LV Thạc sỹ_Enhancing working capital management in Lan Lan company

18 2.2.4.1 Factors influence the needs of working capital in business...18 2.2.4.2 Understanding working capital demand in business...20 2.3 Working capital management theory...20 2.3.1

CONTENTS

LIST OF TABLES 2

LIST OF FIGURES 3

ABBREVIATION 4

ACKNOWLEGEMENT 5

ABSTRACT 6

CHAPTER I INTRODUCTION 9

1.1 Rationale 9

1.2 Research objectives 10

1.3 Research methodology 10

1.4 Research scope 10

CHAPTER II: FUNDAMENTAL FRAMEWORK FOR WORKING CAPITAL MANAGEMENT 11

2.1 Overview of Operating capital in enterprises 11

2.1.1 Definition and characteristic of operating capital 11 2.1.2 Classification of operating capital in enterprises 12 2.1.2.1 Fixed capital 12

2.1.2.2 Financial investment capital 13

2.1.2.3 Working capital 13

2.2 Introduction of working capital in enterprises 14

2.2.1 Definition of working capital 14 2.2.2 The role of working capital in enterprises 15 2.2.3 Classification of working capital 16 2.2.3.1 Regarding the role of working capital in business process 16

2.2.3.2 Regarding to the form of presence: 17

2.2.3.3 Regarding to origin of working capital ( see the classification of operating capital) 17

2.2.4 Working capital demand and factors influence working capital needs 18 2.2.4.1 Factors influence the needs of working capital in business 18

2.2.4.2 Understanding working capital demand in business 20

2.3 Working capital management theory 20

2.3.1 Important of enhancing working capital in enterprises 20 2.3.2 Managing working capital21 2.3.2.1 Cash management 21

2.3.2.2 Inventory management 25

2.3.2.3 Receivables management 27

2.3.2.4 Payables management 29

2.3.2.5 Working capital management efficiency ratios 31

2.4 Financing of working capital 31

CHAPTER III: REAL SITUATION OF WORKING CAPITAL MANAGEMENT IN LAN LAN CO., LTD 34

3.1 Overview of Lan Lan company 34

3.1.1 Brief history and foundation of Lan Lan Co 34 3.1.2 Main function and duty of Lan Lan Co 35 3.1.3 Organization structure of Lan Lan Co., LTD 36 3.1.4 Human resource of Lan Lan company 38 3.1.5 General business activities of Lan Lan Co., LTD 38 3.1.6 Textile market characteristic and competitors in Thai Binh province40 3.2 Business performance and Financial situation of Lan Lan Co., Ltd in the period 2009 – 2011 42

3.2.1 Business results 42 3.2.2 Financial analysis (ratios) 44 3.3 Working capital management in Lan Lan company 47

3.3.1 Working capital structure of the company 47 3.3.2 Assessing managing working capital efficiency of Lan Lan company 49 3.3.2.1 Managing cash 49

3.3.2.2 Managing receivables 50

3.3.2.3 Managing inventory 52

3.3.2.4 Managing payables 53

3.3.2.5 Measure of Working capital management efficiency ratios 55

3.3.3 Working capital financing in Lan Lan company 57 CHAPTER IV: RECOMMENDATIONS FOR IMPROVING WORKING CAPITAL MANAGEMENT IN LAN LAN CO 60

4.1 Evaluating working capital management of Lan Lan company 60

4.1.1 Achievements of Lan Lan company in working capital management 60 4.1.2 Restrictions of Lan Lan company in working capital management and the reasons for those constraints 61 4.2 Recommendations for improving working capital in Lan Lan company 63

CONCLUSION 67

REFERENCE 69

APPENDIX 70

LIST OF TABLES

Table 1: Component of Working Capital 15

Table 2: Cash in and Cash out in Cash budgeting 17

Table 3: Cash budget format 18

Table 4: Working capital management efficiency ratio 26

Table 5: Human Resource of Lan Lan company 33

Table 6: Business performance results of Lan Lan company over 2009-2011 37

Table 7: Financial ratios of Lan Lan company over 2009-2011 40

Table 8: Working capital structure of Lan Lan company 42

Table 9: Structure of receivables of Lan Lan company over the year 2011 46

Table 10: Structure of inventory of Lan Lan company over the year of 2011 47

Table 11: Structure of payables of Lan Lan company 48

Table 12: Measurement of Working Capital efficiency in Lan Lan company 50

Table 13: Structure of Assets, Liability and Equity of Lan Lan company 52

Table 14: Financing sources of Lan Lan company 53

LIST OF FIGURES

Figure 1: Working Capital in manufacturing process 13

Figure 2: Organizational Structure of Lan Lan company 33

Figure 3: Manufacturing process of Lan Lan company 36

Figure 4: Profit growth of Lan Lan company 41

Figure 5: Current Assets’ components in Lan Lan company over three years now 45

Current AssetCurrent LiabilityDays Sales OutstandingDays Payables OutstandingDays Inventory OutstandingDays Working Capital

No thesis can be completed without a great deal of help and encouragement I

am exceedingly grateful to all people for giving me such huge support throughoutthree-month internship

Firstly, I would like to give my heartfelt thanks to my instructor, Assoc Prof

… – Director of International School of Management & Economics for his enthusiasticsupervision from the beginning of forming thesis’s topic until the completion Despite

of busy time schedule, he still spent a lot of time listening to my opinions whenevernecessary, contributing his comments and ideas, and correcting internship draft

I also express profound gratitude to my internship guide, Mrs …., LTD chiefaccountant She passionately oriented me to choose the internship topic, helped me tocollect all essential data, explained me what I am confused, provided me useful advice

to comprehend problems in the thesis

In addition to direct instruction from my teacher and internship guide, I highlyappreciated indirect support from Advanced Program Faculty staff, who gave me astraightway instruction, reminded me of the internship schedule, supported referencedocuments, and were always available anytime for help

My last but not least thanks from the bottom of my heart are to all of mybeloved family and friends for their care and love that inspired me all through myinternship course

Sincerely thanks again for all of your support and inspiration!

Thai Binh had been known for an agricultural and under- developed industryprovince for past years However, in accordance with the National Industrializationand Modernization policy of the whole country, Thai Binh has changed its economicstructure from pure - agricultural model to agriculture-industry orientation since1990s Industry in general, especially light industry has played the more and moreimportant role in the local economy beside the continuous - main players, agriculture.Textile that has been heavily invested recently is considered key direction in industrydeveloping policy of local province

Finding out the significantly decisive role of textile industry in the province’seconomic growth at this time, I would like to take a close look at this market by,specifically, conducting the research on a textile company in Thai Binh- Lan Lan Co.,Ltd My concentration is evaluation on how efficient the firm is operating andperforming when taking three-month internship course, then having a deeperunderstand about textile market in the province

For a manufacturing firm, one of the most vital aspects is managing inventory,cash flows and credit policy in order to well survive in the strict competition of themarket In sum, working capital management is essentially decisional to stably standand prestigious development Due to the limited time internship and the boundlessknowledge and information, this thesis will just focus on the assessment andimprovement of working capital management in Lan Lan Co., Ltd

This thesis will go through fundamental concepts related to working capital ,and some general information about the company will be revealed before directing tothe real performance of the company, in which the main issues that will be discussedclearly include: the overall business results, the financial ratio criteria, and the facts ofworking capital management By and large, the thesis will be summed up with somerealistic recommendations and solutions for efficiency of working capital, in specific,and of the firm’s performance in general The purpose is to figure out the currentproblem of the firm and somehow consult the firm to find ways to improve theirmanagement in working capital

The thesis can not avoid short- comings; therefore; constructive comments andcontributions will be highly appreciated

CHAPTER I INTRODUCTION1.1 Rationale

Every running business needs capital vitally including fixed capital andworking capital Even a business which is fully equipped with all types of fixed assetsrequired is bound to collapse without an adequate supply of raw materials forprocessing; cash to pay for wages, power and other costs; creating a stock of finishedgoods to feed the market demand regularly; and, the ability to grant credit to itscustomers All these require working capital Working capital is thus like the lifeblood

of a business The business will not be able to carry on day-to-day activities withoutthe availability of adequate working capital Having such working capital is just anecessary condition to doing business, but how to use those working capital is muchmore significant term Therefore, managing working capital always gains the top ofattention from corporate managers

As a foreign corporation operating in Vietnam for years, Lan Lan co., Ltdalways considers working capital management is key strategy to do businessproficiently The firm has deep understand the substance of working capitalmanagement in a manufacturing company where cash, inventory and accountreceivables are plays the main role in business cycle

Comprehending such vital character of working capital in manufacturing firm,this thesis has valued the reality of working capital management in Lan Lan Co., Ltd

as the outstanding and essential issue Throughout three-month-internship course at theFinance-Accounting Department of the firm, the thesis’s topic would appropriately be:

“Enhancing working capital management in Lan Lan company ” that concentrates

on two main research question:

1 What is the real situation of working capital management in Lan Lan Co., Ltd?

2 How to improve working capital management quality in Lan Lan Co., Ltd?

In order to make these question clearly, some fundamental concepts of working capitaland overall features and business performance of Lan Lan company are also revealed

1.2 Research objectives

To assess the facts of working capital management in Lan Lan company

To identify problems existing in the firm and to give some fundamentalrecommendations and solutions for solving such matters effectively

1.3 Research methodology

The thesis approaches both primary data and secondary data Primary data ismostly the analysis results and calculated financial and business ratio from the balancesheet and Income statement of the firm

Secondary data is reference documents from previous thesis and from reports,papers, websites that will be mentioned in the appendix part at the end of the thesis.Some of the qualitative and quantitative date is sessile for the firm, so thesis justapproaches them by interviewing people who are related to such information

1.4 Research scope

Due to limited time and the availability of the data supplied, the thesis will befocus on three fiscal year of Lan Lan company from 2009 to 2011, then go to analyzesome of the most outstanding problems and financial ratios

Some aspects of working capital related to fundamental concepts chapter will notgiven in the real situation of the company because of the limited resource ofinformation

The thesis will mention Lan Lan company’s situation majorly in the picture of textilemarket in Thai Binh province to have a better look at how the firm is doing business

CHAPTER II: FUNDAMENTAL FRAMEWORK FOR

WORKING CAPITAL MANAGEMENT

2.1 Overview of Operating capital in enterprises

2.1.1 Definition and characteristic of operating capital.

In order to conduct business, any firm requires capital, which is the prerequisiteand decisive to the next step of business process Firms use capital to procure theelements of business processes such as labor, material and labor equipments Throughsuch factors, goods and services are created and sold on the market, that are transferredinto the initial state of currency To ensure the survival of the business development,the revenue from consumption of products must ensure to fully cover expenses andearn interest Thus, the money invested originally not only preserved but also be

increased when doing the business The entire value of the initial in–advance amount and of the next process for the business is called capital

Capital is represented both in cash and the asset value of materials and goods of

the enterprise, which exists under physical forms and has nonphysical forms In sum, the operating capital of the enterprise is indicated by the amount of all tangible and intangible assets are invested in the business for profitable purposes In the market

economy, the real value of a corporation not only is just the sum of present workingcapital and fixed capital, but also includes the value of other interest-earning assetssuch as the geography of corporation, trade secret, credibility of the products, etc

In order to doing business, firm needs capital including initial investmentcapital and additional capital to expand business Operating capital can be financedfrom different sources: State budget, equity of ownership, retained earnings, venturecapital, valuable paper issuance, etc

 Funds from state budget: the capital that the government supply initially fornew business of SOE, State-Owned Enterprises This kind of capital tends to bereduced including the proportion and volume The SOE must proactively add capitalthemselves with other funding sources

 Equity: fund that is contributed by investors through share issuance Shares arecertificates of ownership of mainly join stock company Shareholders will bebeneficial from the dividends from the profit of the firm.

 Venture capital: the contribution proportion among investors to do business andearn profits that depending on how much capital owned The joint venture can beformed from various sources: state budget - private equity venture, state budgetbetween nations venture, private equity venture, etc Venture capital is appropriate forsmall scale company, simple dividend form

 Credit capital: the amount of capital that businesses can borrow long-term fromcommercial banks, finance companies, insurance companies and the like , or canmobilize from staff members, or self-borrowing and self-pay from foreign parties,also form corporate bonds to raise capital for business investment

Researching on content and nature of the capital help businesses choose themost appropriate capital sources and exploiting capital funding with each capacity,situation of each firm However, internal source should be utilized before fundingoutside This helps to reduce credit risk and enhance the quality of capital management

of the firm

2.1.2 Classification of operating capital in enterprises

According to the economic function, operating capital can be divided into three types:working capital, fixed capital and financial investment capital

Through manufacture process, fixed assets do not change their physical forms,but the production capacity and value diminish This is due to they depreciated

overtime There are two kinds of depreciation: tangible and intangible depreciation Tangible depreciation is related to the reduction in the using value of fixed assets Intangible depreciation is devaluation, which may be due to:

 Old fixed assets may be devalued because the new one has the same cost buthigher production capacity or since the new one has the same capacity but less costly

 Old fixed assets produce the products that are no longer suitable with the tasteand preference of consumers

Tangible fixed assets are often worn both visibly and invisibly; however; for intangiblefixed assets, invisible devaluation is major

The values represent the amount of wear and tear of fixed assets is called moneydepreciation Money depreciation is a factor of production cost and component ofproducts’ price When products are consumed, the amount of depreciation is deductedthen forms the depreciation fund

2.1.2.2 Financial investment capital

A part of capital that firms invest long-term outside for profit making is calledfinancial investment capital There are many forms of financial investment such asBuying stocks or bonds of other companies, joint venture business The purpose ofoutside financial investment is buying stocks and bonds of other companies, jointventures with business other industry The purpose of financial investment to theoutside is for profit and capital preservation For business, before going to financialinvestment decisions, firms must be very prudent in deliberating the safety andreliability of projects and having thorough understanding of the necessaryinformation, analysis and assessment of the benefits in order to choose the appropriateforms of investment

2.1.2.3 Working capital will be discussed more detail in the next chapters.

2.2 Introduction of working capital in enterprises

2.2.1 Definition of working capital

We have no unity for a definition of working capital These following are twomeanings that are in common use:

 According to Theory of Finance, Working capital is cash-presented value of the entire current assets of enterprises that obliges the demand of day-to-day business operation.

 In Accounting, Working capital (abbreviated WC) is a financial metric which represents operating liquidity available to a business, organization or other entity, including governmental entity Along with fixed assets such as plant

and equipment, working capital is considered a part of operating capital

Mentioning about Working capital, it is necessary to refer two related definitions:Gross working capital and Net working capital

 Gross working capital

The Gross Working Capital is the capital invested in the total current assets ofthe enterprises Current assets are those assets, which can be converted into cashwithin a short period, normally an accounting year

Gross Working Capital = Total Current Assets

 Net working capital (NWC): the net of current assets minus current liabilities.

That is net working capital is equal to the value of inventories (raw materials,work-in-progress, finished goods) and accounts receivable less accounts payable)

NWC = CA – CL

NWC = Inventories + Receivables – Payables

 Inventories include raw materials, work-in-progress and finished goods

 Receivables are types of receivables (customer receivables, notes receivables,interest receivables) and prepaid expense ( insurance and supply)

 Payables are types of payables (supplier payables, wages payables, bank loanspayables, interest payables, taxes payables, etc.) and unearned revenues

Net working capital is a qualitative concept It indicates the liquidity position ofthe firm and suggests the extent to which working capital needs may be financed by

permanent sources of funds Current assets should be sufficiently in excess of currentliabilities to constitute a margin or buffer for maturing obligations within the ordinaryoperating cycle of a business In order to protect their interests, short-term creditorsalways like a company to maintain current assets at a higher level than currentliabilities It is a conventional rule to maintain the level of current assets twice thelevel of current liabilities However, the quality of current assets should be considered

in determining the level of current assets vis-a –vis current liabilities A weak liquidityposition poses a threat to the solvency of the company and makes it unsafe andunsound A negative working capital means a negative liquidity and may prove to beharmful for the company’s reputation Excessive liquidity is also bad It may be due tomismanagement of current assets

Therefore prompt and timely action should be taken by management to improve andcorrect imbalances in the liquidity position of the firm

Net working capital concept also covers the question of judicious mix of term and short-term funds for financing current assets For every firm there is aminimum amount of net working capital which is permanent Therefore a portion ofthe working capital should be financed with the permanent sources of funds such asequity, share capital, debentures, long-term debt, preference share capital or retainedearnings Management must decide the extent to which current assets should befinanced with equity capital or borrowed capital

long-2.2.2 The role of working capital in enterprises

The working capital meets the short-term financialrequirements of a business enterprise It is the investment requiredfor running day-to-day business It is the result of the time lagbetween the expenditure for the purchase of raw materials and thecollection for the sales of finished products The components ofworking capital are inventories, accounts to be paid to suppliers, andpayments to be received from customers after sales Financing isneeded for receivables and inventories net of payables

The proportions of these components in the working capital changefrom time to time during the trade cycle The working capitalrequirements decide the liquidity and profitability of a firm andhence affect the financing and investing decisions Lesserrequirement of working capital leads to less need for financing andless cost of capital and hence availability of more cash forshareholders However the lesser working capital may lead to lostsales and thus may affect the profitability.

Current assets are similarly important for the financialmanager's of small and medium enterprises Further small firms arerelatively limited access to the long term markets, it mustnecessarily rely on the trade credit and short term bank loan , both

of net effect on net working capital by increased current liabilities

2.2.3 Classification of working capital

Working capital can be classified according to the role in business, the form of presence and the origin of capital.

2.2.3.1 Regarding the role of working capital in business process

This classification is considered majorly Three steps of manufacturing includesstoring, production and consumption will have the correspondent capital : capital forstoring ( capital for main material, sub material, equipments, fuels), capital forproduction (work-in-progress, semi-finished products, prepaid expense) and capital forconsumption ( finished products, cash, short-term investment, payables, receivables)

Figure 1: Working Capital in manufacturing process

2.2.3.2 Regarding to the form of presence:

 Cash and capital for payment

Cash: cash, cash equivalents, bank deposit, remitting cash, gold and preciousmetals

Capital for payment: receivables, payables, paid in advanced, etc

 Inventories: raw materials, main and sub materials, energy, equipments, in-progress products and finished products

work- Capital for prepaid expense: expenses that are huger than reality and related tomany periods of business will be allocated into the price of products They includefixed assets preparing, leasing assets, research and development expense, constructionfees, etc

2.2.3.3 Regarding to origin of working capital ( see the classification of operating capital)

Finished productsCash

Short –term investmentPayables

Receivables

 Credit loan capital

 Valuable paper issuance capital

2.2.4 Working capital demand and factors influence working capital needs.

2.2.4.1 Factors influence the needs of working capital in business

The working capital needs of a business are influenced by numerous factors.The important ones are discussed in brief as given below:

 Nature of Enterprise

The nature and the working capital requirements of an enterprise are interlinked

While a manufacturing industry has a long cycle of operation of the working capital,the same would be short in an enterprise involved in providing services

The amount required also varies as per the nature; an enterprise involved in productionwould require more working capital than a service sector enterprise

Different industry types require different levels of working capital Service industriesneed little to no inventory whereas retailers need more Depending on the retailer’sbusiness their inventory will also vary Manufacturers will probably require morebecause they need raw material stocks, work-in-progress and finished goods Retailersmay sell for cash therefore having few receivables and producers may have tradecustomers and have greater receivables

 Manufacturing/Production Policy

Each enterprise in the manufacturing sector has its own production policy, somefollow the policy of uniform production even if the demand varies from time to time,and others may follow the principle of “demand-based production” in whichproduction is based on the demand during that particular phase of time Accordingly,the working capital requirements vary for both of them

 Operating cycle

The company’s operating cycle will also determine the level of working capital.

Operating capital is the length of time between the company’s outflow on raw

materials, wages and other expenditures and the inflow of cash from the sale of goods.The operating cycle is made up of three elements:

 The inventory turnover days

 The average receivable collection days

 The average payable days

Inventory days + receivable days - payable days = operating cycle

Inventory days = Inventory / Cost of sales x 365days

Receivable days = Receivables / Sales x 365

Payable days = Payables / Cost of sales x 365

The operating cycle is important because it determines the amount of workingcapital a business needs If you can have the operating cycle you will have the workingcapital requirement of the business If the turnover period for inventories and accountsreceivable lengthen, or the payment period to accounts payable shortens, then the

operating cycle will lengthen and the investment in working capital will increase

 Operations

The requirement of working capital fluctuates for seasonal business The workingcapital needs of such businesses may increase considerably during the busy season anddecrease during the slack season Ice creams and cold drinks have a great demandduring summers, while in winters the sales are negligible

 Market Condition

If there is high competition in the chosen product category, then one shall need to offersops like credit, immediate delivery of goods etc for which the working capitalrequirement will be high Otherwise, if there is no competition or less competition inthe market then the working capital requirements will be low

 Availability of Raw Material

If raw material is readily available then one need not maintain a large stock of thesame, thereby reducing the working capital investment in raw material stock On theother hand, if raw material is not readily available then a large inventory/stock needs

to be maintained, thereby calling for substantial investment in the same

 Growth and Expansion

Growth and expansion in the volume of business result in enhancement of the workingcapital requirement As business grows and expands, it needs a larger amount of

working capital Normally, the need for increased working capital funds precedesgrowth in business activities.

 Price Level Changes

Generally, rising price level requires a higher investment in the working capital

With increasing prices, the same level of current assets needs enhanced investment

2.2.4.2 Understanding working capital demand in business

Business needs to estimate the requirement of working capital in advance forproper control and management The factors discussed above influence the quantum ofworking capital in the business The assessment of working capital requirement ismade keeping these factors in view Each constituent of working capital retains itsform for a certain period and that holding period is determined by the factors discussedabove Consequently, for correct assessment of the working capital requirement, theduration at various stages of the working capital cycle is estimated Thereafter, propervalue is assigned to the respective current assets, depending on its level of completion.The basis for assigning value to each component is given below

Table 1: Component of Working Capital

Stock of raw material

Stock in work-in-progress

Stock of finished goods

Debtors (Receivables)

Cash

Purchase cost of raw material

At cost or market value, whichever islower

Cost of productionCost of sales or sales valueWorking expense

Each constituent of the working capital is valued on the basis of valuation enumerated

above for the holding period estimated The total of all such valuation becomes the total estimated gross working capital requirement.

2.3 Working capital management theory

2.3.1 Important of enhancing working capital in enterprises.

The aim of working capital management is to achieve balance between havingsufficient working capital to ensure that the business is liquid but not too much that thelevel of working capital reduced profitability

Optimizing working capital improves cash flow, reduces debt and related interest costsand, therefore, boosts earnings

Working capital management is always a compromise between cash and profit,and between risk and reward For example, carrying a higher level of inventory is cashinefficient but does reduce the risk of stock-outs and the possibility of losing sales.Working capital management is essential for the long-term success of a business Nobusiness can survive if it cannot meet its day-to-day obligations A business musttherefore have clear policies for the management of each component of workingcapital

Management of working capital by managing the proportions of the WCM components is important to the financial health of businesses from all industries To

reduce accounts receivable, a firm may have strict collections policies and limitedsales credits to its customers This would increase cash inflow However the strictcollection policies and lesser sales credits would lead to lost sales thus reducing theprofits Maximizing account payables by having longer credits from the suppliers alsohas the chance of getting poor quality materials from supplier that would ultimatelyaffect the profitability Minimizing inventory may lead to lost sales by stock-outs Theworking capital management should aim at having balanced, optimal proportions ofthe WCM components to achieve maximum profit and cash flow

2.3.2 Managing working capital

Managing working capital is also managing its components: cash, inventory,receivables and its mainly financing source: account payables

2.3.2.1 Cash management

Any business that is storing the cash in order to the following purposes:

 For doing business: procurement of materials and goods, payment for necessaryexpenses for normal manufacturing activities such as wages payment, taxes payment,etc

 For speculation: enterprises take advantage of temporary business opportunitiessuch as devaluation of raw materials, discount, etc to increase profit

 For provision: in doing business, every firms have a provision in cash in order

to meet the unexpected demand when needed

The company needs cash to be able to run the business while at the same time tryingnot to keep idle cash which generates little or no return and costs money fund

Therefore, planning cash and controlling its use are very vital tasks.

 Planning cash in business

There are a lot of methods to planning cash in business such as: Miller Orr’s

model, Baumol’s model and the like However, Cash budget is useful device andpopular method being used in Vietnam accounting context

Cash budget basically incorporates estimates of future inflows and outflows of cash

over a projected short period of time which may usually be a year, a half or a quarteryear Effective cash management is facilitated if the cash budget is further brokendown into month, week or even on daily basis

There are two components of cash budget (i ) cash inflows and (ii) cash outflows.The main sources for these flows are given hereunder:

Table 2: Cash in and Cash out in Cash budgeting

Cash sales

Cash received from debtors

Cash received from loans, deposits, etc

Cash receipt of other revenue income

Cash received from sale of

investments or assets

Cash purchases Cash payment to creditors Cash payment for other revenueexpenditure

Cash payment for assets creationCash payment for withdrawals, taxes Repayment of loans, etc

Cash budget will figure out how much projected money needs added or rejected in aspecific period of time.

A suggestive format for ‘Cash Budget’ is given below

Table 3: Cash budget format

Estimated cash inflows

-

-I Total cash inflows

Estimated cash outflows

-

-II Total cash outflows

III Opening cash balance

surplus/Deficit

during the month (I–II)

V Closing cash balance

 Controlling the use of cash

After planning, enterprises concentrate on how to control the use of projected cash Two basic formulas exist for determining cash turnover

The first is simply sales revenue divided by average cash balance The figuresneed to be from the same accounting period This formula basically states that acompany will generate X dollars for every $1 in cash

Cash turnover =

(Average Cash = Beginning Cash + Ending Cash)/2

The second formula has two parts First, subtract depreciation from the cost ofgoods sold and then divide the difference by the ending cash balance Secondly, divide

365 days by this figure to determine how many times the company spent its entire cashbalance during the year

 Decreasing speed of cash expenditure: utilizing cash for investment to makemore profits, instead of settlement for suppliers, firms should defer credit due withdeliberation between the additional profit and opportunities cost such as decliningcredibility, increasing financial and other costs, etc

 Properly investing idle cash: cash holding is non-profit investment, utilizingcash to invest in safe but interest generating is a good management way when firms donot need cash in hand Some such investment channels are government bills, bonds,short-term savings, savings for payment, etc

2.3.2.2 Inventory management

Most of enterprises employ inventory because time of purchasing, producingand selling expands, not at a same point Firms keep stock in order to

 To facilitates smooth production and sales operation (transaction motive)

 To guards against the risk of unpredictable changes in usage rate and deliverytime (precautionary motive)

 To make advantage of price fluctuations (speculative motive)

Types of inventories in manufacturing firms

 Raw materials: basic goods that will be used in production but have not yetbeen placed into production

 Work-in-process: the portion of manufactured inventory that has begun theproduction process but is not yet completed

 Finished goods: manufactured items that are completed and ready for sale

There needs to balance between the benefits and cost of holding stock Thebenefits of holding stock are that it allows the business to sell a range of goods which

is immediately available to customers However, holding stock incurs cost, inparticular the opportunity cost of money tied up in stock

The types of cost associated with cost

 Ordering cost: cost related to the placing of orders These include clerical,administrative, the accounting cost of placing an order and exclude the cost ofmaterials ordered

 Holding cost: total annual cost of holding orders These include warehousingand storing cost involved, and exclude the cost of material orders

 Stock-out cost: cost associated with the lost contribution through lost of sale,the lost future contribution through lost of customers, the cost of emergency orders ofmaterial, and the cost of production stoppages

 Purchase cost: the cost of what is bought

Two most popular inventory management methods are Just In Time and Economic Order Quantity

 Economic Order Quantity: the reorder quantity which minimizes total cost of

holding and ordering materials over a given period of time The size of the orderplaced will affect the total holding cost and ordering cost over the year If the companyhas a policy of holding large orders rather than small ones then the total annualholding cost will increase However, if the order size increases the number of ordersneeded to satisfy the year’s sales will decrease and so the total annual cost of placingorders will fall

The formula for optimal order quantity

Q* =

Q*: optimal order quantity

C: The order cost This is the fixes fee charged for making any order and isindependent of quantity demanded

D: Demand for widget in quantity per unit of time (weekly, monthly, etc.)

h: Holding cost per widget per unit of time

 Just In Time method: the basic aim is to eliminate or minimize inventory The

theory holds that stock is only needed if there are inefficiencies in production process,that is business needs stock because they can not schedule the work accurately, qualityproblems and inflexible work practices Under JIT method, companies manufacture orpurchase goods just in time for use and significantly lowered inventory levels and cost.The success of a JIT system depends on reliable suppliers

In order to asset the management of inventory, two popular criteria are employed

Inventory turnover =

This index represents the ability of the firm to inventory management effectively Thehigher the ratio is, the faster the firm sells goods and the less inventories are stuck instore That means businesses will be likely less risky if seen in the financialstatements, inventory items are valued down through the years However, if this index

is too high, it is not good due to this means that stocks in the warehouse is equivalentenough when market demand increases suddenly The firm may lose customers and

market share for competitors In addition, reserves of raw materials for production arenot enough lines can cause disruption in manufacturing So, inventory turnover must

be high enough to ensure production that fulfills the demands of customers

Days inventor outstanding =

This ratio has the same economic meaning with inventory turnover, but takes intoconsideration about average number of days “turnover” of inventory Commonly, thelower the ratio, the better the firm manages inventory

The most important content in receivables management is credit policy of firms.

Receivables are managed in compliance with proper credit policy in order to maximizeprofit It involves a trade off between the profits on additional sale that arises due tocredit being extended on one hand and the cost of carrying those debtors and bad debtslosses on the other Credit policy includes two important elements: volume of salescredit and credit period allowed to customers Following factors may be consideredbefore allowing credit period to the customer:

 Nature of the product

 Credit worthiness of the customer, which varies from customer to customer

 Quantum of advance received from customers

 Credit policy of company, say number of days allowed to customer for payment

to the customers

 Cost of debtors

 Manufacturing cycle time of the product

 Credit analysis

This requires to determine as how risky is to advance credit to a particularcustomer Careful credit analysis will help firms accelerate receivables process, reducerisk of bad debts Customer credit analysis includes some important aspects:

 Credibility: this criterion can be assessed basing on the historical data ofpaying debts to firms

 Conditions of customer: customer’s current position in industry, customer’sperformance in comparison with other companies in the same industry

 Collateral: loan payment capacity of the customer basing on the assets backed

 Increasingly keeping on track each kind of receivables

 Giving out discount and stimulation policy

 Stop proving goods or services for specific customers

 Liquidating account receivables for loan trading companies

 Imposing pressure to specific customers

 Control of receivables

This requires the firm to follow up debtors and decide about a suitable creditcollection policy It involves both lying down of credit policy and execution of suchpolicies

In account receivables, customer receivables occupy majorly and convey importantmeanings to the firm’s assets The assessment ratio following just mentions aboutcustomer receivables

Receivables turnover =

Average customer receivables=

This ratio points out how many “turnover” of customer receivables in one period oftime The higher the ratio is, the faster the firm collects cash from customers

However, too high receivables turnover shows that the credit policy is too tight, thenwill negatively affect the sales of the firm because the customers will switch toconsuming products of competitors provide longer credit period And so, our businesswill reduce sales collapsed When comparing this index over the years, found that thedecline is likely that businesses are struggling with debt collection from customers andmay also be a sign that sales have exceeded.

Average collection period = =

Average collection period ((Days sales outstanding-DSO): Like accounts receivable

turnover, this indicator tells us the average number of days that money is collectedfrom business customers The lower the ratio, the better collecting cash is

2.3.2.4 Payables management

In payables management, payables to suppliers are vital determinant for thepayment capacity and the firm’s credibility When payables cannot be liquidated, theprestige of the firm will decline and vice versa Overdue payables with majorproportion may result bankruptcy So, the firm has to frequently analyses payables tosuppliers These following ratios just take into consider managing suppliers tocustomers

Payables turnover =

Average payables to suppliers =

This ratio reflects in accounting period, how many times payables to suppliersturnover The high ratio means that the firm’s settlement for suppliers in time andhelps to enhance the credibility of the firm with counterparty However, if this index istoo high, that may be thought that due to the firm has excess of cash, it always paybefore maturity This fact will influence the efficiency in utilizing capital of the firm

Days payables outstanding = 365/ payables turnover

This ratio shows the average days of one “turnover” payables to suppliers The shorterthe ratio, the faster payment capacity of the firm is and vice versa

When analyzing this ratio, we can compare with the purchasing time in sales contractwith suppliers If DSO is higher than the settlement maturity time, the firm shouldconsider the in-time payment in order to maintain its credibility

2.3.2.5 Working capital management efficiency ratios

Measurements of WCM are summarized in the following table:

Table 4: Working capital management efficiency ratio

Days WC outstanding = Days of a WC turnover

The lower , the more efficient using WC

Quick ratio =

Commonly, the higher, the better

Days inventory turnover The shorter, the better

Receivables turnover The higher, the better

Days Receivables Outstanding The shorter, the better

Days payables turnover The shorter , the better

Cash conversion ratio The shorter, the better

2.4 Financing of working capital

Working capital can be funding by both short-term and long-term finance Most

of firms financing their working capital use mix; however; the proportion betweenshort-term and long-term funds depends on each firm’s policy In common, there arethree types of financing mixes including:

 Hedging (matching) approach states that the maturity of assets is matched with

that sources of financing That means, the permanent current assets or fixed assets will

be financed by long-term funds, and temporary current assets are financed by term funds

short- Conservative approach affirms that almost of assets are financed by long-term

sources Short-term financing is just taken into account a small amount

 Aggressive approach is the approach in which most of assets are financed by

short-term funds, and long-term fund is very little

However, in fact most firms finance working capital through short-term fundsdue to the proper matching between working capital and short-term funds ( currentliabilities)

Advantages of short term finance:

 Short-term finance is cheaper than long-term finance because lenders woulddemand a greater compensation for having their money tied up for long periods

 Short-term finance is more flexible than long-term finance because the amount

of finance needed will fluctuate over the operating cycle A business will only payinterest on the amount of overdraft (short-term) utilized whereas with long-term thebusiness will pay fixed interest even though the loan is not fully utilized

 Easy to arrange an overdraft is simple to arrange and is normally unsecuredagainst the company’s assets It does not need any of the formalities that go withsetting up long-term finance

Some of the popular short-term funds raising are following:

Suppliers’ credit (supplier’s payables)

At times, business gets raw material on credit from the suppliers The cost ofraw material is paid after some time, i.e upon completion of the credit period Thus,without having an outflow of cash the business is in a position to use raw material andcontinue the activities The credit given by the suppliers of raw materials is for a shortperiod and is considered current liabilities These funds should be used for creatingcurrent assets like stock of raw material, work in process, finished goods, etc

This kind of financing is easily to access, less costly, and be influenced mostly by thecredibility of firms, suppliers’ credit policy If firms’ credibility weakens, they maybear much more cost due to the tight credit policy of suppliers

Bank loans for Working capital

This is a major source for raising short-term funds Banks extend loans tobusiness to help them create necessary current assets so as to achieve the requiredbusiness level The loans are available for creating the following current assets:

 Stock of Raw Materials

 Stock of Work in Process

 Stock of Finished Goods

 Debtors

Banks give short-term loans against these assets, keeping some security margin

The advances given by banks against current assets are short-term in nature and bankshave the right to ask for immediate repayment if they consider doing so Thus bankloans for creation of current assets are also current liabilities

Others short-term funds are unearned revenues, other payables (tax payables,

labor payables), over draft, bill of exchange, etc These sources are less costly, but arejust available for short-term, so firms should not abuse such financing

Another source financing working capital is using owners’ capital or equity.This is the kind of self-finance Firms do not have to pay interest or cost, but paydividend on the case of having profit after all

CHAPTER III: REAL SITUATION OF WORKING CAPITAL MANAGEMENT IN LAN LAN CO., LTD.

3.1 Overview of Lan Lan company

3.1.1 Brief history and foundation of Lan Lan Co.

 Legal name : Công ty TNHH may Lan Lan

 International Trading name: Lan Lan Co., LTD

 Address: Km4, Road No.10, Phu Khanh, Thai Binh

 Tell: (84 - 36) 3 836 638

 Fax: (84 - 36) 3 834 041

Lan Lan Co has been formally the joint venture between Minh Khai Thai BinhExport-Import enterprise and Yumine Sewing Co, LTD (Japan) The firm has beenestablished and operated under investment license No.01/GP-UB dated 05/04/2000and amended investment license No.09/2002 GPĐC1-UB dated 21/3/2002

According to investment license No.01/GP-TB dated 04/02/2005 of People ofCommunity of Thai Binh province, all rights and obligations in Lan Lan Co of MinhKhai Thai Binh Export-Import enterprise was transferred to Yumine Sewing Co,.LTD Hence, Lan Lan Co became a hundred-percent-foreign-investment-capitalcorporation

Accordingly, Yumine Sewing Co, LTD, which has headquarter in No.650 -5Numamachi, Furukawa-Cho-Yoshinki- Gunggifuken- Japan by Mr Michiyuki Masai,the director, established foreign corporation under the regulation of ForeignInvestment Law of Vietnam

According to Investment license No 01A/GPDC1-TB dated 26/07/2005:

 Legal capital of the firm: 1,400, 000 USD

 Investment capital: 1,800,000 USD

The firm was constructed in the area of 14, 227 m2 with a 6498-meter-square factory

3.1.2 Main function and duty of Lan Lan Co.

Objectives and scope of business activities: Manufacturing and sales ofgarments for export

Capacity: average of 2,500,000 products of all kinds per year

Main duties:

 Organizing garment production for export in accordance with processtechnologies to ensure the quantity and quality