Working Capital Simulation

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Management of working capital is a tough task, though essential for the growth and sustainability of any business. For simplicity in working capital management, managers are required to effectively allocate and fund the required working capital. Effective capital management will enable the management take care of the needs of the business and in appropriate time (Sagner, 2011). It would therefore be very important that the CEO of a company keenly examines and make use of the best and most appropriate working capital for the business. In this paper, I will evaluate the case of the case of working capital simulation as SNC brings in new customers.

Phase 1- Decisions

a. Selection of an option that will lower working capital requirement thereby reducing the short term debt well.

b. Adoption of an option that lowers the cycle of cash conversion.

c. Strategizing on an option that would set free the capital locked in inventories and receivables.

d. Adoption of an option that would eventually lead to the minimal working capital policy in the long term.

The above laid decisions will affect SNC from the below explained perspectives.

Sales: A keen evaluation of SNC reveals that their sales have been increasing by $4 million each year and this sale is quite admirable sale given that the company only started business in 2006. (Cantot & Luzeaux, 2011). However an effort should be made to raise this sale with time. The additional sale targeted over the next three years will help in the boosting of the sales trend analysis meaning better results on the part of the management and the whole company in large.

Earnings before Interest and Tax (EBIT): in the next three years, it is expected that EBIT would remain more or less flat given that sales may stagnate within the three year period. It is important that the company adopts strategies to attract more customers to boost their sales and hence their earnings. The company has recorded an EBIT of approximately $0.27 million annually, which will take care of the company’s financial situation for now. Improved EBIT implies a better financial performance of the company in the first three years.

Net Income: Though the company’s net income has changed drastically, phase 1 does not reflect a substantial improvement. The company’s current trend reveals minimal improvements meaning stagnation as far as production of net income is concerned. We are only left to predict that increased net income will move forward (Hostland & Karam, 2006). T o increase the net income, we may decide to tighten the accounts receivable and at the same time drop those products yielding a percentage decrease in working capital.

Free cash flow: At phase one, the company is only starting its operations meaning that it has not yet taken into consideration certain expenditures such as amortization and depreciation. The interpretation is that the net income from the company’s operations will directly be added to the free cash flow.

Phase 2 – Funding decisions for materials acquisition

a. Selection of an option that will increase sales by relatively increasing the company’s requirement of capital.

b. Selection of cost effective equipments and materials

The above named funding decisions in phase 2 will affect SNC in the following ways.

Sales: Entering new phase calls for a higher capital requirement. This is because the business will most definitely need to boost their annual sales and increase the overall revenue. In fact, it is during this phase that the business would expect the highest returns from the increased market share. It is in this stage that FMCG, capital goods and diversified are expected to bring down their CPP (Sagner, 2011). SNC Company is expected to make expenses more visible as increased expenses accompanied by lower excess amounts may negatively impact the working capital. Active stock management will promote effective communication between departments.

Earnings before Interest and Tax (EBIT): As stated here above, it is in phase 2 (between 3rd and 7th year) that we expect the highest returns. In phase 2, leverage management will be done at extremely higher levels. It is only through effective leverage management that SNC can know how debt will impact the company’s profit generating capability. The concept of Interest Cover (IC) will help in examining SNC’s capability of recovering profits from its operation mostly to take care of interest payments (Kim & Srinivasan, 1991).

Net Income: The financial results of SNC for the year 2000 reveal that the company reduced its working capital by a higher percentage between 12% and 17%. This has some very huge positive impacts on net income. The company has also produced similar results in the past three years. The company may also reduce the working capital further so that it can reap additional benefits related to effective cash management improvement. The company should also closely tie the management of bonuses with the Earnings per Share (EPS) to boost the Net income.

Free Cash Flow: The Company will only maintain free cash flow through effective excess cash management. SNC Company has staggering excess cash amounting to more than 100 million and, this has huge negative implications on net income. For effectiveness, the company will have to reduce the total debt by 29% which will most definitely increase the annual profits by a 12% margin (Hostland & Karam, 2006). The Return on Capital (ROE) will also have to be raised from 13.8% to 15.0%.

Phase 3 – Funding decisions for capital expansion

a. Selection of the best source of funding

b. Strategies to promote SNC’s long term financial sustainability

c. Review of the company’s financial performance so that corrections may be made.

The above mentioned decisions will effects to SNC from the following directions.

Sales: This is the last phase of our capital simulation process. Though we expect stagnating sales during this period, the company has to make an effort to boost their sales anyway. The company can do this by looking for a source of funding with the lowest charges and earns the company the best in terms of returns. The company can also consider alternative funding given that not all banks will be willing to assist (Preve & Sarria-Allende, 2010). It is in this phase that the company should ensure that the suppliers are paid in time to avoid low stock levels.

Earnings before Interest and Tax (EBIT): EBIT is an important factor in this phase as it will show the intrinsic performance of the company. Now that EBIT and its variations are not overly accepted under GAAP, SNC will have to register its securities and reconcile its net income with EBIT so as to avoid misleading investors. The company will also have to consider reverting and activating efforts that will see the active development of the profit and loss statement (Sagner, 2011). This will later increase EBIT in addition to the total output.

Net Income: By the third phase, the net income has started to decrease if not stagnating. The company will in this case have to institute financial dispute management protocols that will deal with disputes such as increasing Accounts Receivable (A/R). The company may also consider benefiting from e-procurement. E-procurement will greatly enhance the company’s buying processes to cut their costs by an average of 19%, in addition easing their working capital.

Free Cash Flow: Liberating the millions in cash trapped on SNC’s balance may not be an easy task and will thereby call for a strong working capital performance and corporate management. For simplicity in working capital management, the company will have to remember to collect their cash through the use of effective ongoing procedures of collection. This will prevent the building-up of excess or overdue funds (Hostland & Karam, 2006). Build-up or excess funds may limit the company access to financing.

References

Cantot, P., & Luzeaux, D. (2011). Simulation and Modeling of Systems of Systems. London: Wiley.

Hostland, D., & Karam, P. D. (2006). Assessing debt sustainability in emerging market economies using stochastic simulation methods. Washington, D.C.: World Bank, Development Prospects Group.

Kim, Y. H., & Srinivasan, V. (1991). Advances in working capital management: A research annual. Greenwich, Conn: JAI Press.

Sagner, J. S. (2011). Essentials of working capital management. Hoboken, N.J: Wiley.

Preve, L. A., & Sarria-Allende, V. (2010). Working capital management. New York: Oxford University Press.