EXECUTIVE policy guarantees the smooth functioning of the

EXECUTIVE SUMMARYAN1 

 

INTRODUCTION

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The working capital policy refers to the level of investment in current assets for achieving their targeted sales. The policies are typed as restricted, relaxed, and moderate. The relaxed policy has higher level of current assets, restricted has lower levels of current assets whereas moderate positions itself between relaxed and restricted.

THREE TYPES OF WORKING CAPITAL POLICIESAN2 

1.    RESTRICTED POLICY

In this policy, the estimation of the current assets for achieving targeted revenue is done very aggressively without considering for any contingencies and provisions for any unforeseen event. These policies, after decision, are forcefully implemented without tolerating any deviations. This policy adaptation would advantage of low working capital due to low current assets level. Therefore, this policy saves interest cost of a firm and produces higher profitability, that is high Return on Investment (ROI). It is worth noting this policy would disadvantages of high risk due to its aggressiveness. This policy also called as aggressive working capital policy.

 

2.    RELAXED POLICY

Opposite the restricted policy, in the relaxed policy the estimation of the current assets for the achieving the targeted revenue is prepared after careful consideration of uncertain events such as seasonal fluctuations, a sudden change in the level of activities or sales etc. After the reasonable estimates also, a cushion to avoid any unforeseen circumstances is left to avoid the maximum possible risk.

 

 

The firm’s that implement the relaxed working capital policies assume an advantage of almost no or low risk. This policy guarantees the smooth functioning of the operating cycle. It is worth noting this policy would disadvantages of lower return on investment because higher investment in the current assets attracts higher interest costs and reduces profitability. Due to its policy nature, it is also called as conservative working capital policy.

 

3.    MODERATE POLICY

A balance between restricted and relaxed policy and lies in-between the two, the moderate policy assumes the characteristics of both. To strike a balance, the moderate policy assumes the risk higher than relaxed and lower than restricted. As of the profitability point of view, it lies between the two policies. The biggest benefit of this policy is that it has reasonable assurance of smooth operation of working operating capital cycle with a moderate profitability

 

CASE 2 – PART AN3 1

2015

2014 (25% less than total current assets of 2015)

2013 (54% less than total current assets of 2015)

Cash

342500

Marketable securities

78000

receivables

210000

inventories

375000

Total current assets

1005500

754125

462530

SALES (2015,2014,2013)

3,718,500

 

According to the total current assets of the course of three years, the GsBrow publishing company had reached the relaxed working capital policy in 2015, because the total current assets (1,005,500 USD) is bigger than of 2014 and 2013 while remaining the sales almost constant (3,718,500 USD). In 2014, the publisher company had reached reaches the moderate working capital policy because of the lower level of cash inventory, marketable securities, receivables, and inventory as summation (754,125 USD). Moreover, the GsBrow had reached restricted working capital policy in 2013 because of the lowest total current assets in this year (462,530 USD) comparing to 2014 and 2015.

CASE 2 – PART AN4 2

Arranging the given data to prepare the balance sheet of the GsBrow publishing company as of 2015.

 

GsBrow balance sheet – 2015

Assets

Current assets

Cash

342,500

Marketable securities

78,000

Receivables

210,000

Inventory

375,000

Total current assets

1,005,500

Fixed asset

Long term investment

162,000

Liabilities and equity

Current liabilities

Account payable

262,000

Long term loan (10 years -4.4%)

1,650,000

 

 

 
 
YearAN5 

 
 
current assets

 
 
Sales

 
 
Turn Over

2015

1,005,500

3,718,500

3.698160119

2014

754,125

3,718,500

4.930880159

2013

462,530

3,718,500

8.03947852

 

The GsBrow publishing company had implemented low current assets in 2013, i.e. high turnover (8.03947852) for the firm and high sales rate. That shows the company has followed a restricted finance policy. This policy, on one hand, would advantage of use of low working capital due to low level of current assets. Moreover, this saves interest cost that results in higher profitability (high Return on Investment ROI). On the other hand, the policy would disadvantages of high risk due to its aggressiveness. That is why it is called as aggressive working capital policy.

In 2014, according to the findings, the GsBrow publishing company had implemented the moderate finance policy. The total current assets had increased (754,125AN6 ) compared to 2013 (462,530) with moderate turnover (4.930880159) while taking the sales constant (3,718,500). This policy benefits the publishing company of the assurance of smooth operation of operating capital cycle and the moderate profitability.

In 2015, the publishing company’s total current assets had increased (1,005,500) comparing to the years 2014 and 2013 respectively. The company had implemented the relaxed finance policy with low turnover (3.698160119) compared to 2014 and 2013. This policy, on one hand, ensures the low or no risk and a smooth working operating cycle. On the other hand, it brings low return on investment as for high investment in the current assets would attract high interest cost and lowers the profitability. Due to its conservative nature, this policy called as conservative working capital policy.

 

Case 2 – Part 3

Companies of seasonal industries such as in our case a publishing company (GsBrow) is adopting a conservative working capital policy from the three main policies (Maturity matching, Conservatives and Aggressive). Because the fixed assets, temporarily and permeants current assets is funded by long term sources to buffer against risk. In a conservative working capital policy, there’s plenty of cash in the bank, the warehouses are full of inventory and the payables are all up to date. Conservatively managed working capital will help lower the risks of short-term cash shortages but on the other hand long term may not provide much financial flexibility, because excess cash doesn’t earn much of a return but it ensures that a pre- determined level of finance will be available for a pre-determined period of time.

The decision to use long term loan/debt depends on explicit and implicit cost of this form of finance. This in turn necessitates a careful consideration of the interest rate, maturity or payment dates, loan size, borrower risk etc..This attribute minimizes the risk of an abrupt shortage of finance which in turn could have serious implications for liquidity.

Choosing between the approaches;

(1) GsBrow has borrowed a long-term basis (conservative approach) its interest costs will be relatively stable over time. But if it uses short-term credit, its interest expense can fluctuate widely, perhaps reaching such high levels that profits are extinguished.

 (2) If GsBrow borrows heavily on a short-term basis, in other words (Aggressive approach) a temporary recession may negatively affect its financial ratios and render it unable to repay this debt as they are a seasonal firm and the size of the current assets has been reducing over the years. Recognizing this point, if GsBrow financial position is weak, the lender may not renew the loan, which could force the borrower into bankruptcy.

In our case study, the size of current assets in 2014 and 2013 has reduced, is not required to take more risks because the customer of their product is almost the same during the years, also the product of the company for previous years remaining in the inventory. Furthermore, books have declined in popularity in 2015 and GsBrow was stuck with a larger inventory of obsolete books and according to the inventory activities for the first quarter of 2015 the sales was not reaching the forecasting amounts. For example, GsBrow company in January, they have purchased $401000, while in the end of March, which is also the end of the season they had $286000 sales. If we are comparing the total amount of balance inventory with total sales its half of the money planned to sales but not reached, while this is the pick time for the company’s sales.

Considering all the points mentioned above, this leads us to advise that the company should stay in the same conservative strategy because a conservative policy suggests not to take any risk in working capital management and to carry high levels of current assets in relation to sales. Surplus current assets enable the firm to absorb sudden variations in sales, production plans, and procurement time without disrupting production plans. It requires to maintain a high level of working capital and it should be financed by long-term funds.

 

Case 2 – Part 4

Since GsBrow is approaching conservative strategy, in which it uses the long-term loan/sources. The figure shows below the dashed line above the line designating permanent current assets, indicating that long-term capital is used to finance all the permanent assets and to meet all of the seasonal needs. And by that GsBrow beside using a small amount of short credit to sell their product during the months of September till March, but it also meets all of its seasonal needs by “storing liquidity” in the form of marketable securities. This is the most suitable strategy that GsBrow is implementing it.

 AN1Will summary the whole idea at the end as to write this, we need to combine the result of all parts of the case….

 AN2Do not forget references: for Definitions: https://efinancemanagement.com/working-capital-financing/working-capital-policy-relaxed-restricted-and-moderate

 AN3Put caption for tables and figures later…

 AN4Place the caption of the table

 AN5Caption: the current assets vs. sales and turn over of the GsBrow publishing company as of 2013, 2014 and 2015.

 AN6Dollar sign to all figures?