Working Capital Control

• What is it?– Essentially net current assets (but strictly

speaking should exclude cash)

• Why is it important?– Cash tied up in day-to-day operations– The business cannot continue without it– It has to be funded from somewhere– If business runs out of cash, it will fail

Why do we need to control it?• Use cashflow forecast to work out how much

cash we need to borrow/invest• To keep working capital to a minimum (and

hence free up cash for other purposes):– keep stocks low– keep debtors low– delay payment to creditors

• BUT if working capital too low (or negative), risk bankruptcy– fail to meet liabilities as they fall due

Cash Flow ForecastJan Feb Mar Apr May Jun Total

£ £ £ £ £ £ £Inflowse.g. Capital Sales

AOutflowse.g. Purchase ofFixed Assets Purchases ofStock Wages Rentetc.

B

Net cash flow A-B=CCash b/f D ECash c/f C+D=E

Cashflow Forecast Example - Carruthers

Receipts July August September October November December

SalesShare capital

£ £ £ £ £ £

Sub Total A

Payments

MaterialsWagesOverheadsFixed assets

Sub Total B

Balance (A–B)Balance b/fwdBalance c/fwd

Bank Reconciliations• You can check the cash at bank (or bank

overdraft) balance in the accounts by comparing it to the balance on your bank statement.

• The two figures are unlikely to agree exactly - this does not mean that the balance in the accounts is wrong.

• Acceptable differences are cheques that have not yet cleared (deposits and payments). Other differences should be adjusted.

Bank Rec. Example

• Balance per bank statement = £351.05

• Balance per cash book (accounts) = £319.04

• Why are they different?– 3 cheques you have issued have not cleared– 1 deposit has not been cleared– the bank has made an error with the amount of

another deposit– these are all acceptable differences

Bank Reconciliation as at 30 Nov£ £

Balance per bank statement

Less: outstanding cheques

Add: outstanding deposit

Less: error on statement

Balance per cash book

Daphne Ltd Example

• Acceptable differences are cheques outstanding (not yet presented) and deposits not yet credited (cleared).

• But we must adjust for investment income, bank charges and standing order as we should have entered these in the books (accounts).

• Nb. typo: statement date 30.6.01 not 00

Insert ratio analysis diagram here

Ratio Analysis

• Ratios of accounting numbers are useful to analyse the position and performance of a business.

• It is important to compare ratios over time (trends), or to budgets, or to other businesses/industry averages. By themselves they are meaningless.

Profitability Ratios

• Gross Profit Ratio = Gross Profit 100%

• Sales

• Net Profit Ratio = Net Profit 100%

• Sales

• ROCE = PBIT 100% Capital Employed

ROCE

• ROCE is very important.

• Can split ROCE as follows:– ROCE = Net Profit Ratio Capital Turnover

Ratio• as long as you use PBIT in Net Profit Ratio

– Capital Turnover Ratio = Sales .

Capital Employed

Liquidity (Working Capital) Ratios

• Use Stock Turnover Ratio to see whether the Current or the Quick Ratio is the most appropriate liquidity ratio to use.

• High/quick stock turnover - Current Ratio

• Low/slow stock turnover - Quick Ratio

• Also look at Debtor and Creditor Days to determine changes in payment/collection periods (affect cash cycle of business).

• Stock Turnover Ratio = Cost of Sales

Inventory Held

• OR

• Inventory Held 365 days (no. of days)

Cost of Sales

• Current Ratio = Current Assets .

Current Liabilities

• Quick Ratio = Current Assets – Stock

Current Liabilities

– the quick ratio is sometimes also called the ‘acid test’.

• Debtor Days = Trade Debtors 365 days

Total Credit Sales– (how long it takes your customers to pay)

• Creditor Days = Trade Creditors 365 days

Total Credit Purchases– (how it takes you to pay your suppliers)– if you don’t have purchases, use C.O.S.

Efficiency Ratios

• Tell you how well you use your assets to generate income.

• Capital Turnover Ratio

• Fixed Assets Turnover Ratio =

Sales .

Fixed Assets Book Value

Gearing Ratios

• Debt to Equity = Long-Term Liabilities

Capital + Reserves

• Debt to Capital Employed =

Long-Term Liabilities

Capital Employed

Investor Ratios

• Dividend Yield = Div Per Share 100%

Market Price per Share– Note: You need market price to calculate this but

it may not be available.

• Dividend Cover =

Net Profit Before Ord Divs

Ord Divs paid and proposed

• Earnings per Share = Earnings Before Ord Divs

No. of Ordinary Shares Issued– companies like Somerfield report this at bottom of the

profit and loss account

• Price Earnings Ratio = Market Price per Share

(PE Ratio) Earnings per Share

Writing Reports

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