Working Capital Simulation Essay
Working Capital Simulation
Working capital is an important part of any business. By definition, working capital is the amount of money a company has to meet their liabilities. It is calculated by subtracting liabilities from assets. In order to keep a business running the amount of working capital should remain positive. However, this is not always the case. Many factors determine the amount of working capital for a business. One of these factors is the decisions made to either accept or decline certain opportunities that will affect sales, inventories, accounts receivable, and the bottom line. Sunflower Nutraceutacils is currently running neck and neck. This relatively new product line that offers health foods and vitamins is barely staying above water with a required cash $300,000. They also have flat annual sales and limited lines of credit. The decisions Sunflower Nutraceutacils make to take on different opportunities need to be reviewed carefully. The wrong choices will negatively affect their finances and this could be detrimental to the company’s success. Phase One
During phase one of the simulation Sunflower Nutraceutacils was offered different opportunities to change their financial position. The choices were to acquire a new customer, tighten accounts receivable, drop poorly selling products, and leverage supplier discounts. The ability to take on a new customer is a good opportunity. By doing this the company was able to increase sales significantly. Taking on a new customer also increases popularity of a new product line and opens the door to other new customers in the future. This decision was also made to counter act the decision to tighten accounts receivable and drop poorly selling products. When customers do not pay their invoices it negatively affects Sunflower Nutraceutacils finances. The money can not be used until its received. The company has several customers who are several months behind.
These customers need to be forced to pay or dropped as customer completely. Poorly selling products are a hindrance for the company as well. Products that do not sell are inventorythat create carrying costs and eventually a loss to the company when the product has become obsolete. Dumping these products would increase capacity for good selling items and reduce inventory charges. Though these two decisions reduce the amount of annual sales this is counteracted by taking on the new customer. These two decisions also free up cash which allows the company to look for more opportunities to improve their finances. The decisions made in phase one increased sales by $1,000,000. EBIT, net income, and company value also increased.
During phase two Sunflower Nutraceuticals was offered three opportunities. The first was to pursue Big-Box Distribution. Mega-Mart is a distribution chain with a large clientele base. Mega-Mart pays invoices promptly and it offered a large sales growth for the company. In order to increase sales and margin it is often necessary to partner with a marketing chain. This allows the product to circulate more globally and it increases sales with little effort on the parts of Sunflower Nutraceutacils because the customer is Mega-Mart who in turn sells the product to their clients. The decision increased sales significantly and in turned increased the top line. The EBIT margin decreased some. The next decision accepted was to increase on-line presence.
In today’s market being online is more important than ever. Customers want the ability to purchase view and purchase items with ease. Increasing online presence allows the company to increase salesand also allows the company to become more involved in the market. They have more of a competitive advantage because the market base increases dramatically. The decision to increase online presence increased sales but had no affect on working capital balances. The third opportunity was to develop a private label for a Spa chain. This opportunity was declined. The reason for this rejection was due to the amount of funds that would be tied up in research, development, and implementation of this product.
Sales would be minimal and increase not possible as this would be a private label product only available to the spa company. This would decrease the working capital, increase inventory, and increase work load. There would also need to be a brand new line installed which would deplete any working capital available. The decisions made in phase two increased sales. They also increased equity to $1,233 and total value to $3,776.
Phase three offered three opportunities for Sunflower Nutraceutacils. The first was to renegotiate supplier credit terms. Accepting this opportunity allowed the company to improve their margin because it decreased the balance of accounts payable. The decision to look at credit terms is always beneficial if the amount can be decreased. This frees up cash that would normally be set aside to pay debts. This cash can then be included in the working capital. The next decision was to adopt a global expansion effort. Sunflower Nutraceutacils decided to take on Viva Familia as a new customer. Global expansion is a difficult decision to make and it is risky. However, when a company expands globally it increases their market stability and client base.
A company that is successful should seek out the opportunity to go global. Making this decision increased the top line but did not tie up much money in inventory. The third decision to make was to acquire a high risk customer. This decision was declined. The reason for decline was because the customer was high risk. Recent decisions to tighten accounts receivable would be forfeited by taking on a customer that the company was unsure about. The company does not want to do business with a customer who can not pay and will not bring in a large amount of revenue.
The company should take care to only take on customers who are beneficial to their business. Another customer would tie up more inventory and cash that might never be regained if the customer were to go rogue on them. The decisions made in phase three increased equity to $1,532 and total company value to $4,076 an increase of $299. Final outcome of the decision making process for Sunflower Nutraceutacils resulted in good sales growth for the company. Final sales increased from $10,000 to $19,247. EBIT stayed strong at $1,525,000. Net income for the company at the end of the ten years finished off at $797 and free cash flow increased from $300,000 to $915,000.
The decision to accept or decline opportunities is something that needs to be carefully considered. Not all opportunities are good ones and failure to properly consider how these decisions will affect the overall finances will result in a negative impact for the company. Opportunities are always risky but by properly evaluating and forecasting those risks a company can make decisions that will ultimately increase their value and their position in the market.
Fundamentals of Corporate Finance, Wiley Plus, University of Phoenix Chapters 1-21 retrieved from https://newclassroom3.phoenix.edu
How to Determine Working Capital Needs, Entrepreneur.com Retrieved from http://www.entrepreneur.com/article/225658