Working Capital Management
To manage working capital management Mr. Cold’s Ices has many financial issues that are affecting or will affect its operations. To begin with, this company has negative working capital as of 31st December 2008, meaning that the company is unable to meet current short-term financial obligations if they fall due any time and this may hamper the creditworthiness of the company. Less working capital is like a time bomb and any company without enough working capital may find itself liquidating. There is a large deficit of current assets to cover current liability as of 31st December 2008. It means also there is a low cash flow during the period. However, during the next financial year, it has been projected that the company will have a positive working capital of £ 82,000. This is good news. However, this is a mere projection it is yet to be achieved. If the company has signed a contractual agreement with TESCO and Mark and Spenser and then this dream may be achieved by changing the collection period.
It is also shown from the projected balance sheet that there will be no cash at hand. This creates also a liquidity problem. In normal business operations, there should be a continuous positive and negative cash flow but when there are questions relating to liquidity and capital structure then the company may have financial problems. To demonstrate this, I shall use the current and liquidity ratios to estimate the projected liquidity of the company as of 31st December 2008 and the projections of the company.
From the ratios calculated below the company has positive liquidity after trading for 6 months. However, in the beginning, they have they don’t have enough liquid assets which increase the risk of bankruptcy. When the company fails to pay short-term creditors because of liquidity problems they may be liquidated. Therefore it’s advisable for a company to maintain a large amount of cash and equivalent assets that will be liquidated quickly in case of any technical default in meeting the short-term obligations.
|Current ratio||Current assets |
|50 = 0.21:1 |
|145= 2.3:1 |
|Quick ratio||Current assets |
|50 = 0.21:1 |
|145- 20 = 2:1 |
The company should have a balance between the current liabilities and current assets and at the beginning of 2009 this company does not have a balance and it is at risk of being seen as unable to meet the various short-term obligation. They should try to exploit cheap sources of finance to the fullest extend by prudently managing the working capital elements. What it means is that Mr. Colds Ices plc should maintain sufficient current assets that will enable them to meet short-term liabilities when they fall due.
The company should begin by reducing the number of days the debtors they pay their dues. They should enter into a new arrangement with marks and Spencer to reduce the collection period from two to one month. This ensures that there is a constant flow of cash within the organization for operations. The other issue that is to ensure that there is cash always through changing the stock management. As shown in January they are likely to buy 600,000 and demand is 420,000 units and pay is after one month this leaves 180,000 units. To reduce this they should adapt just in time approach in purchasing stock. The just in time delivery by suppliers will reduce the problem of lack of finance. The other issue the company should consider is increasing the creditors payment period by negotiating longer terms of credit payments such as two or three months. This will ensure that at all times there are cash surpluses which will finance short term credit facilities. However if Marks and Spencer fails to accept the change of this collection period they will have another option of factoring debt of Marks and Spencer. Otherwise the current situation gives the company bad customer goodwill.
In financing, the activities of Mr. Colds Ices there are many options and this can be classified into short term and long term options. However in this case three methods have been identified from the main options that will help this company get out of the current financial problems. These three financing methods that that will be discussed should be blended in a manner to maintain the good capital structure that ensures long term survival of the company. The current capital structure and solvency ratio for the company is as follows:-
|Total debt: total capital||Total debt |
|200 = 0.17:1 |
|125= 0.1:1 |
|Long term debt to equity||Long term debt |
|62= 0.07:1 |
Looking at the above solvency and capital structure ratios shows that the company has not exploited debt capital fully. However from the current ratio and quick ratio of December 2008, the company has problems in meeting short-term obligation as they arise. Bearing this in mind the following methods of financing should be blended;
Issue of shares
The company should think of raising additional equity finance to finance their operations because at the moment there short term liquidity is in question and can only find trust in the shareholders who benefits from the performance of the company. Issue of shares has many challenges which the company should be ready to mitigate. Issue of shares is important to the company because it does not affect the long term survival of the company i.e. It that does not increase the risk of the company getting or the company being liquidated. It also ensures the company gets liquidated from people who understand the business very well. Shares can be issued to the existing shareholders or to new shareholders through a public issue in the stock exchange. However from this case at hand, issue of shares to the existing shareholders will be a viable idea because it will be easier to raise the funds and improve the liquidity of the business before thinking of getting other sources of finance.
Short term financing
The situation under this company which it operates will only dictate exploitation of only one source of short term financing which is working capital management prudently.
- They are risky since they can be paid on demand or within the stated period and normally the duration is short whereas others can be terminated any period depending on the financial position of the company for example bank overdrafts and loans.
- During winding up of the company, they are given last priority since they are not secured.
- They have no voting rights in the company’s general control.
- Flexibility – they can be sued as required can be sued so long as the company does not exceed the required limit. In addition, credit period can be extended depending on the goods or services supplied.
- Liable – any company can easily access this facility so long as it meets the requirements.
- Not expensive – interest rates are usually above the base rate and are tax deductible.
- Risky since they are legally repayable on demand or within a certain stated period depending on the financial position of the company.
- Security is usually required by way of fixed or floating charges on assets or sometimes in private companies by personal guarantees from owners.
- Interest costs vary with bank base rates.
Long term financing
This form of financing is ideal for this company because at the moment they do not have large amount of debts thus the use of large amount of capital. However they must manage their short-term liquidity before winning confidence of suppliers this capital. Long term debt financing is available in many ways. This is a form of loan capital that is payable on long basis. I propose for them to use;
Is a written acknowledge of a debt by a company containing provisions of interest and the terms of repayment of principal. This can be secured, unsecured, irredeemable, or redeemable. Secured debt will carry charge on one or more specific assets or all assets of the company such that on default of repayment of interested principal, the debenture holder will appoint receive to administer the assets until the interest is paid eventually they can sale the asset to repay the principal. Redeemable debt is where the principal is repayable at a specified future date whereas irredeemable is the opposite.
- Cheap – because is less risky, debenture holders can accept a lower rate of return.
- Cost is limited to the stipulated interest repayment.
- There is no dilution of control where debt is offered since no voting rights.
- Interest is a compulsory default will mean selling the company securities or the company will go under receivership.
- It is limited since the shareholders are concerned that a geared company can not pay its interest and still pay its dividend and raise the rate of return that they require from the company to compensate for this risk.
- Provision must be made for the repayment of debt with fixed maturity rate.
- If the general interest rates fall, fixed rate interest payments may prove to be a burden.
Efficient market hypothesis
Mr. Colds Ice plc, is contemplating to issue the shares in the stock market and he has heard that there shares are neither undervalued nor overvalued as per the standard of stock market. He has had that the stock market efficiently prices shares. It is true that the shares of Mr. Cold’s Ice PLC is not over valued or undervalued because the stock market values the shares through the forces of supply and demand. Therefore in this view those shares that are not listed in the stock exchange are not valued at the right price because there are no forces of demand and supply. For one to say that the share is price efficient, it implies that at all times the shares reflect all information available about the business available to all investors for them to make rational decisions in relation to the prices of shares. What is means is that the current price of a share listed in the stock exchange is the present value of the future economic benefit that investor of that stock will get. The stock exchange acts as an interface between the manager and investor and therefore financial decisions made by the manager are reflected in the share prices of the company.
All information that is available in relations to the company is quickly and rationally incorporated into the values of shares of the company. This is because the shares trading in the market are observed by brokers and the general public some of them who have skills and experience in move of shares and what type of motivator increases the value of shares. They buy the shares when they see the information I positive in relation to financial gain from shares. The information this people use is valid and comes from many sources which include financial statements,. Press statements and type of managers in a company. If the management is known to be with people with suspect characters then the shares will be undervalued.
Efficiency means that the shares are not available to a certain group or individual but available to all the people majority of them who have skills knowledge and can make prudent decisions in relation to any new information. The reaction of this people is expected to be quick and efficient. There are three forms of market efficiencies for any stock. This includes;
where the shares reflect the information that has been affecting the past price movements and its already reflected in the current form. The weak form of market hypothesis means that there will be no benefit of an investor carrying out technical activities to forecast the future prices because of the past trends.
Semi strong form means that all relevant information available publicly is reflected in the shares of the company and any investor who will attempt and acquire and analyze extra information will not yield extra returns because all the information is available. This means that as soon as any information is available in the public, it is absorbed and reflected in the stock prices. Fundamental analysis will not assist any investor.
The strong form means that all relevant information has been reflected in the stock prices including the information available to the few i.e. privileged few such as managers and stock brokers.
Therefore, I will advices the company to go public because their current market price does not reflect any of the information because it is not determined by forced of demand and supply where the type of information to the public affects the share price.
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Schlosser M.;(2002); Business finance: application, Models and cases, prentice hall, ISBN 0-13-264649-8.
Westerfield R., Jaffe, and Jordan (2007); Corporate finance core principles and applications by McGraw-Hill. ISBN-13: 978-0-07-353059-8/ISBN-10:0-07-353059-X