Business Finance: Working Capital and Cash Flows

This report provides insights into the importance of working capital and cash flows in business finance. It covers topics such as the difference between profit and cash flow, the meanings of inventory, receivables, and payables, and the effects of changes in working capital on cash flow. It also offers steps to improve cash flows through working capital management. The report is relevant for students studying business finance or related subjects.

BUSINESS FINANCE

TABLE OF CONTENTS
TABLE OF CONTENTS................................................................................................................2
Executive summary.........................................................................................................................1
PART 1............................................................................................................................................1
1. Explanations in context of the given case of Mediterranean Delights Ltd. (MDL)................1
2. Management of company affecting the financial results.........................................................3
3. Steps to be taken for improving the cash flows through working capital management..........3
PART 2............................................................................................................................................4
1. Purpose of preparing the budgets and stating traditional and alternative budgeting methods.4
2. Application of the above methods for planning future cost management...............................7
3. Analysing the traditional and alternative budgetary methods.................................................7
REFERENCES................................................................................................................................9

Executive summary
Business finance refers to funds and credits employed in business. For every business
finance is considered as the foundation on which whole business is based. The present report is
based over the business finance. It covers two parts where part 1 provides understanding about
the working capital and cash flows. Part 2 covers the need and purpose of budgeting approaches.
From this report it could be concluded that business finance is an important factor for any
business enterprise. Companies continuously strive for management of the finance of company
in most efficient manner. Cash flows and working capital both are important part of every
business that are essential for their survival and growth. Budgets helps business to keep its
expenditures and costs under control. Traditional budgeting methods due to various defaults are
not being much used by companies. Alternative budgeting methods like zero based budgets and
activity based budgets are helping the organisations to make more effective budgets by proper
allocation of resources.
PART 1
1. Explanations in context of the given case of Mediterranean Delights Ltd. (MDL)
a) Difference between profit and cash flow.
Profits – It refers to the income left with company after carrying out all the expenses of
business. Profitability is important for its growth and survival. Every business organisation runs
business with the motive of earning profits.
Cash Flows – It refers to the money flowing in and out of organisation. Cash flows are
important for running the business successfully. Company may not survive if it is profitable but
do no have cash for running its operations.
Profits and cash flows are two separate parameters, that are essential for running the
business successfully. Cash flow shows the inflow and outflow of money from the organisation.
This may be from various activities like operating, financing and investing activities. Profits
shows the performance of company during the year. It represents the gain from carrying out the
business. Company is considered profitable if it is left with income after meeting all its expenses
(Mayangsari and Mulya, 2017). There are possibilities that it is profitable but struggling with
cash flows and vice versa. Both are different and are required to be taken care for survival of
business.
b) Working Capital and meanings of inventory, receivables and payables.
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Working capital can be defined as financial indicators reflecting short term status and
financial position of company. This is also termed as measure of the overall efficiency. This is a
difference between current assets like accounts receivable, cash and the inventories and current
liabilities like accounts payables, creditors. Net operating working capital refers to the measure
of liquidity position and measured as difference between the operating assets and liabilities. It is
used for measuring the liquidity, short term health and operational efficiency of company
(Filbeck, Zhao and Knoll, 2017). When a company is having positive working capitals it is
assumed to be having potential of investment and growth. Company with negative working
capital is not considered profitable by the investors. Sources of working capital could be both
long term and short term. Companies regularly strive for maintaining their working capital so
that they do not go out of cash affecting the business operations. Inventory - It refers to the product which company trades or manufactures. It is regarded
as current asset of company. Inventory of the company is always valued at cost or net
realisable value whichever is low. Receivables – When a company sells its product or services on credit it is issues them
accounts receivables that represent the amount due from customers against the purchases
made (Fernandez, Fernández Acín and Ortiz Pizarro, 2017). It is treated as current assets
in the balance sheet.
 Payables - It refers to amount owed by company to the suppliers of raw materials. This is
issued by suppliers to company for goods supplies made on credit. This is presented
under current liabilities in balance sheet.
c) Effects on cash flow due to changes in working capital.
Working capital reflects difference between current assets and liabilities of a firm. It is
essential for the business to maintain their working capital as it impacts the cash flows of
business. When company is not having enough working capital, the ability of company of
operating optimally is decreased. Increase or rise in working capital reflects company has
invested more cash in the working capital and it reduces the cash flows. Companies that have
significant requirements of working capital can see that the working capital growing and the
growth in working capital reduces the cash flows (Lyngstadaas and Berg, 2016). As per this
relationship between cash flows and working capital, it could be seen that companies who are
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efficiently managing their working capital have high value in comparison with the firms having
increased working capital requirement.
Working capital is positive when the current assets of company are more than the current
liabilities. This shows company is available with enough funds for meeting its short term
obligations. All the fluctuations in current assets and liabilities cause the working capital to
change and it has direct impact over cash flows. WC requirement is high when company is not
able to manage its operations.
2. Management of company affecting the financial results.
In the present case it could be seen that MDL is a company operating delicatessens across
South England. Company is performing well and had a turnover in excess of 50 million. It is
having two corporate customers San Pedro and Delios Ltd. The financial position of the
company is adequate as per the industry standards. However profits have decreased and debts
have increased. It also made investments in Italian Company of 40% producing pasta. It has
agreed to make investments of 10 million with an advance of 8 million for supply of exclusive
products. Company is owing 1.5 million for order placed by Delios last year. On the other, it is
having dispute with San Pedro for 2 million for delivery made in 2017.
The dispute between Pedro arose because of supplying low quality products. It could be
seen that the company is not being managed properly. There is great requirement of funds by
company for making the investments in Italian company and for making the advance payments
for supplies. For meeting this requirement it will be raising short term loans (Davis, Mark and
Shepherd, 2017). It is outstanding receivables of 3.5 million from last year. The amount is high
and affects the working capital. There is possibilities that the substantial part of the dues from
Delios may not be received due to lower quality. This affects the financials of company. This
increases the current assets of company showing working capital to be positive where it is
considerable sum of money blocked in disputes. Due to this company will be required to raise
loans from banks and financial institution on payment of interest.
3. Steps to be taken for improving the cash flows through working capital management.
Cash flow management is important for every business enterprise. It has direct effects
over the insolvency and success of company. The cash flows of significant influence of the
working capital changes. If company is not able to manage its working capital requirements by
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establishing an optimum working capital operating cash cycle. MDL should adopt the following
steps for improving the cash flows and working capital.
Taking the responsibility of working by every person in the organisation. This is not the
sole task of finance department. Company can use tools like KPI's and benchmarks for meeting
its working capital requirement which ensures efficient utilisation of resources.
Making timely payment to suppliers.
Company should make timely payments to the suppliers so that they will be providing the
goods on credit as per the requirements. This will also avoid charging of high interests by the
suppliers affecting the reputation.
Demanding payments from customers
The credit days should not be high as it will cause the gap between the payments to
suppliers. Timely collections will provide company for making payments it will not be required
to make loans and overdrafts for making payments.
Inventory Management
There is a increased need for company to manage its inventory. It should not stock up
more than required and also should not go out of stock during productions (Leifer and Leifer,
2016). This is also part of working capital of the company.
Referring all the above depicted aspects, it can be mentioned that by offering credit to the
trustworthy debtor’s company can improve its cash flow or working capital. Moreover, WC of
the company is affected negatively when they don’t receive funds from debtor on time. Along
with this, emphasis should be placed on giving less credit to the debtors so that monetary
requirement can be met pertaining to doing operating or daily activities timely. Further, business
unit should contact to the supplier who provides raw material with additional time frame. In
addition to this, firm should lay focus on employing stock management tools & techniques. This
in turn helps in ensuring and replacing inventory within suitable time frame. In this way, by
taking such measures working capital can be improved to the significant level.
PART 2
1. Purpose of preparing the budgets and stating traditional and alternative budgeting methods.
Budgets refers to the spending plans of the company. It could be defines as a tool used in
accounting that involves predicting and analysing the income and expenses of company. It
provides companies with structured path for carrying out the activities and operations. The
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process of preparing budgets is known as budgets. This process is performed by the executives
and top level management of company. The budgets are prepared on forecasts about the future
income and expenses. It is a defined course of action which is not merely limited to reporting.
Company has to prepare number of budgets for different activities (Popesko, 2018). They are
prepared for keeping the cost and expenditures of an enterprise under controls.
Traditional budgeting approaches
Traditional budgeting refers to the method of preparing budgets for each financial year
or at such frequency as may be required. In this budgeting approach budgets are prepared taking
th budgets of previous year as base. The budget is prepared by making choices from the last
year's budget. The budget for current year is made after making adjustments and changes in the
previous budgets related to inflations, market conditions, consumer demands and behaviours and
many other things affecting the business. Costs and revenues of previous budgets form an
integral part of the business. The items specified in the budgets that are over & above the budgets
of last year are to be justified in the current budgets. This methods is different from activity
based, rolling budgets and zero based budgets. This budget also revolves around the projections
of sales or revenues from the business. These projections are based on the trends of previous
years.
Advantages
Traditional budget can be beneficial for the business enterprise for decision-making.
Budgeting approaches allows to identify easily the issues, that are to be addressed for making
changes to the business. If the expenses are exceeding from the budgeted ones, it can take
measures for its improvement (O’Grady, Akroyd and Scott, 2017). It is also easy to prepare and
implement the business and is less time consuming as compared with other alternatives.
Disadvantages
Traditional budgets are not flexible and are very rigid as they cannot be changes once
they have been prepared by the organisation. They are prepared by the top management without
involving lower management which do not provide them with concerned insights about the
issues faced. They rely mainly over the trends of past year.
Alternative budgeting methods
Rolling Budget
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These are the budgets that are required to be updated regularly on the expiry of period of
earlier budgets. The budget involves incremental extensions of existing budgets. This helps
company in being ready with the budget for next period.
Advantages
 This is less time consuming as they are extension of previous budgets with the required
changes. The rolling budgets can be changed easily in case of unexpected events (Weigel and
Hiebl, 2018).
Disadvantages
 Rolling budgets create confusion and affects performance of employees due to constant
changes.
 The budget is not advisable for companies with constant changes.
Zero Based Budgets
Zero based budgets refers to the budgets that are prepared by the company every year.
These budgets do not consider the budgets prepared in previous years. The budget is prepared
taking base of zero that means it is prepared from the starting analysing each factor in budget
newly.
Advantages
 The zero based do not consider the trends of information of previous budgets. The errors or mistakes of previous budgets are not continued in the new budgets.
Disadvantages
 Zero based budgeting is very time consuming.
 It starts from the zero that makes it costly for the company.
Activity based budgeting
It is a budgeting method where the budgets are made on the basis of Activity Based
Costing. In activity based budgets the management do not rely solely over budgets of previous
year. The budgets are prepared after properly analysing the activities performed by company
(Alain and Melegy, 2017). This brings more efficiency to the company.
Advantages
 This budget evaluate every factors and costs drivers influencing the budgets.
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 The budgets helps in identifying and eliminating the unnecessary activities and for saving
the costs.
Disadvantages
 It requires deeper understanding of the activities and functional areas for drawing
decisions.
 It is complex and time consuming in nature.
2. Application of the above methods for planning future cost management.
The above budgeting methods are used by the enterprise for planning the future costs of
company. Rolling budget is used by the enterprise for forecasting the sales budget, revenue
budgets or the other budgets. This is applied to update the budget by making updates as per the
requirements of company to the budgets. Zero based budgets is applied for making budgets for
departments with major fluctuations where management is required to deeply analyse all the
factors. The previous trends are not used in this budget which enable company to make effective
management of all the resources (Popesko and et.al., 2016). Activity base budgeting assess every
activity of company before the budgets are prepared, it also considers the information provided
by activity based costing method. All these budgeting methods are applied in the business
process for increasing the efficiency by allocating the resources of company in the best possible
manner. It enables company to make comparisons between the budgets for identifying the areas
of improvement.
3. Analysing the traditional and alternative budgetary methods.
Traditional budgeting involves consideration of the the factors of previous budgets. The
budgets are completely based on the trends and expenses and revenues of previous years. It only
makes necessary adjustments to the existing budgets for preparing current budgets. The
alternative budgetary methods such as activity based budgets are more used by the companies for
analysing the effects of changes. This makes effective allocation of resources to different
departments and activities. They are prepared and based over new goals and business targets.
Traditional budgets do not provide the areas of improvement as they follow the previous trends
and do not consider the changes. These are more rigid as changes could not be made on uncertain
circumstances.
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On the other alternative budgets are based over new concepts and approaches that are
focused mainly over making continuous improvements. Budgets such as zero based are prepared
from the scratch after considering and analysing all the factors affecting growth and success of
company. The alternative budgets enable the management in analysing the variances between the
actual and budgeted outputs. Considering this companies take corrective strategies and measures
for improving the efficiency and productivity (Vanica, 2018). Alternative budgeting techniques
are helping the organisations to control their costs and expenses with proper allocation of
resources between the activities and departments. Companies are adopting the alternative
techniques along with the traditional budgeting for achieving its goals and objectives of business.
The above depicted aspects clearly exhibit that Second sight plc should undertake or
employ alternative budgeting system over traditional. Moreover, traditional budgeting system
has several limitations in terms of transparency, consideration of trends etc. On the contrary to
this, alternative or modern budgeting tools provide clear view of financial aspects. As, ZBB
focuses on assessing each alternative method of performing business activities. Thereafter, fund
is allocated to the concerned business activities which in ensures optimum utilization of funds.
Along with this, instead of considering previous budget focus is placed on evaluating current
business activities or practices so that undesirable activities from operations can be avoided.
Thus, by preparing budget according to alterantive methods Second Sight Plc can save cost and
thereby maximize profitability.
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REFERENCES
Books and Journals
Mayangsari, S. and Mulya, A.S., 2017. Value-added Enterprise, Corporate Governance on
Sustainable Enterprise with Investment Opportunities Set Asintervening Variable. Media
Riset Akuntansi, Auditing & Informasi. pp.31-70.
Filbeck, G., Zhao, X. and Knoll, R., 2017. An analysis of working capital efficiency and
shareholder return. Review of Quantitative Finance and Accounting. 48(1). pp.265-288.
Fernandez, P., Fernández Acín, I. and Ortiz Pizarro, A., 2017. Net Income, Cash Flows, Reduced
Balance Sheet and WCR (Working Capital Requirements). Cash Flows, Reduced Balance
Sheet and WCR (Working Capital Requirements)(October 17, 2017).
Davis, T., Mark, T. and Shepherd, J., 2017. Simulated Western Kentucky Grain Farm Cash
Flows, Working Capital Erosion, and Evaluation of Risk Management Tools to Manage
these Risks. (No. 1377-2016-109959).
Lyngstadaas, H. and Berg, T., 2016. Cash Flow and the Consistency Principle in Working
Capital Management Calculations. Journal of Applied Management Accounting
Research. 14(2). p.65.
Leifer, I. and Leifer, L., 2016, February. Small business valuation with use of cash flow
stochastic modeling. In 2016 Second International Symposium on Stochastic Models in
Reliability Engineering, Life Science and Operations Management (SMRLO). (pp. 511-
516). IEEE.
Popesko, B., 2018. Transformations in Budgeting Practices: Evidence from the Czech
Republic. International Advances in Economic Research. 24(2). pp.203-204.
O’Grady, W., Akroyd, C. and Scott, I., 2017. Beyond budgeting: distinguishing modes of
adaptive performance management. Advances in management accounting, pp.33-53.
Weigel, C. and Hiebl, M.R., 2018. Beyond budgeting: review and research agenda. Journal of
Accounting & Organizational Change.
Alain, A.M.M. and Melegy, M.M.A.H., 2017. Program and Performance Budgeting System in
Public Sector Organizations: An Analytical Study in Saudi Arabian Context. International
Business Research 10(4). pp.157-166.
Popesko and et.al., 2016. Predictability of Business Environment within Budgeting Process-is it
Connected with Fluctuations of Economy?. Economics & Sociology. 9(2). p.90.
Vanica, V., 2018. Portfolio management approaches within a risk budgeting framework:
evidence from European markets.
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