, firm’s operation will be difficulty and not carry out Sothat, ensuring the operation of the business to jog on regularly andcontinuously depends more on the mobilization of capital of firms

1.2.2 The content of working capital management

1.2.2.1 Determining working capital requirements and organizing working capital sources

a Methods of determining working capital requirements

Working capital requirements of firms consists of 2 types: Regularnecessary WC requirement and short-term WC requirement (not regularly).Short-term working capital requirements is necessary minimum amount ofworking capital which ensure business operations of the company normallytake place in a short period of time This needs of firm is only determinedwhen a firm make a financial plan With other situations, firms onlydetermine regular necessary working capital requirements

Demand for regular necessary working capital is amount of working

capital needs to ensure that manufacturing business operation of firms iscarried out normally and continuously Under this amount, manufacturingbusiness operation will be difficult and even stagnation and disruption But ifover this amount, capital will be stagnant, wasted and ineffective usage

With this conception, working capital requirements is determined by formula:

WCR = Inventories + Accounts receivables – Accounts payables to supplier.

Internally, inventories are minimum amount of capital needed toreserve materials, work in progress, semi-finished goods and finished goods

of the company

Working capital requirements is affected by many factors such as:nature of business; size of business; manufacturing cost; market conditions;other factors (transport facilities, changes in price level, the credit standing ofthe company,…) The true determination of factors effecting will helpbusiness to determine accurately WCR and have methods to manage, use WC

To determine WCR, we can use direct method and indirect method:

i Direct method

To determine directly the demand for working capital for inventories,receivables, accounts payable to suppliers and then aggregate them into totalworking capital demands of enterprises

WCR = Receivables from customers + Inventory – Payable to suppliers

In which:

Receivables = Average daily revenues x Days of sales outstanding

Inventory = The average daily amount of

consumption for capital

rotation period

Or WCR = Mn x N

Internally:

 Mn is the average daily amount of consumption for capital

 N is working capital rotation period

 Advantages: it clearly reflects the demand of working capital foreach type of material and good in each stage of business It can evaluateexactly the capital needs of enterprises

 Disadvantage: complex calculation, take more time to determineworking capital requirements

i Indirect method

This method is based on the analysis of the actual working capital use

of the company in the reporting year, the change in business size, the rotationspeed of working capital in the plan year or the fluctuation of working capital

demand according to the turnover of reporting year to determine the workingcapital demand of the company in the plan year There are some of methods:

- Using adjusted rate of WC requirements:

Essentially, this method is based on the practice of the demand of WC

in this year to adjust according to the size of business and WC turnover innext year

- Percentage of Sales Method:

It is the easiest of the methods for calculating the WCR of thecompany This method is based on the principle of ‘history repeats itself’ It is

a financial planning method based on the premise that predicted sales are thedriven, and most of the financial variables on the balance sheet and incomestatement are functions of the forecasted sales

 Advantages: This method is a simple prediction, not count tochanges in factors in future that will change the ratio of WC to turnover, sothis method is more suitable for forecasting WC

 Disadvantage: When using this method, requires operator tounderstand the business characteristics of the company and must understandthe rules of the relationship between revenue to assets, resources andappropriation of profits of enterprises

- Operating Cycle Method:

This is probably best of the methods because it takes into account theactual business or industry situation into consideration while giving anestimate of working capital The longer the working capital operating cycle,the higher would be the demand of WC and vice versa Following formulacan be used to estimate or calculate the working capital:

Working Capital Demand = WC turnover in next year Net revenue

 Advantages: this method is simple It can help firm to evaluateinstantly working capital requirements for planing year, so as to determineresonable soures

 Disadvantages: the result of this method isn’t high exactly

b The working capital financing:

The organisation and assurance of WC of enterprises is based on thebalance between assets and capital throughout finacial modeling of company:

- Model 1: When CA exceed CL , it means net working capital is

positive There will be a stability in the business operations of a companybecause there is a part of NWC to sponsor current assets to use for businessoperations

- Model 2: If CL exceed CA, net working capital is negative It is said

that the company may have problems meeting its short-term obligations Thenthe business may not have sufficient funds available to pay for its currentliabilities, and may be in danger of bankruptcy However, with trading field,this clay model still incur because this field has quick rotation capital

Current liabilitiesCurrent assets

resourcesNon-current assets

- Model 3: If CA are equal to CL, a company is just able to cover all of

its short-term obligations This clay model doesn’t make sure stable inmanufacturing business operations of company, especially the industry ofslow rotation capital

1.2.2.2 The allocation of working capital

Working capital is a necessary condition for ensuring normal andcontinuous business operations Therefore, the organization of reasonable WCstructure is a great significance for enterprises, basis of the efficiency of WCusage, and foundation for the development of each enterprise Enterprises useworking capital effectively when they allocate WC in each stage: the purchase

Current assets

Non-current assets

Current liabilities

Permanent resources

NWC < 0Non-current assets

Permanent resources

NWC = 0

of reserved materials, production and consumption of products in a reasonableway Resonable allocation increases the rotation of capital from one type toanother types, from one form to another forms, contributing to shorten thecycle of working capital, improving production efficiency of enterprises.

Because of the difference of business characteristics, WC structure isalso different for each business Therefore, the analysis of WC structure isnecessary It helps us to see the situation of WC allocation and the proportion

of each capital in each rotation stage, thus identifying the key of workingcapital, finding the method of efficient WC usage in each specific conditionand in each firm Thereby, contributing to raising the efficiency of productionand business of enterprises

 Some of factors affecting to structure of working capital:

- Factors about supplies, reserved materials, finished goods: The

distance between enterprises and suppliers of materials; possibility ofproviding of market; delivery period and volume of materials supplied; thedistance of business and consumption market;…

- The factors about manufacturing: Characteristics of technique;

complexity of manufactured products; the level of organization andproduction management of enterprise

- The factors about payment: Factors about withdrawing money of

goods sold such as resonable payment method, payment procedures,…; theimplementation of payment discipline among units, implementation ofpayment contracts, choice of the form of payment also affect the structure ofworking capital

Moreover, structure of WC is also affected by the characteristics ofseason production, the level of organization and management In each stage,depending on firm’s abilities and conditions, each firm will choose itself

resonable structure to make sure that manufacturing business operation is themost efficient

1.2.2.3 Cash management

Cash is the most important current asset and is considered as the

“lifeblood” of a business, helping the business running in a continuous basic.The term cash includes currency, checks and balance in back accounts

According to Keynes, there are three motives for holding cash:

- Firstly, cash is needed for transactional motive In other words,companies need to hold certain level of cash to pay bills The collection cash

is from selling products and sevices, selling assets and from new financing

- Secondary, the precautionary motive is the need to hold cash forsafety margin to act as a financial reserve

- Thirdly, with the speculative motive, cash is hold with the purpose oftaking advantages of attractive investment opportunities that may rise, forexample, investments with high interest rate or favorable exchange ratefluctuation

 The management of cash concerns with three important aspects:

- Firstly, determining the target cash balance: The firm has to find an

optimal holding cash balance to maximize the interest earned on funds thatare not immediately needed and reduces the cost associated with the delays intransmission of funds Holding a small amount of cash can increase theopportunity to invest the excess cash with a good return but it also increasesthe risk of insolvency, financial distress and thus bankruptcy When decidingthe relevant cash holding levels, it is necessary to concern with liquidity andrisk of insolvency In addition, the cost of transaction is high; by contrast, the

opportunity cost is low Thus, firms need to ensure the safety when decidingthe level of cash hold

Determining the optimal cash balance is one among the most a crucialtask in cash management area So, the question is “ By the way to determinethe target cash balance? ”

William Baumol and Miller - Orr offer cash models to determine the optimalcash balance that we can use

 William Baumol’s cash model:

• Provides for Cost efficient transactional balances

• Assumes that the demand for cash can be predicted with certainty

• Determines the optimal conversion size/lot

• Focus of the model is to minimise the total cost

• Associated with cash management

• Comprising total conversion costs (that is, costs incurred each timemarketable securities are converted into cash) and the opportunity cost of keeping idle cash balances which otherwise could have been invested in marketable securities

Exhibit 1.5: Costs of Holding Cash

 William Baumol developed a cash model to determine the optimumamount of transaction cash under conditions of certainty The optimal level ofcash is determined using the following formula:

ECL = √2 CF O

In which:

ECL = Economic Conversion lot or Optimum Cash Balance

C = Cost per conversion

F = Projected cash requirements during the planning period

O= interest rate per planning period on investment in marketable securities

 Miller – Orr’s cash model:

• Provides for cost-efficient transactional balances

• assumes uncertain cash flows

• determines an upper limit and return point for cash balances

• Objective of Model is to determine the optimum cash balance level which minimises the cost of cash management.

 To use the Miller-Orr model, the manager must do four things:

• Set the lower control limit for the cash balance

• Estimate the standard deviation of daily cash flows

• Determine the interest rate

• Estimate the trading costs of buying and selling securities

 The firm allows its cash balance to wander randomly between upper and lower control limits

Exhibit 1.6: The Miller – Orr Model

 You can use a stochastic model for cash management where

uncertainty exists for cash payments The Miller-Orr model places an upper and lower limit for cash balances When the upper limit is reached, a transfer of cash to marketable securities is made When the lower limit is reached, a transfer from securities to cash occurs A transaction will not occur as long as the cash balance falls within the limits

 Determining optimal cash balance under conditions of uncertainty:

b = fixed cost per order for converting marketable securities into cash.

i = daily interest rate earned on marketable securities

 2 = variance of daily changes in the expected cash balance

LL = the lower control limit

UL = the upper control limit

- Secondary, controlling the collections and disbursements of cash: The

objective of the managing is to speed up the collections and slow down thedisbursements of cash Firms aim at maximizing the cash receipts by reducingthe time it takes customers to pay their bills and the time money is collected.They can delay the payment by keeping cash to put in the bank or investing infinancial market as long as possible

- Thirdly, the cash budget that involves the forecasts of the cash

receipts and payments for the next planning period, is used to improve themonitor of all cash flows, estimate the cash needs for business and anticipatecash surpluses or deficits

 The goal of cash management is (1) to maintain an adequate level

of cash on hand to meet the daily cash requirement in operation and (2)maximize the amount of money that are available for investments and obtainthe maximum of interest earned on excess cash while ensuring the safety

The optimal cash balance depends on the following factors:

 The forecasts of future cash inflows and outflows of companies

 The efficiency of the firm’s cash flow management

 The availability of liquidity assets to the firms

 The company’s borrowing capacity

 The company’s tolerance of risk

1.2.2.4 Receivables management

Account receivables represents the amount of money that customersowed the firm on their purchases of the firm’s goods or services Everycompany wants to buy low and sell high But it can lose everything with poorreceivables management during the last phase of the sales process (payment).Over half of all bankruptcies can be attributed to poor receivablesmanagement, which demonstrates its importance

In order to manage efficiently account receivables, when formulatingthe company policy on credit sales, a firm has to pay attention to the decisionsinvolved the following components of credit policy:

- Term of sale: refers to the conditions that a firm establishes for selling

products and services on credit The term of sale are consist of three elements:

 The credit period: is the length of time for which credit is extend.

 The cash discount and the discount period: is the time that discount

is allowed It is an expensive source of financing for the firm

 The type of credit instruments: refers to documents that evidence adebt

- Credit Analysis: aims at making a judgment about customer’s ability

to pay back their owes and deciding whether or not to extend credit toparticular customers

Firms need to gather relevant information and then determine the creditworthiness of customers through credit information ( the customer’ financialstatements; credit reports on customers’ payment history with other firms;banks; the customers’ payment history with the firm ) and credit evalutationand scoring ( character; capacity; capital; collateral; conditions )

- Collection policy: Involves monitoring account receivables It is used

with the purpose of collecting receivables on time ad to deal with past-dueaccounts There are several produres employed to collect overdue amount andreduce bad debts

 Monitoring account receivables: Is after establishing a credit policy

A firm must monitor its accounts receivables It is aimed to analyze whetherits credit policy is working effectively or not; and to keep an eye on thecustomers’ payment to spot over-due problems

Two tools that firms use to monitor the accounts receivables are theDays Sale Outstanding (DSO) (or average collection period) and the agingschedule

Days Sale Outstanding (DSO)= (Receivables) / (Average Sales Per Day)

The “accounts receivable days” are the average number of days that ittakes a firm to collect on its sales A firm can compare this number to the

payment policy specified in its credit terms to judge the effectiveness of itscredit policy

 Aging schedule: An aging schedule categorizes accounts by thenumber of days they have been on the firm’s books It can be prepared usingeither the number of accounts or the dollar amount of the accounts receivableoutstanding All accounts or customer’ debts are classified based on thelength of time the amounts have been past due and the relative proportion ofthese accounts to total value of accounts receivable are presented

After knowing the status quo of the account receivable, firms decidethe method for collecting over-due amounts

1.2.2.5 Inventory management

Like receivables, inventories represent a significant investment formany firms For a typical manufacturing operation, inventories often exceed15% of assets For a retailer, inventories could represent more than 25% ofassets Despite how size of a typical firm's investment in inventories, thefinancial manager of a firm will not normally have primary control overinventory management Instead, other functional areas such as purchasing,production, and marketing will usually share decision making authorityregarding inventory Inventory management has become an increasinglyimportant specialty in its own right

Inventory management is a humungous task for all the businesscorporations For those into manufacturing and retailing, inventorymanagement is that vital business function that determinestheir survival, profitability, and competitiveness in the market There havebeen devised numerous techniques and software that claim to provide aperfect plan to effectively and efficiently manage this area

Managing inventory is a delicate balancing act It requires theorganisation to maintain a fine balance between maintaining optimuminventory levels always and avoiding ‘Stock out’ situations on one hand andavoiding investing too much of capital in a stock on the other hand, whichmay entail heavy carrying costs of warehouse rentals and potential dangers ofdamages and obsolescence resulting into heavy losses for the business.

Hence, many techniques have proved useful for the managers incalculating optimum inventory levels and managing them throughout all thephases of business cycles and accounting periods Here, we will discuss somemodels of Inventory management

 Inventory management model

The Economic Order Quantity (EOQ) is used to calculate the optimalinventory level, at which the carrying costs and ordering costs are minimized

The model’s assumption: Firstly, inventory demand for the year iscertain and known The demand occurs at constant rate Secondly, inventoryreplacement is instantaneous, which means that there is no order lead time.Thirdly, the cost of the orderings remains constant Fourthly, the purchaseprice is constant Fifthly, the optimal plan is calculated for only one product

Exhibit 1.7: Typical Inventory Cycle

Exhibit 1.7 illustrates the inventory circle under the EOQ assumptions.There is a gradual rundown of inventory from the maximum inventory level Q

to zero stock With the assumption of instantaneous inventory replacement, atthe time that inventory level reaches zero, the inventory level is instantlyfulfilled to the maximum level However, if the firm reduces the total ordercosts by decreasing the number of ordering per period, it has to increase thequantity per order to respond to the inventory need in its business This result

in the level inventory held increase and obviously the total carrying costincrease