WORKING CAPITAL, CASHFLOW, AND BUDGETING

Executive Summary

The present paper has two parts. Part A has the first section that discusses the meaning of profit and cash flow and how they differ from each other. The second section addresses the meaning of working capital and the meaning of receivables, inventory, and payables. The third section address how changes in working capital affect cash flow in the last section of part A analyses and recommends steps to improve cash flow in the organization part B addresses budgeting and its application to Boatworld in its projected expansion. The purpose of preparing a budgeting and different forms of budgeting in relation to Boatworld company, their strengths, and weaknesses and how they apply to Boatworld. The last section of the part B address the traditional budgeting system and alternative budgeting system that applies to Boatworld, in addition to challenges of traditional budgeting system and why it is not the most appropriate in meeting the company’s demands.

PART ONE

Cash Flow and Profit

Cash flow and profit are two important financial parameters that need to be kept on track for the growth of an organization. Cash flow is the finances that flow in and out of the company from different operations, investments, and financing activities. Cash flow is important as it is required to meet current and future objectives.

On the other hand, profit is the remaining money from sales revenue after all the company expenses have been subtracted (Atrill, 2009). Cash flow in an organization determines the company’s business viability, and poor cash flow management can lead to the failure of a business, unlike profit, which is important as it ensures the thriving of a business. Therefore, for a business to continue its operations, it must generate profit and also operate on a positive cash flow.

Working Capital, Inventory, Payables and Receivables

Working Capital

Working capital is money that is available to a firm and used in its daily operations. Working capital is critical as it measures a firm’s efficiency and liquidity, as it includes cash, accounts payable, accounts receivable, debt due in a given year, among other short term accounts that are present in the organization (Atrill, 2009).

Payables and Receivables

Account payable is the money that is owed for the purchase or goods and services an dis indicated as an outstanding or open liability since it is not paid. On the other hand, trade receivable is the money owed to a corporation as a result of service or goods delivery on credit (Atrill, 2009). Accounts receivables claims are expected to be collected in cash within the established timeframe.

Inventory

Inventory refers to the raw material that is used to produce goods that are available for sales or goods that are available for sale (Atrill, 2009). Inventory is one of the important assets of a business as the turnover of inventory represents one of the main sources of revenue to the corporation.

Working Capital Impact on Cash Flow

Changes in the balances of each line item of working capital from one period to another have a major impact on a firm’s cash flow (Watson & Head, 2010). Positive working capital that is recorded when the company has more current assets than liabilities is an indication of financial strength in the company (Aktas, Croci & Petmezas, 2015). However, excessive working capital is a sign that the firm is not effectively managing its assets. Negative working capital that is recorded when the current liabilities surpass the current assets is likely to occur when the company has had a large cash outlay due to a large purchase of products from suppliers (Aktas et al., 2015). A negative working capital for an extended period is a concern to the company’s cash flow as the company is likely to be struggling in its operations, and is likely to rely on borrowing or depend on stock issuances in order to boost their working capital.

Application of Concepts to Boatworld Case

Brighlawns Ltd (BLL)  has a huge turnover; however, cash flow is a challenge to the company, which can be attributed to the challenges affecting the company’s operation. The company requires a lot of resources to produce the products, and with the cash flow challenges, the company’s debt is likely to grow continuously as more inputs are required to meet market demand. Additionally, with the purchase of a 30% stake in the ornamental garden fountains and water features, the company will require more investment to ensure its operations are not interrupted due to a reduction in cash flow.

BILL has a big account payable compared to the account receivable. The imbalance is likely to have an impact on the working capital and the overall operating cash flow. The company has recorded a profit in the last year; however, with the purchase of shares and the unpaid inventory to the company, the turnover is likely to increase significantly, which will consequently increase working capital. At the company’s London site, BLL has a high inventory attributed to the build-up of materials and supplies and the suspension of the work on the site. The stock is important as it is likely to be used after the issue has been solved with the supplying BricoFrance company; however, the inventory will affect the company cash flow in the future as the company will have to pay for the inventory which will increase the working capital.

Analyses and Recommendation

As indicated in the case study, BLL has major cash flow problems attributed to the cash flow management in the organization. BLL has a large turnover of more than 50 million and has a debt of 18 million, which has increased from 16 million as of the year before. The company has invested 10 million in ornamental garden fountains and water features and is scheduled to pay an 8 million advance fee for exclusive use of the designs. The company is owed an additional  2 million from Bricofrance for a consignment delivered and works in the site have been suspended; hence, no revenue generation operations are being carried out. The contractor has also threatened legal actions to the company for withheld payments. The company can take up various steps and measures to improve its cash flow through effective management of the working capital. The steps include;

• Acceleration of cash inflows
• Minimizing expenses
• Delay or cut back on expansion plans

Acceleration of Cash Inflows

BLL can improve its cash flow by accelerating its cash inflow, which is applicable by requesting payment from the consumers for goods delivered Atrill, 2009). As indicated, the BLL manager is reluctant to press his key customers too hard for payments. However, this move is likely to affect the company’s cash flow. The manager should, therefore, negotiate payment plans with its consumers to ensure that the money owed by the C&P company is paid hence promoting efficient cash flow and shorten the receivables period.

BLL should also ensure that the dispute with Bricofrance is solved in order to ensure the 2 million receivable is released hence increasing the company’s cash flow. The company can solve the issue and work out a payment plan with the company hence increase the cash flow and reinforce their working relationship.

Minimizing of Expenses

Cutting down on cost by reducing the purchasing of items unless they are critical to the business can help BLL improve its cash flow. The company should cut down on expenses by withdrawing from payment of 8 million advance fee for exclusive use of the company’s design as it is not a critical move for the company. Cutting down on this cost will not only increase the company’s cash flow but also help the company in evading any debt increment.

The company should also pay its contractors and settle the issue before any legal action is taken against them as extra costs are likely to occur. Also, settling the issue with the contractor will open up the delayed operations in the company’s London site. The current stock in the London site can be used by the company hence cutting down any extra expenses that may emanate from purchasing new stock.

Delay or Cut Back on Expansion Plans

More than 10 million of the cash outflows of the BLL company are attributed to its 30% stake purchase, which can be identified as an expansion of the company. In addition, the company intends to spend an addition of 8 million for the exclusive use of the designs, which accounts for company expansion. Delaying the expansion will help the company conserve cash in the short term. The company’s expansion plan can be carried out in the future ones all the debt is settled or reduced significantly.

PART TWO

Budgeting

A budget is an approximation of expenditures over a given period, that is compiled and evaluated over a given duration. Budgets are an important part of management that helps in the decision making policies in planning, cash flow, expenditure, and project management. Business managers and corporations require to have the prospect of their business, and hence, the budget is a critical part of the business planning process (Atrill & Mclaney, 2009). Budgeting is important to Boatworld as it can help alleviate any imminent problems that are likely to occur in its planned opening up on new company’s outlets and the rollout of 30 boats with support facilities.

Purpose of Budgeting

Budgeting is important to a company due to various reasons, including.

• Services as a communication tool
• Planning business activities
• Performance evaluation and motivation tool
• Operations coordination
• Managing of the company’s operations

Serves as a Communication Tool

Definite forms of communication must be established within an organization in order to ensure the effective functioning of the company’s operations. Communication within an organization is imperative to ensure all concerned stakeholders are informed of plans, policies, and issues experienced within the organizations at different levels (Atrill & Mclaney, 2009). Different stakeholders have a role in the preparation of the annual budget. The process of budgeting works as a communication tool to ensure all the bodies within the organization are made accountable for executing the budget (Drury, 2005). The management uses the budget to communicate their expectations to the stakeholders so as every party can understand their role and work towards their set objective.

Planning Business Activities

A budget indicates how an organization is likely to perform financially when different events, plans, and measures are taken into considerations. The budget ensures that the management plans for future operations and they consider different situations that may occur in the future and outline different approaches that they should carry out in response to any changes in the future (Atrill & Mclaney, 2009). The budgeting process ensures the managers predict problems before they occur and derive solutions that are in line with the company’s budget.

Performance Evaluation And Motivation Tool

A budget is an important part of managers’ performance evaluation. Business managers and administrators use the budget to influence managerial performance and inspire their employees to work towards meeting the company’s objectives and goals. A budget is used as a standard in which employees can work under the set conditions to achieve the company’s goals and objectives. A company’s performance is assessed by measuring the accomplishments in meeting the set budget (Drury, 2005). The budget, therefore, serves as a vital tool to inform the stakeholders of how well they have performed in meeting the set objectives.

Operations Coordination

Different operations in an organization are coordinated and reconciled using a budget, making it a common plan. To ensure efficiency within an organization, different operations of the company can be integrated together using a budget (Atrill & Mclaney, 2009). The budget compels the administers to analyze the link between different operations from different departments and coordinate to ensure that all stakeholders work in harmony to fulfill the organization’s objective.

Managing of Company’s Operations

Budgeting helps the stakeholders to manage and control different operations within the organizations. The budget is used as a comparison tool where the findings and the finances budgeted are compared to determine the expenses that are not in line with the company’s budget (Atrill & Mclaney, 2009). The budget is, therefore, important in the determination of inefficiencies that occur in the organization.

Traditional Budgeting

Traditional budgeting is a budgeting approach that is dependent on the previous year’s expenditure and is used to budget for the current year’s spending. The traditional budget offers a framework to manage to make it easy to control different operations effectively, as it is easy to prepare and implement (Weetman, 2010).

strengths

Traditional budgeting is important in promoting decentralization in the organization as any department of the corporation can develop a budget on its own and make changes within the set limits.

weaknesses

Traditional budgeting is, however, inflexible since after its preparations can not be altered in case of changes in the future.

Traditional budgeting promotes bureaucracy as it is developed by the top management. Different departments and operations in the organization may require budgetary changes depending on the business environment; hence, traditional budgeting is a limitation when planning for the future.

Boatworld, since its inception, has operated using the traditional budgeting system; however, the approach is likely to be a challenge in the plans of the company. The traditional budget may not be applicable as a lot of changes have occurred since the inception of the company, and different allocations may be inaccurate with the changes that have taken place within the past 25 years, which are likely to be carried forward into the projected new branches. Also, application of the traditional budget in planning for the company’s future, which encompasses the opening of new branches in Germany and Netherlands can be a challenge since the company has not operated in these markets before hence no past budgets that can be used as the basis for the new outlets. The outlets are also in a new market, which differs in terms of expenses since different locations differ in terms of cost of operations. The company is also likely to be faced with the unpredictability of the business environment with the preparation of the United Kingdom to leave the EU, which is projected to have an impact on company operations; hence, the Boatworld requires a flexible budget that can be altered to meet the market demands.

Rolling Budget

Rolling budget is the incremental extension of the present budget model as it is continuously rationalized to add a new budget period. The budgeting strategy requires a corporation to add the costs of operations (Weetman, 2010). In Boatworld, the new capital to purchase new boats, cost of rent, support staff salary, maintenance, and cost of marketing in the new market are easy to include in the rolling budgeting approach.

Strengths

Boatworld company can use the rolling budgeting method in its new outlets as it is easy to develop and can be used to mitigate any changes in the new business environment. Rolling budgeting offers stakeholders a chance to recognize what is important for the business at a given time (Weetman, 2010). The rolling budget will offer Boatworld a chance to amend changes based on the new business environment constantly.

Weaknesses

the rolling budget can easily be manipulated, leading to an increased expense to the company operations, especially in different departments of the company (Weetman, 2010).

Zero-Based Budgeting

Zero-based budgeting a form of budgeting in which all the expenditures are justified at a given time. Administrators are responsible for justifying how the finances are used in every budgeting time frame (Weetman, 2010).

strengths

Unlike the traditional budgeting that is based on a fixed budget from the previous years, the approach applies to Boatworld as it can help the company determine the operating costs, for instance, rent in the new outlets and other expenses in the markets that are to be established.

weaknesses

The approach is resource-intensive as it takes a lot of time to develop and review, unlike the traditional budgeting system that just requires modification (Weetman, 2010).

The approach is prone to manipulations by stakeholders in order to get more resources into different operations of the company.

Activity-Based Budgeting

This budgeting approach uses the activity cost of every operation after putting into perspective the overhead expenses. The approach is based on present activities carried out in the firm (Weetman, 2010).

strengths

The approach analyses every activity in a firm, and budgets are developed based on the results to ensure efficiency in the firm’s activities (Weetman, 2010). The approach allows more control over the budgeting process, and expenditure planning occurs at a specific level, which gives the firm useful details about plans.

weaknesses

the activity-based budgeting is time-consuming and expensive to develop and maintain compared to the traditional budgeting approach.

Analysis of Traditional and Alternative Budgeting System

Boatworld uses the traditional budgeting approach throughout the company operations, as it is easy to manage and maintain.  Boatworld can prepare its new budget based on its previous year’s budget and make changes based on inflations and other costs. The company can use the traditional budgeting system in its headquarters where there are different operations, including human resources, finance, and administration. The outlets and the proposed outlets can make modifications to the budget based on the expenses and inputs required in the rest of the regions, which are then reflected in the traditional budget. The traditional budgeting approach is, however, challenging to the company due to the new market in Germany and Netherlands as the company has not had any experience in the market, which can be used as a basis for the corporation.

The projected opening of the new outlets will require varying expenses, regulations, changes, and threats in the new market that require a cohesive budgeting approach that can aid Boatworld transform to meet the changes in the market. The company’s head office Boatworld can continue to use the traditional budgeting system and incorporate the activity-based budgeting in the rest of the centers, which can be modified based on the different activities and expenses as they arise. After the establishment of the new outlets, the company can integrate the traditional approach, which is easy to manage.

Reference List

Atrill, P., 2009. Financial Management For Decision Makers, FT Prentice Hall. Financial Times, England.

Aktas, N., Croci, E., and Petmezas, D., 2015. Is working capital management value-enhancing? Evidence from firm performance and investments. Journal of Corporate Finance, 30, pp.98-113.

Watson, D., and Head, A., 2010. Corporate finance: principles and practice. Pearson Education.

Atrill, p. And Mclaney, e., 2009. Management accounting for decision-makers. Pearson

education LTD.

Drury, c., 2005. Management accounting for a business. Cengage Learning EMEA.

Weetman, p., 2010. Management accounting. Pearson Education LTD