Accounting Unit: 10

Managing Finances: Working Capital and Cash Management.

Assignment on: The scope of financial management, working capital needs and
funding strategies.

Prepared by:

SAKIB RAHMAN
ID: 5145

Prepared on:
Anlima Group

Corporate Headquarters :

Anlima Group
Suit # 4/3, City Heart
67 Naya Paltan, Dhaka - 1000
Tel: 88-02-9349881-4, 9341373, 8317216
Fax: 88-02-8317184
E-mail : mailto:info@anlima.com
 Acknowledgement

In preparing this assignment a long, ambitious and rigorous work plan was constructed.
For the successful completion of the work plan the unbridled support of my subject
coordinator and mentor came as a veritable source of knowledge and mental strength. A
especial thanks goes to the spokesperson of National Credit & Commerce Bank Ltd. for
his time, resource and continual cooperation and assistance.

I would like to express my sincere gratitude to assignment super-visor and subject

coordinator, MD. Noman H. Chowdhury, for his timely instructions and interventions
keeping the project focused on its objective.
 Table of Contents

Table of Contents.............................................................................................3

Accounts Receivable......................................................................................20

Inventories.....................................................................................................21

COMPANY BACKGROUND

A VISION TO CHERISH
The company’s has a vision where they have relentless endeavor

to
contribute in Bangladesh’s economic advancement in the global context. The company
has a motive to work for the enhancement of the country's position as an international
provider of quality products.

MISSION

The mission here is to strive hard to be a provider of world class textile and garment
products and services, while positioning the country in the higher value segment of the
international textile market. The company’s goal is to satisfy customers through
technological superiority and synergic synchronization of man and machine, tailoring
quality products and services to harvest the reward of responsibility.

VALUES TO UPHOLD

Anlima Textile Ltd. holds the value to create a better future for the stakeholders of the
company, maintaining high standards of integrity, propriety and goodwill in shouldering
social responsibilities. To assimilate efficiency, innovation and state-of-the-art
technology for developing operational infrastructure and to establish linkages and
integration the company forwards its activities at achievable targets. The management of
the company also works to foster an environment conducive to grooming productive
talent and to forging mutually rewarding relationships with employees, clients and
society, based on the highest standard of professionalism.

GOALS TO PURSUE
The goal of the company is to satisfy customers through technological superiority and
synergic synchronization of man and machine, tailoring quality products and services to
harvest the reward of responsibility.

DIVISIONS

Anlima Textile Ltd. - An export oriented knit textile composite project with state-of-the-
art knitting dyeing, fishing and garments machinery under one roof.

Products :

 Knit Fabrics
 Dyeing
 Finishing
 Garment

Anlima Yarn Dyeing Ltd. - The house of quality yarn dyeing catering to the need of
international textile market - knitting & weaving fabrics and sweater factories.

Products :

 Dyeing Services
 Sewing Thread
 Dyed Cotton Yarn

Allied Enterprise Ltd. - Builder of prestigious shopping-cum-commercial complex.

Products :
  Office Spaces

Anlima Build-Tech Ltd. - Developer of luxury residential apartments for the clients
looking for real value for their money.

Products :

 Flats of different sizes

Task 1:
Analyze the nature and scope of financial management activities of your choosen
organization.
Anlima Group’s financial management is about planning and controlling the financial
affairs of the organization, to ensure that the organization achieves its objectives,
particularly its financial objectives. This involves decisions about:
• How much finance the business need for its operations, both its day to day
operations and for its long-term investment projects.
• Where the finance should be obtained from: long-term finance is raised as equity
capital (share capital and profits) or as debt capital, and short term finance is
obtained mainly from trade suppliers and bank overdrafts.
• What should be the balance between long-term and short-term finance, what
should be the balance between equity capital and debt capital
• Investing short term cash surpluses
• Ensure that the providers of finance are suitably rewarded: Anlima group make
sure that it can meet the interest payments on its borrowing, and companies must
ensure that shareholders receive an appropriate dividend out of profit
• Where appropriate, protecting the organization against financial risk

Anlima Group’s management accounting systems provide information, both financial and
non financial, to assist management with making decisions about planning and
controlling the resources of the organization. Important elements of Anlima group’s
system of management accounting are:
• Financial planning, particularly budgeting
• Control reporting systems, particularly budgetary control and variance reporting
• System for monitoring the costs and performance of Anlima group
• Providing information to assist with decition-making, both short term decisions
and long term decisions (investment decisions).

Comments-

Financial accounting systems of Anlima are concerned with reporting the financial
position and financial performance of the organization. It reports on historical
performance. However, the systems for reporting historical performance are also relevant
for planning for the future. An important aspect of Anlimas’ financial management is to
plan and control strategic and operations so that financial performance is consistent with
the organization’s objectives.

Task 2:
List down different stakeholders’ names of your chosen organization and briefly
describe their relationship with the organization.

Stakeholders and their objectives:

Different stakeholders’ names of ANLIMA GROUP and their relationship with the
organization are as follows:

INTERNAL:
• Employee: Want to maximize rewards and prolonged employment assurance
• Managers: Want to maximize rewards and prolonged employment assurance

CONNECTED:
• Shareholders: Wants to maximize their wealth
• Debt lenders: Wants to increase their invested money
• Customers: Wants better services and the assurance of security for their valuables
• Bankers: Wants to expand their increase their financial transection
• Suppliers: Wants to be paid in full and in time

EXTERNAL:
• Government: Wants sustained economic growth and high levels of employment
• Legal governing bodies: Legal bodies enforcing legal mandates standardizing the
protocols for running a bank.

Although the theoretical objective of a company is to maximize the wealth of its owners,
but Anlima group has some other factors that influence objectives. Such as, Incentive
schemes.

Incentive schemes: Managers may be encouraged to work in the best interests of the
company if there are incentives schemes linked to profit or share price. This incentive
schemes include-
• Profit-related pay
• Share option schemes

Comments-

There are several stakeholders in a company and this presents a problem for the financial
manager in deciding which stakeholder objectives are the more important and how to
satisfy several different types of stakeholder objectives are the more important and how
to satisfy several different types of stakeholder at the same time.

Task 3
Briefly describe the financial objective of your organization.

The following are the mission, values to uphold and goals to pursue of the Anlima Group
of Industries.
MISSION
The mission here is to strive hard to be a provider of world class textile and garment
products and services, while positioning the country in the higher value segment of the
international textile market. The company’s goal is to satisfy customers through
technological superiority and synergic synchronization of man and machine, tailoring
quality products and services to harvest the reward of responsibility.

VALUES TO UPHOLD
Anlima Textile Ltd. holds the value to create a better future for the stakeholders of the
company, maintaining high standards of integrity, propriety and goodwill in shouldering
social responsibilities. To assimilate efficiency, innovation and state-of-the-art
technology for developing operational infrastructure and to establish linkages and
integration the company forwards its activities at achievable targets. The management of
the company also works to foster an environment conducive to grooming productive
talent and to forging mutually rewarding relationships with employees, clients and
society, based on the highest standard of professionalism.

GOALS TO PURSUE
The goal of the company is to satisfy customers through technological superiority and
synergic synchronization of man and machine, tailoring quality products and services to
harvest the reward of responsibility.

FINANCIAL OBJECTIVES
Business organizations are set up to fulfill objectives, or purposes. While specific
objectives vary from business to business, some general objectives are shared by most
businesses. Typical aims of profit-making organizations are:
 • To make profit: Any surplus of income over expenditure is profit. The profit of a
business is used in three basic ways-
 Some profits are distributed to the owners of the business.
 Some of the profit of the business must be paid to the government in
tax.
 The reserves may be used to reinvest in the business, perhaps in new
machinery, for expansion, or to pay off loans.
• To gain and enlarge a share of the market: The market for a product can be
regional, national or international. Larger share of the market means more sales
and greater profits.
• To increase sales revenue: Increasing sales revenue without a corresponding
increase in costs generates a higher profit.
• To provide a commercial or public service: A commercial product is one for
which there is an effective demand that meets the needs of customers and is
competitive with similar product of other business. To remain competitive, the
business must ensure the product continues to satisfy customer at a price they are
willingly to pay. A public service is one that is provided for the benefit of society.

Task – 4
How does your chosen organization measure its financial performance in time to
time?
As we all know that business organization measure its financial performance with
financial ratio analysis. Even the credit controller is interested in a whole variety of
accounting ratios, to build up, where possible, a broad picture of the customer. However,
the credit controller is only interested in the accounts insofar as they affect a business’s
ability to its debt on time.

A problem with financial ratio analysis is that historical information about profit, assets
and liabilities is used for an assessment of a future cash flow position, when they offer
only uncertain guide.

Profit margin, asset turnover and return on capital employed

Profit margin

This is the ratio of profit to sales, and may also be called ‘profit percentage’.

Profit $20,000
--------------- = --------------- = 20%
Sales $100,000
This also means that its costs are 80% of sales. A high profit margin indicates that:
(a) Either costs are being kept well under control
(b) And/or sales price are high

Net asset turnover

This is the ratio of sales in a year to the amount of net assets (capital) employed. Anlima
Group has sales in 20X4 of $720,000 and has assets of $360,000 the net asset turnover
will be:
Sale $720,000
----------------------- = ---------------- = 2 times
Capital employed $360,000

This means that for every $1 of assets employed, the company can generate sales
turnover of $2 per annum. To utilize assets more efficiently, manager should try to create
a higher volume of sales for the same assets and so a higher turnover ratio.

Return on capital employed (ROCE)

This is amount of profit as a percentage of capital employed (i.e. net assets)

(a) Profit $40,000
----------------------- = --------------- = 16%
Capital employed $250,000

(b) Profit Profit Sales

----------------------- = --------------- x -----------------------------
Capital employed Sales Capital employed

(ROCE) (Profit margin) (Net asset turnover)

An increase in sales volumes can offset a decrease in profit margin, by increasing net
asset turnover, while ROCE stays the same.

Changes in turnover
It is also worth to commenting on the change in turnover from one year to the next.
Strong sales growth will usually indicate volume growth as well as turnover increase due
to price rises, and volume growth is one sign of a prosperous company like Anlima.

Task – 5
Describe the elements and nature of working capital of your chosen organization.
The period of time which elapses between the point at which cash begins to be expended
on the production of a product and the collection of cash from a customer. Working
capital needs of Anlima Group also fluctuate during the year.

The amount of funds tied up in working capital would not typically be a constant figure
throughout the year. Only in the most unusual of businesses would there be a constant
need for working capital funding. For most businesses there would be weekly
fluctuations.

Many businesses operate in industries that have seasonal changes in demand. This means
that sales, stocks, debtors, etc. would be at higher levels at some predictable times of the
year than at others.
In principle, the working capital need of Anlima Group can be separated into two parts:

• A fixed part, and

• A fluctuating part

Figure : Working Capital Cycle

Here, the whole mechanism of working capital cycle has been shown. The fixed part
remains always constant and the fluctuating part differs because of the various reasons.
Movement of liquid assets is one of the important reasons.

As Anlima Yarn Dyeing Ltd., Allied Enterprise Ltd., Anlima Build-Tech Ltd.
Anlima Textile Ltd. has a huge working capital cycle. The company basically works on
a credit basis so the level cash funds are low. Usually the payments are not taken in
advance but while making their own payments they tend to receive long-term credits.
This is why the company’s working capital cycle is large.

The current portion of debt (payable within 19.5-20 months) is quite good, because it
represents a long-term claim to current assets and is secured by long term assets.
Common types of long-term debt are bank loans.
An increase in working capital indicates that the business has either increased current
assets (that is received cash, or other current assets) or has decreased current liabilities.
Task – 6
What is operating cycle and calculate and comment on the average operating cycle
of your organization.

The focus of discussion of this segment of the report will be on the Operating Cycle or
WCC of the Anlima Group. An elaborate WCC is pretty farfetched in the manufacturing
industry. Anlima Groups as we know a huge production company and so, it can be
considered as an organization operating therefore the common concept for WCC as
represented by the equation below applies effectively for Anlima Group.:

WCC = Average Raw Material in Stock Time – Credit Period + Time Taken for
Production + Time the Finished Products Remain in Stock + Payback Periods of
Customers.

During my meeting with Mr. Anwarul Islam the head of finance of Anlima Group I
learned that the bank considers the following items (accounts) as their inventory:

• Postage Material & Stamps

• Printed Stationery (Checkbooks, Deposit Slips, and Forms etc. etc.)
• Security Stationery
• Petty Stationery

Mr. Anwarul Islam said that although these are considered as stock or inventory the bank
directly charge its clienteles for these items. Keeping that into mind the calculation of
Anlima Group WCC should be:

Average Raw Material in Stock Time - 2 months

(-) Credit Period - 1 month

(+) Time Taken for Production - 3 month

(+) Time the Finished Products Remain in Stock 1.5-2 month

(+) Payback Periods of Customers. 12 months

Working Capital Cycle - 19.5-20 months

Although the WCC calculation is showing an almost ridiculous figure for time taken to
complete one cycle, we must not forget that the Operating Capital Concept is most
popular for manufacturing companies. Yet, even with the absurd working capital cycle
(Anlima). Seem to be currently in a very sound position of liquidity. The following table
is the Statement of Liquidity of Anlima Group Collected from the annual report of last
year.
Task – 7
Describe the working capital financing strategies of your chosen organization.

Working Capital Management

Decisions relating to working capital and short term financing are referred to as working
capital management. These involve managing the relationship between a firm's short-
term assets and its short-term liabilities. The goal of Working capital management is to
ensure that the firm is able to continue its operations and that it has sufficient cash flow to
satisfy both maturing short-term debt and upcoming operational expenses.

Decision criteria
By definition, working capital management entails short term decisions - generally,
relating to the next one year period - which is "reversible". These decisions are therefore
not taken on the same basis as Capital Investment Decisions (NPV or related, as above)
rather they will be based on cash flows and / or profitability.
• One measure of cash flow is provided by the cash conversion cycle - the
net number of days from the outlay of cash for raw material to receiving payment
from the customer. As a management tool, this metric makes explicit the inter-
relatedness of decisions relating to inventories, accounts receivable and payable,
and cash. Because this number effectively corresponds to the time that the firm's
cash is tied up in operations and unavailable for other activities, management
generally aims at a low net count.
• In this context, the most useful measure of profitability is Return on
capital (ROC). The result is shown as a percentage, determined by dividing
relevant income for the 12 months by capital employed; Return on equity (ROE)
shows this result for the firm's shareholders. Firm value is enhanced when, and
if, the return on capital, which results from working capital management,
exceeds the cost of capital, which results from capital investment decisions as
above. ROC measures are therefore useful as a management tool, in that they
link short-term policy with long-term decision making.

Management of Working Capital

Guided by the above criteria, management will use a combination of policies and
techniques for the management of working capital. These policies aim at managing the
current assets (generally cash and cash equivalents, inventories and debtors) and the
short term financing, such that cash flows and returns are acceptable.

• Cash management. Identify the cash balance which allows for the
business to meet day to day expenses, but reduces cash holding costs.

• Inventory management. Identify the level of inventory which allows for

uninterrupted production but reduces the investment in raw materials - and
minimizes reordering costs - and hence increases cash flow; see Supply chain
management; Just In Time (JIT); Economic order quantity (EOQ); Economic
production quantity (EPQ).

• Debtor Management. Identify the appropriate credit policy, i.e. credit

terms which will attract customers, such that any impact on cash flows and the
cash conversion cycle will be offset by increased revenue and hence Return on
Capital (or vice versa).

• Short term financing. Identify the appropriate source of financing, given

the cash conversion cycle: the inventory is ideally financed by credit granted by
the supplier; however, it may be necessary to utilize a bank loan (or overdraft),
or to "convert debtors to cash" through "factoring".
Task – 8
What factors do your organization considers most in determining the cash
requirements.

Finance houses: Finance houses providing medium-term installment credit to the

business and personal sector. These are usually owned by business sector firms or by
other financial intermediaries. They offer services similar to the clearing bank.

Bank loan:
Bank loans are very flexible form of finance. Banks will consider applications for loan
for virtually any term, from a few months to several years. Bank loans to businesses are
rarely for more than 7 years, unlike loans to individuals which can be for anything up to
25 years in the case of a mortgage.

Interest on a bank loan can be fixed for the duration of the loan, particularly if the loan is
short-term. However, for longer-term loans, the interest is usually at a variable rate or
‘floating rate’. Variable rate interest means that the interest payable is linked to a
reference interest rate, which is either the bank’s base rate or a money market interest
rate.

Types of bank loan

There are various way of classifying loans:
 Payment terms, e.g. installment versus single payment.
 Period-of-payment terms, e.g. short-term versus intermediate-term or long-term.
 In the manner of its security term, e.g. secured versus unsecured.
 In interest payment term, e.g. simple interest versus add-on, versus discount, versus
balloon.

Overdrafts:

With a bank overdraft, a bank allows a customer to pay more out of his current account
than there is cash in the account. An overdraft is therefore a form of borrowing through
the current account. The bank sets a limit to the size of the overdraft and the customer can
be overdrawn on the account up to agreed limit. The size of the overdraft continually
changes, with payments into and out of the account reducing and increasing the balance.

Interest on an overdraft is usually charged at a daily rate on the overdraft balance, and the
rate is variable. Overdraft is repayable on demand unlike for private individuals, business
pay and arrangement fee on an overdraft. This is in addition to the overdraft interest and
is charged for setting up the overdraft facilities.

There are two types of overdraft facilities:

 Committed.
 Uncommitted.

With a committed facility the bank agrees to allow the customer to be overdrawn up to
the agreed limit, at any time during the agreed period of time.

With a uncommitted facility bank agrees to allow the customer to be overdrawn up to the
agreed limit, but reserves the right to reduce overdraft limit, or withdraw the overdraft
facility completely, at any time and without notice.

Secured and unsecured loans:

Loans and overdrafts can be either secured or unsecured. Borrowing is secured when the
bank takes security for the money it lends. For companies that borrow, security is
provided in the form of a charge over its assets.

Loan terms and conditions:

The term and condition of a loan arrangement or an overdraft arrangement can vary
considerably. Every arrangement should specify:
 The term of the agreement.
 The amount of the loan or overdraft limit.
 The interest rate payable.
 The frequency of interest payment.

For a loan, the agreement will specify whether the loan principal is to be repaid gradually
over the term of the loan, or whether there will be no principal repayments until the end
of the loan period.

A loan or overdraft agreement will also have other terms and conditions. Most of these
related to undertakings given by the borrowers to the bank.

 If a loan is unsecured the borrower might be required to give an undertaking that he

will not subsequently take out any secured loans from any other lender.
 The borrower might give an undertaking to provide the bank with regular information
about the financial position, such as a profit and loss account very six months or a
regular cash budget or cash forecast.
 A borrower might also give undertakings to keep its financial position acceptable to
the bank. For example, the borrower might undertake that its current assets will always
be at least twice the amount of its current liabilities.
 Any such financial ratios in a loan agreement will be continually monitored by the
bank.

Factoring is a word often misused synonymously with accounts receivable financing.

Factoring is a financial transaction whereby a business sells its accounts receivable (i.e.,
invoices) at a discount. Factoring differs from a bank loan in three main ways. First, the
emphasis is on the value of the receivables, not the firm’s credit worthiness. Secondly,
factoring is not a loan – it is the purchase of an asset (the receivable). Finally, a bank loan
involves two parties whereas factoring involves three.
NB: In Europe the term Factoring typically mean accounts receivable financing. Here the
correct word for this article is: American factoring.
The three parties directly involved are: the seller, debtor, and the factor. The seller is
owed money (usually for work performed or goods sold) by the second party, the debtor.
The seller then sells one or more of its invoices at a discount to the third party, the
specialized financial organization (aka the factor) to obtain cash. The debtor then directly
pays the factor the full value of the invoice.
company sells its invoices, even at a discount to their face value, when it calculates that it
will be better off using the proceeds to bolster its own growth than it would be by
effectively functioning as its "customer's bank." In other words, it figures that the return
on the proceeds will exceed the income on the receivables.

Task – 9
What factors do your organization considers most in determining the requirements
of working capital other than cash.

Anlima Group considers three areas of business where managers have the most direct
impact:
• accounts receivable (current asset)
• inventory (current assets), and
• accounts payable (current liability)

Accounts Receivable

Accounts receivable are generated when a firm offers credit to its customers.
The first thing that needs to be addressed when establishing a credit policy is to set the
standards by which a firm is judged in determining whether or not credit will be
extended. There is what’s known as the 5 Cs of credit:

1. Character – the willingness of the borrower to repay the obligation

2. Capacity – the capability of the borrower to earn the money to repay the
obligation
3. Capital – sufficient assets available to support operations (as opposed to
a firm that is undercapitalized). Sometimes capital is interpreted to mean
equity capital; i.e., to make sure the owners of the firm have sufficient money
at stake to give them proper incentive to repay the loan and not let the
company go bankrupt.
4. Collateral – assets to support the loan which can be liquidated if default
occurs
5. Conditions – current and future anticipated conditions of the firm and the
industry.
 Once the credit standards have been set, the terms of credit need to be
established. When must the customer pay? If they pay early, will they receive a
discount? If they pay late, do they get charged a penalty?

While the whole purpose of extending credit is to increase sales and, thus, gross
profits, the expected increase in gross profits must be compared with the costs
associated with extending credit to customers.
These costs include-

• The time value of money tied up in accounts receivable

• Bad debts that occur
• Credit checks (to minimize bad debts)
• Collection costs
• Discounts for early payment (reduces revenues)
• Clerical costs associated with maintaining a credit department

Competitors will respond very quickly to a change in price. How many times
have we seen the claims that “We will meet or beat any advertised price”? A change in
credit policy, on the other hand, is a more subtle means of competing for customers and
one that the competition will not necessarily respond to. In fact, many firms base their
business on easy credit. How many times have we seen the advertisements where they
tell us “Good credit? Bad credit? No credit? We don’t care!” Of course, these firms will
have larger bad debt expenses and larger financing costs, etc. Obviously, they will also
need to have higher prices (higher gross profit margins) in order to cover these costs.

Inventories

Inventories (raw materials, work-in-process, finished goods) make up a large

portion of most firm’s current assets, and for many, total assets. As such, the extent to
which a firm efficiently manages its inventories can have a large influence on its
profitability. Thus, keeping abreast of inventory policy is critical to the profitability (and
value) of the firm.

Several factors influence the amount of inventory that a firm maintains. The most
important of these include

• Level of sales – typically, the more sales a firm has, the more inventory it
holds
• Length of time and technical nature of the production process – The
longer it takes to produce finished goods inventories from raw materials, the
larger the amount of finished goods that a firm will typically hold (a safety
stock). Also, if the production process is highly technical, requiring that
retooling be performed prior to each production run in order to assure that
production is meeting specifications, larger amounts of inventory will be
produced with each production run in order to minimize the set-up costs
associated with retooling.
 • Durability vs. Perish ability – If an inventory item is highly perishable, such
as fresh vegetables, a small amount will be held. Similarly, fashions of
clothes and car styles are “perishable” and will result in smaller inventories
than durable goods such as tools and hardware.
• Costs – Cost of holding inventories as well as costs of obtaining
inventories will influence inventory sizes.

Inventory costs can be broken down into three major categories:

A. Ordering Costs
1. Fixed costs – stocking, clerical
2. Shipping costs – often fixed
3. Missed quantity discounts – an opportunity cost

B. Carrying Costs
1. Time value of money tied-up in inventories
2. Warehousing costs
3. Insurance
4. Handling
5. Obsolescence, breakage, “shrinkage”

C. Stock-out Costs
1. Lost sales
2. Loss of goodwill
3. Special shipping costs

Ideally, we want to balance these costs against each other so that our total costs
are minimized.

Account payable:

any amount owed by a company as the result of a purchase of goods or services from
another company on a credit basis. Under a trade-credit arrangement, the purchasing
company, after placing its order with the seller, receives the goods and an invoice
denoting the price of the goods and the terms for payment. The purchasing firm does not
send a trade acceptance or promissory note for payment but enters the amount owed as a
current liability in its accounts.

Companies incur this type of short-term debt primarily to finance their inventories; if
inventory turnover is rapid within an industry, a company may be expected to have large
accounts payable. Within any given industry, smaller companies are more likely to make
use of this type of trade credit because they are less able to pay cash and take advantage
of discounts than larger companies and have fewer sources of credit open to them.