Current Liability Components
4.6 WORKING CAPITAL TRENDS OF THE FIRM
4.6.1 ALTERNATIVE STRATEGIES OF WORKING CAPITAL
Chapter Three discussed the three alternative strategies/policies of working capital. On the other hand as is said the firm didn't have a clearly stated working capital strategy. If there was one, there would be very little to describe. The questionnaire responses and the other side of the evidence (the financial statements) will be addressed in making suggestions regarding closest strategies the firm should follow.
4.6.1.1 Analysis based on the questionnaire responses
As the questionnaire reveals there is no clear working capital policies or strategies the firm would follow. There reasons could be:
Firstly, following the joint venture the firm focused its attention on boosting production capacity and expansion of the plant rather than on drawing and designing policies, in particular financial policies. Secondly, the firm as with most small and medium scale manufacturing firms in developing economies lacks skilled experts in the finance and commercial section, and at the same time, it is understaffed.
When the managers were asked about how they treat the firm's working capital needs and what working capital policy they follow, in all levels they were in almost unanimous agreement in their responses (See Questions no. 5, 7, 8, 9 & 10 of Appendix 1).
They said that very little of the working capital policies, is described in the company manuals and furthermore they added that a cost benefit-analysis is done when they introduce financial policies, including working capital, but that is done informally. They also stated that the strongest features that attribute the working capital needs of the firm and thereby would shape their working capital policies are, compliance with budget, company traditions and customs, and monitoring and evaluation.
Compliance with budget: The budget dictates how much receivables and inventories to hold, whether to sell on a cash basis (custom of the firm) or to target credit, whether there is a need to finance their shortage of cash from bank overdraft or to raise additional capital from owners and so on.
Company traditions and customs: As it is common in most developing economies' firms, the rule of thumb, or the traditions the firm once taken on would remain one of the strongest features in decision-making. For example, how much materials to purchase and in what season, what type of product to produce, to whom (the client) to sell, how much to invest in current assets, when to collect cash and so on, may rely on company customs.
Monitoring and evaluation: The level of investment in working capital can serve as a catalyst to prompt internal control of the firm. For instance, if the current ratio is high it may indicate that the profitability of firm would be endangered because too much capital is tied up either in receivables or inventories. On the contrary, if this ratio is low it may indicate to the firm that its liquidity would be threatened.
Finally the managers described that sales and purchasing are the most important activities related to working capital needs of the firm and production, marketing, budgeting (finance) are considered of major concern by the firm towards effective working capital management whereas, construction and contracting and expanding firm operations are not.
The general manager stated in the questionnaire, "We don 't have any stated working capital policies or strategies in our working capital needs with regards to how much to limit the level, when to increase the level and so on. It all depends on orders received from clients and our production schedule. "
The financial manger regarding this subject said, "Financing of our working capital needs in majority is from equity financing. This is because we have got plenty of financing funds from the owners. There is no need to turn to bank loans which claim interest as long as we have a safe haven in financing".
4.6.1.2 Analysis Based on financial statements
The financial statements are the archival documents, which contributed as secondary data to this study. In Chapter Three of the case study an abridged financial statement is presented to help in analysis of the working capital strategies and ratios.
Table 3.8 illustrates the percentage of current assets to total assets of the five years period.
The current assets constitute about 68 percent of the total assets on average during the five- year period. This indicates that the current assets level investment is far higher than the fixed assets. Besides, the investment in current assets has increased constantly throughout the period. It increased by 8 percent in 1999, by 4 percent in 2000, by 61 percent in 2001 and by 21 percent in 2002 but not consistently with the increase in sales volume in each year. Sales increased by 47 percent in 1999, by 81 percent in 2001, by 40 percent in 2002, but reduced by 4 percent in 2000.
Against this backdrop it may be apparent that the working capital strategies adopted by the firm would be closer to the conservative (relaxed) approach. In fact it can be said that it is more conservative because the management's view seems inclined towards investing a considerable amount in current assets to avoid a liquidity problem.
Moreover, based on the given data one can observe that the working capital financing policies of the firm would be inclined to look more conservative in nature, because the firm finances only a few of its current assets whether it be temporary or permanent, from current liabilities or short term financing. The major part of the current assets is financed from own funds, that is, from retained earnings or equity capital. Even they didn't have any long-term financing sources (loans). The current liabilities constitute, on average, 15 percent of the total liabilities and capital and by definition this denotes only 15 percent has been used as short-term to
finance current assets. However, the major part of the current assets was financed by equity capital.