I am going to produce a report which assesses the working capital management of MarksSpencer using information from their annual report Essay Example

I am going to produce a report which assesses the working capital management of MarksSpencer using information from their annual report Essay Example I am going to produce a report which assesses the working capital management of MarksSpencer using information from their annual report Essay I am going to produce a report which assesses the working capital management of MarksSpencer using information from their annual report Essay Working capital measures how much in liquid assets a company has available to build its business. The number can be positive or negative, depending on how much debt the company is carrying. In general, companies that have a lot of working capital will be more successful since they can expand and improve their operations. Companies with negative working capital may lack the funds necessary for growth. Working capital is a critical aspect of business operation, without adequate working capital a business may not be able to reach success or the aim of the business, for example, if MS don’t have enough working capital to found employees’ wages then the employees may decide to quit and this will slow down productivity which in turn will cause the business to stop functioning. Also if MS don’t have enough capital then they may not be able to pay their suppliers and their suppliers may decide not to supply them with goods anymore which may have an effect on the company’s market share, because customers will choose to go to rival companies instead. The key components of working capitals are current asset and current liability. To find the working capital of a business we use the formula: CURRENT ASSETS- CURRENT LIABILITIES= WORKING CAPITAL Based on this formula the working capital of MS at the end of 2010 2011 financial year can be calculated as; 2010  £1,153.80 – 2,210.20 = (1056.40) 2011 1,641.7 – 1,890.5 = (248.80) Both figures from MS working capital show a negative figure, this means that currently the company is unable to meet its short-term liabilities with its current assets. However, comparing these two years there has been a decrease of  £807.60 from 2010 to 2011 which is a good thing because this shows that MS are taken up strategies to improve its working capitals. Current assets are cash or assets owed buy a business that will be turned into cash within one year, examples of current assets are; Trade receivables (Debtors): debtors are money owed to a business by its clients or customers. This is a current asset because customers that purchase goods on credit are usually required to pay the amount owed within a year, so due to this reason they become an asset to a business. Trade receivables are shown on the balance sheet under the current asset section. Inventories (Stock): inventories are products or merchandise owed by a business that has not yet been sold. These are current assets because as part of the normal trading activities of a business, inventory will be expected to be sold off within a year to generate income. There are two types of inventory, opening inventory and closing inventory. Opening inventory is the stock held at the start of each financial year and closing stock are the total amount of stock left at the end of the financial year and this is recorded in the balance sheet as a current asset. Prepaid: these are expenses that have been paid for in advance but services or products have not yet been used. Example of prepaid expenses is insurance and business rates. Other examples of current assets are bank balances and cash in the till. Current liabilities: these are debts owed by a business that need to be repaid within one year. Examples of current liabilities might include; Trade payables (creditors): creditors are people usually suppliers that a business owe money to. Creditors are current liabilities because suppliers will usually request you to pay back the amount owed within one year. If trade creditors are not paid on time it may affect the reputation of the business because suppliers wouldn’t want to sell gods to you on credit as they know there will be chances of late repayment. Short term loan: this type of loan is borrowed from a bank and is scheduled to be repaid in less than a year. Accrued expenses: these are expense that has been incurred, but not yet paid for. Example of accrued expenses may be interests that has been accrued on loans that has not yet been paid for and also taxes that has been accrued but not yet paid for. Other examples of current liabilities are bank overdraft, this is when an individual or a company withdrawals more money from their account than they owe. This is a current liability because bank overdrafts are supposed to be paid within a short period of time. Marks Spencer uses short term finances such as overdrafts and bank loans to fund their working capital. Overdraft may usually be used to cover utility bills, and short term bank loans may be used to pay wages. Also they use trade creditors as a short term finance to purchase goods on credit from their suppliers. The use of short term finance for the day to day running of the business is a better source compared to long term source because resources such as stock will be used soon and there will be no point incurring more charges on it if you were to get a long term loan instead of acquiring it from trade creditors. In this part of my work, I am going to identify and explain the key ratios, using the information I gathered from MS annual report. Ratio is the term applied to a variety of calculations used to compare the results of a business over time or to compare the results of two or more business in the same business sector. Ratios enable changes in important aspects of a business’s performance to be pin pointed and quantified. The calculations of ratios enables trends to be highlighted and also ratios are particularly important to the owners, managers and stake holders of businesses as they will be keen to assess the performance and rivals will be interested too. I will be using five(5) key ratios namely current ratio, acid test ratio, debtor collection periods, credit payment period and stock turnover to compare the results of MS business over 2010 and 2011 financial year. Current ratio: this is also known as the working capital ratio, it is used to compare current assets to current liabilities the formula for working out the current ratio is, CURRENT ASSETS / CURRENT LIABILITIES. Current ratios are always expressed as ‘something’:1. The ideal current ratio is 2:1 which means that for each  £1 owed the business can cover with current assets 2 times. Even though a high current ratio can be a good thing, it is possible for it to be classed as a wasteful of resources, because the business is holding money in that could be put to good use such as expanding the business. Current ratio 2010 2011 ( £1153.80/ £2210.20)= 0.5220 ( £1641.70/ £1890.50)= 0.8684 Current ratio= 0.5:1 Current ratio: 0.9:1 MS current ratio has increased from 0.5:1 to 0.9:1 this means that liquidity has gone up and for every  £1 owed MS can cover with current assets of 0.9 times. Compared to the ideal ratio which is 2:1, the current 2011 ratio is still not good enough and this may imply that the business will find it difficult its debts since the business is operating with inadequate levels of working capital. Acid test ratio: this is similar to current ratio because it measures liquid assets in relation to current liabilities and also the amount of liquid assets available to pay the debts of the business. The differences between current ratio and acid ratio is that, current ratio looks at liquidity and cash flow issues further ahead than acid ratio because acid ratio is a more immediate measure of liquidity. The formula for finding acid test ratio is; (Current assets – stock)/ Current liabilities Acid test ratio is also written in the form ‘something’: 1, the ideal acid ratio is 1:1 meaning that for every  £1 a business owes it has  £1 of current assets less stock to cover this debt. Stock is removed to give an indication of the cash the business has in relation to its liability. 2010 2011 (1,153.8 685.3)/2210.2 = 0.212 (1641.7-613.2)/1890.5= 0.54403 Acid test ratio = 0.21: 1 Acid ratio = 0.54:1 MS has been able to increase its acid ratio from 0.21:1 in 2010 to 0.54:1 in 2011, yet still this is not close to the ideal ratio and this suggests that the business has nearly twice as many liabilities as it has cash to pay for those liabilities and this might put the firm under pressure. Stock turnover – this compares the average stock to the total cost of stock sold during a year. Average stock is calculated by adding the two years stock and then dividing it by 2. Stock turnover is very important to MS since stock is involved in their normal trading activities. The stock turnover will indicates how quickly stocks are being sold. If the rate is increasing, it can mean that the business is selling more stock or perhaps the average stock held is being reduced. However, if the stock is decreasing, this could mean that the business is selling less stock or the business is holding more average stock. The formula for finding stock turnover is; (Cost of sales / Average stock) = number of times per year Average stock= (685.3+613.2)/2 =649.25 2010 2011 (6015.6/649.25)= 9.265 (5918.9/649.25)=9.117 Number of times per year= 9.23 times Number of times per year= 9.12 times Based on the calculation, the resulting stock turnover ratio was equal to a little more than 9 in both years. This means that MS reduces and replenishes its stock nine times per year to satisfy consumer demand for its products. The goal of any retailer such as MS is to have a high inventory ratio, since its always better to sell inventory in the shortest amount of time possible. The longer a company holds on to inventory, the more expenses it incurs to store it, which ultimately reduces profits. Moreover, when theres low stock turnover, it indicates that the company is failing to accurately project what the demand is for the products it sells. Debtor collection periods -this is the average amount of days for collection period. It is used to measure the business’ efficiency in collecting payment. If the debtors collection period is increasing this tells you that the debtors are taken longer to pay than previously. Formula for calculating the debtor collection period: (Trade debtors x 365)/sales turnover = number of days 2010 2011 (250.3 x 365)/9740.3=9.38 (613.2 x 365)/9536.6=23.46 Number of days = 10days Number of days= 24days There has been an increase in of 14 days in the debtors’ collection period from 2010 to 2011 and this could be a weakness to MS because it could imply that credit control is not being as carefully managed as previously and this could lead to an increase in bad debt, bad debt is when debtors are not able to pay for their amount owed, this is treated as an expense in the business income statement. Creditor payment period: this measures the number of days taken on an average to pay for credit purchases. Since MS deals with lots of stock one of their sources of finance form purchasing goods on credit, if the credit payment increases this shows that the business is taking longer to pay creditors than previously. This change can either be a weakness to the business because it could mean that that the business is exceeding the credit period allowed by suppliers and as a result suppliers may discontinue offering credit facilities. On the other hand it can become a strength because it will improve the cash flow of the business. If the creditors’ collection period is decreasing this means that the company is taking less time to pay creditors. The change in the creditors’ payment period can be interpreted as a strength because the credit control is being more carefully managed and that difficulties with suppliers over exceeding credit limit will no longer occur but it can also be a weakness because the business is now paying suppliers earlier than necessary, resulting in negative impact on cash flow. Formula for calculating creditor payments period; (Creditors x 365) / Purchases = number of days 2010 2011 (1347.60 x 365)/6015.6= 81.77 (1153.8 x 365)/5918.1= 71.16 Number of days= 82days Number of days=71 days Since these figures are decreasing, it shows that MS are taken less number of days to repay their suppliers. However, if the credit payment period between MS and their supplier is 30 days then the business will have to ensure that their debt are repaid more quickly to build up trust between them and the suppliers. In order to maintain the capital structure, the MS has decided to adjust the number of dividends paid to shareholders, return capital to shareholders, issue new shares or sell assets to reduce debt. But if the credit payment period is more than 71 days, e.g. 100 days instead, then MS can wait for some more days to repay their debt as this will can help them get a positive cash flow and will attract investors into the business. Comparing the changes in debtors collecting period and creditors collecting period over the 2 years period shows that MS take longer time to pay their suppliers but it takes shorter time for them to receive payments from their debtors. The reason behind this could be that, since MS is not really a wholesale company they don’t give out lots of credit purchases to their customers but they purchase most of their stock on credit which thereby explains the huge difference between the creditors and debtors collecting period. To be able to manage working capital, there are certain tools in which a business can use. Usually making sure that the business has enough money to pay the bill when they arrive may be good practice however it is important to take into consideration of other tools as it will help you to manage your business more effectively. The following are ways in which a business can use to manage working capital; Credit control: these are practices used by businesses that extend credit to customers for the purpose of financing purchases of goods or services offered by the business. The purpose of these practices is to identify whether a customer is a good credit risk, and to monitor existing customer lines of credit for consistent repayment. As MS don’t give out a huge amount of their stock on credit because they are retailers they still use credit control to assess the few people they sell goods to on credit as this will avoid any bad debt from occurring. From the calculation of the debtors collection period, it is clear that MS debtors are taken longer days to pay than in the previous years, and this could cause cash to be tied up in debtors and MS may not be able to pay for their own debt. To be able to decrease the number of debtors, MS can offer a discount to their credit customers, such as 5% discount if payments are made 14 days earlier rather than the agreed credit collection p eriod. Also MS should make sure that they are paying a close attention on their debtors and if they spot out any late payments, they should send a reminder to their debtor. Stock control: is essential in MS because the more stock it holds the greater the amount of money that is tied up and this can have a significant effect on company profits. There are different types of costs that occur when stocks are held in a business for so long, these costs are; Opportunity cost, this is when capital has been tied up in stock, in this situation a business earns a zero financial return, meaning that no money is raised by holding stock in. Storage and handling, if lots of stocks are held for so long in MS it will have an impact in the warehousing space, and extra capital will be wasted on the controlling of these stock, lighting heating and labour. Spoilage, since MS deals with perishable goods like food, there will be a high risk of these perishable items to get expired. Usually stock will have to be insured against fire damages or theft, and keeping a higher amount of stock in the business it means that the business will have to pay more money on insurance to cover all the stocks available in the moment. Theft and shrinkage, when there is lots of stock held in a business it becomes a target for theft by staff and others. Due to this reason MS has put in a careful strategy called the â€Å"Radio Frequency Identification (RFID) technology†. This RFID uses microchips to wirelessly transmit serial numbers to a reading device wirelessly, allowing goods to be tracked electronically along the supply chain from warehouse to point of sale. Stuart Senior, IT director at MS, said the company wanted to use the technology to ensure 100% product availability, allowing managers to fill stores with as many different types of merchandise as possible. With automatic tracking of stock we can get a perfect picture of the goods we have on the sales floor and in the warehouse, he said. If we can improve data accuracy, we can replenish accurately. Another way I would suggest MS to use to controls its stock is to use â€Å"just-in-time approach† on perishable food. The just in time approach is when orders for delivery are made and ready to be sold to the customers straight away, this will help MS reduce the amount of money wasted on Debt factoring: this is when a third party usually a bank is given the authority to collect a business’ debts in exchange for a percentage of the original debt. Using debt factoring will be particularly important to MS as this will help them improve on their cash flow and wouldn’t have to wait till their debtors are ready to settle payments. Currently MS are not using debt factoring, but I would recommend they use it as this will help them decrease the number of debtors’ collection period and hopefully use the money to obtain new stock or to pay off their creditors. Cash budgets: cash budget is an estimate of future cash income and cash expenditures. Creating a cash budget helps MS to ensure that there is always sufficient cash available to allow the normal trading activities of the business to take place. It will also highlight time when MS have excess cash and this allows the management team in the business to arrange short-term investment of those surplus cash in order to gain maximum return. Lastly cash budgets high light when the business have cash deficits and this allows the management team of MS to arrange short-term alternative sources of finance which can be bank overdraft, arrangement of extended period of credit, or reducing the agreement on the time limits for existing long term debt collection periods. Even though creating cash budget helps MS in the management of its working capital, there is still some limitations, because; 1. If the data included in the cash budget is inaccurate then the cash budget will be of little use. 2. Budget might become an overriding goal and this could lead to a misuse of resources or incorrect decisions been made. 3. If budget are made compulsory instead of negotiated, staff members may become demotivated. 4. If budgeted plans are easily achieved this will make the departments appear to be more efficient than they really are and this will lead to underperformance. In conclusion, the analysis of working capital efficiency of Marks Spencer is showing instability in the business. Stock holding period is around on the same level in 2011 as it was in 2010. MS has increased in its debtor collection period in 2011, which is showing their weak position to collect their receivables early. The business can improve its debtors’ collection period by using the credit control ideas I talked about previously. Since MS is a retail shop, for the companies working capital to increase we have to look at the main operating activities to be able to solve the issues the company is facing at the moment. MS sales have falling from 9,740.3 million in 2010 to 9,536.6 million in 2011 and this reduction in sale will give a bad impact of MS to all its stake holders. It is important for MS to increase the number of sales as this will help their working capital to increase too, to do this the business will have to invest in exciting clothing that are in fashion and also look at their marketing strategy to see if they could include discounts sales or give cash discounts to its customers. Even though MS is doing quite well in its food department it can look in improving even better by comparing their marketing strategies to their competitors such as Tesco and Sainsbury and incorporate the strategy they find helpful from its competitors into their own business. From the creditors payment period ratio figure we could tell that MS takes longer time to repay their creditors, and the reason behind this is that the business has got more than 2000 direct suppliers of finished products. 1500 suppliers are supplying clothing, footwear, beauty and home products and rest 500 provide food products. Keeping the record of 2000 suppliers is not easy and in future complex supplying chain could create problem for MS. MS could improve on this issue by probably looking to find suppliers that could offer more than one products at a cheaper price to the company and this will help to reduce the number of suppliers they have and hopefully be able to keep track of their creditors payment period. In 2011 the acid ratio test which measures the liquidity of the business has fallen below 1 and it is 0.54, this is very unhealthy for MS because it means that for every  £1 liability they owe they have just 0.54p to cover it, for MS to improve on its liquidity, it needs to reduce its expenses that are incurred through rent, payment of indirect labour and professional fees and also the amount of money spent on advertisement. Also if the business has any assets that are unproductive they could sell it and the money gain would help increase their current assets figure. To add up MS can improve profitability by looking at stocks that could be charged at a higher a price or they might want to reduce the price of certain stocks as this will attract more customers. MS can also improve in its stock turnover by targeting at different age groups, because currently the shop has an image of selling clothes that are targeted to people over their 30’s and in the current market of retail clothing it is known that people below the ages of 30 spend lots of money of clothing. The company could focus on buying and selling products that sell consistently, because there are some products that might sit in the shelf for so long and this will cost cash to be tied up in the stock.