Management of Working Capital Case Study: George's Trains
Actionable information on the future and current cash flow, working capital, and capital budgeting are what managers in both small and big businesses work hard to obtain in their daily activities. Working capital is can be used to measure up the liquidity of the operations of the business (Sullivan 2010). It is usually the current assets subtracted from the current liabilities. Managers are normally concerned about working capital and would always seek the best practices to achieve a better working capital management. This report tries analyses the case study of George’s train business with an aim of understanding; working capital practices, capital budgeting, and how important these concepts are to the business.
Description of Capital Practices and Capital Budgeting Analysis
In George’s capital budgeting practices, many potential pitfalls may plunge the business into a big problem unless proper care is taken. George plans for long-term investment and decides of buying a house to expand the business (Thomas, 2013). This was a very brilliant idea as moving to another place would have led to the loss of the already established customer base. However, the decision seems to have come too soon, and he has to use most of the borrowed money from the bank (Tommy, 2013). The disadvantage with financing investment through a bank loan is the high interest rate especially when the borrowing is on a long-term basis (Jean, 2013). The cost of borrowing may reduce the business current assets which are very essential for taking care of the day today activities. George borrows to buy the business and before long enough, he again goes to the bank to buy the premise that forces him to cut down expenditure to a lower minimum. This is a very dangerous undertaking as it may reduce the potential of the business to meet short-term obligations. He reduces the turn over to a very low level because of the burden of loan with the hope that it could pick faster (Sullivan 2010). This assumption may be very risky especially when demand goes high and loyal customers find that there are no adequate products, they will be inconvenienced, and George can easily lose them to the competitors. The other problem is the decision of investing in new liners when the business had no many funds to do that. George needs to do his planning and manage his capital budgeting to avoid any potential failure especially when venturing into a new business (Thomas, 2013). While budgeting for the level of the inventory to stock during peak and off peak periods, George uses the past record of sales and inventory stocking to reorder. He also uses anticipated demand to manage cash flow; he also uses the anticipated demand to determine the quantity of inventory to order (Jean, 2013). This may not be so accurate since past records may never be so accurate, and therefore, George should look for a better capital budgeting technique to be able to calculate the level of inventory to stock, and to calculate the cash flow (Thomas, 2013).
Simple Cash Flow Statements
George has a number of sources of finance, and a number of areas of expenditure, from this sources and expenditure, a simple cash flow can be drawn. One major area where George gets funds is from the borrowed loans, sales from the inventory, and payment from the repairs (Sullivan 2010).
A simple illustration of cash flow statement indicates that George has a negative cash flow which implies that the he has more obligations than the owned finances. More of the financing activities come from borrowed loans that are weighing the business down (Jean, 2013). He takes the first loan to purchase the business and within a short period, he goes for another loan to purchase the building (Varshney, 2011). He should find a more economical financing activity such as donations, retained profit, and such like to reduce the burden on the loans.
Reasons for Debates on Capital Budgeting in Boardrooms
Capital budgeting has several advantages to those businesses that practice it. As a result, most businesses normally have capital budgeting as main agenda in board meetings. One reason that makes capital budgeting a major concern in most businesses is the need to have forecast that is free from error (Varshney, 2011). Most of the forecast done are prone to error that always lead the business into losses. Poor decision on investment can lead serious financial distress, which mere end up as bankruptcy. However, a successful financial performance of a firm can be achieved when a proper decision is done concerning capital investment. Through capital budgeting, businesses are able to achieve a tactical capital investment that will see the performance of the business rise consistently (Tommy, 2013). The other reason firms want to embrace capital budgeting is because it has the effect over a longer period, implying that it will affect the businesses for a longer time. When a wrong decision is made, the business will feel the effect for quite a long time. Capital budgeting involves large funds that need to be properly accounted for to avoid potential loss (Debonse, 2012). Most of the decisions on capital investments are normally irreversible; therefore, making a mistake can cost the business a lot. Most of the boards find capital budgeting a very difficult thing to make (Varshney, 2011). This normally attracts many heated debates as an overall assessment is done to proposed decisions. Every business that plans to remain competitive must adopt the culture of capital budgeting to ensure that the road map for the future is clearly drawn.
Ways in Which Capital Budgeting Promote Financial Health
A properly planned capital budgeting becomes a major solution to the financial problems in the organization. A business that has a team that comes up with a well-planned capital budgeting normally reduces forecasting error (Tommy, 2013). The business will be relieved from the stress of uncertainty as all are captured in the forecasted budget (Hays, 2014). The organization is able to design contingency measures to counter the identified risk within the forecasted budget of the firm. With capital budgeting, the organization is able to plan for finances both in the long-term and short-term, ensuring that there are adequate fiancés to cater for the short-term obligations. It is through capital borrowing that the organization can be able to identify a viable investment from a poor one (Varshney, 2011). This saves the organization stress of possible failure from the investment taken. All shows that the growth of any business require the knowledge of capital budgeting. With the knowledge of capital budgeting, the business stand a better chance of growth as finances will be allocated to buy more assets (Benour, 2012). Therefore, capital budgeting can be a good way of promoting the financial position of any given business.
Application of Financial Techniques
Using financial techniques, such as the present value of money, the performance of the business can be significantly enhanced (Tommy, 2013). When planning to invest in any long-term, or even short-term, there is the need to know how much the project cost today and the possible cash flows in future. The potential of any investment should be determined in prior before any fund is committed. Since a dollar today much higher than the same dollar in a future, an entrepreneur need to identify how much should be invested today to get a specific amount in future (Tommy, 2013). The rate of return of a proposed investment should be calculated for a variety of investments to choose the one that has the higher return, which will be very healthy for the business.
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