Business Finance: Working Capital Management and Financial Performance

This document provides an overview of business finance, focusing on working capital management and its impact on cash flow and financial performance. It explains the meaning of profit and cash flow, the differences between them, and the effects of working capital changes on cash flow. The document also discusses different financial ratios and their interpretation, along with ways to improve cash flow through working capital management. The content is relevant for students studying business finance or related subjects.

Business Finance

Table of Contents
INTRODUCTION...........................................................................................................................3
MAIN BODY...................................................................................................................................3
PART 1............................................................................................................................................3
I...............................................................................................................................................3
a. Presenting meaning of Profit and cash flow and explaining their differences...................3
b. Presenting meaning of working capital and receivables, inventory and payables.............4
c. The effects of working capital changes over cash flow......................................................4
2. Financial position management by the different concepts.................................................5
3. Ways to improve the cash flow by working capital management......................................6
PART-2............................................................................................................................................6
1.a Explaining the component that each of the ratio depicts in relation to financial
performance............................................................................................................................6
1.b. Computing the ratios for 3 years.....................................................................................7
1.c. Interpreting the results by showing the reasons for the change in each of the ratio over the
years........................................................................................................................................9
2. Assessment and the recommendations in respect of the financial performance of an entity10
CONCLUSION..............................................................................................................................10
REFERENCES..............................................................................................................................11

INTRODUCTION
Business finance refers to money and credit invested in business for the effective and
efficient growth of the company. The report is conducted in 2 parts. In 1 part Flashy product Ltd
company is taken which is a manufacturer company produce sport equipment. They manufacture
the products in UK & China and sell in different countries such as UK, south Asia and Australia.
The report highlights the importance of financial statements in management company financial
results. In the second part of the report it explains the different financial ratio and their changing
trend of Farringdon Pharma Ltd. Company.
MAIN BODY
PART 1
I.
a. Presenting meaning of Profit and cash flow and explaining their differences
Profit:for na organisation can be understood as financial gain which is earned by
company which is basically the difference between the amount earned and expenditure made for
generating such revenues. The profits are the real earning of a firm which is reached after
deducting all operation and financial expenses for the overall activities of business.
Cash flow: of a business is the total inflow and out flow of the cash within business
operation for a specific time period (Cash Flows from Operating Activities, 2019). This is
basically the incoming and outgoing of the cash from the operating, financing and investing
activities of the business. The cash flow depicts the changes in holding of cash over an income
year through the incoming and outgoings of cash form company within same period.
Difference between profit and cash flow:
Cash and profits are both crucial aspects of a business and required for successful
operations in the long term. A company is required to generate profits while operating with
positive cash flow. Cash flow is inflow and outflow of cash form the business which is required
to meet daily expenses of the business such as purchase of inventory, taxes, paying employees
and others. On the other had profits are the surplus after all the expenses are met and the total is
deducted from the overall revenues earned (Are a Firm's Cash Flow and Profit Different, 2019).
Cash flow is basically the way through which cash flows in business and company can have a
positive cash flow with having no profits. On other others hand a company can have negative
cash floes while having large profits, so the one of the major difference between both profits

realization depends on accounting basis while cash flow depends on sources of the cash
transactions.
b. Presenting meaning of working capital and receivables, inventory and payables
Working capital: for a business is a financial metrics representing operating liquidity of
company which depicts the ability of firm in meeting short term obligations of organisation. WC
is calculated as deducting current liabilities from current assets. Under normal trade cycle
working capital is equals to working assets.
Receivables: or account receivables reflecting at asset side of balance sheet depicts the
balance of money due to the firm for the goods and services delivers to its consumers which is
not yet paid by the users. This is the money owned by consumers to the organisation and the
quantum of amount and its rotation shows the credit sales made by company also the capacity of
organisation in realising the dues form consumers.
Payables: or account payables reflects of liability side of balance sheet of a company and
this shows the amount that is owed by the company to its suppliers and creditors. This quantum
shows the credit purchase of goods and services made by company. This is short term debt of the
company classified under current liability of organisation.
Inventory: for a business includes raw material used for production of goods, work in
progress and the finished goods. This is basically the merchandise, goods and material held by
the business for selling to consumer (finished goods), or make the final products after processing
(raw material and work in progress) in order to generate profits.
c. The effects of working capital changes over cash flow
Working capital of a business is represented as difference between current asset and
current liability of the business (Working capital finance,2019). Changes in the working capital
are reflected in the cash flow statement of company, which can be explained with some
examples:
 When a transaction reflects an increase in current asset and current liability with same
amount there is no change in the working capital.
 In case of decrease in assets, cash floe from operations will increase while reducing the
working capital.
 Also, an increase in account receivables shows that there is less collection by company
and this effects the cash flow negatively while increasing the working capital.

From the above examples it can be stated that changes in the working capital have a
direct impact on the cash flow which can be both in negative and positive way.
2. Financial position management by the different concepts
The profit of the company helps to manage the various financial activity. The operating
profit of Flashy product Ltd. Company is £4 million and the average turnover of the company in
last 5 year is £50 million which present that company is able to manage the performance in
market. But from the internal reorganisation it has been reflected that they did not control the
credit, manage inventory and purchases in the organisation which increases the wastage.
The working capital management help the Flashy product Ltd. Company to improve the
cash flow position. To manage the working capital they have to control the inventory level by
using the various software to regulate the inventory level and only order the quantity when they
required (Muhammad, Rehman and Waqas, 2016). The management of inventory also reduces
the maintenance cost and increases the working capital to meet day to day short term expenses.
The mismanagement of working capital increases the cost and debt of the company which
ultimately decreases their profit.
The formulation of budget help the company to regulate the cost involve in each activity
and manage the activities according to the differences arise in expected and actual budget of
particular accounting period. They have to use the electronic payments to manage the cash flow
in the organisation for fulfilling the daily requirement of cash (Robinson and Sensoy, 2016).
Flashy product Ltd. Company has to control the credit and reduces the time period of collecting
payment from the debtor. It increases the cash level and present the positive cash flow. The
management of working capital by regulating inventory, receivables, payables etc. and cash flow
provide the support to improve the financial results.
The financial position of Flashy product Ltd. Company reflect the £5 million overdraft
which shows that in compare to the last year company's overdraft is increases. The overdraft of
the company increases the current liability and show the negative working capital. It also
increases the debt of the company because a long term negative working capital reflect that
company is struggled to manage current liabilities. The different financial tools help the
company to manage financial position and improve the profit in the market.

3. Ways to improve the cash flow by working capital management
The current position of Flashy product Ltd. Company reflect that they never focus on
working capital management. They have to manage the working capital by regulating the current
assets and current liability (Mathuva, 2015). Working capital reflect the difference between
current assets and current liability. The excess of current assets reflect positive working capital
and excess of current liability reflect negative working capital. Due to the mismanagement of
credit control and inventory level the working capital cycle is increases 4 times.
It can be recommend that Flashy product Ltd. Company has to control the credit and
regulate the time period of collecting the payment from the debtors which help to reduce the
liabilities and increases the cash inflow by collecting payments on time. They have to use the
credit card rather than to pay in cash. The usage of credit card in purchasing the inventory and
other current assets increases the current asset level and does not reduce the cash inflow which
also reflect positive cash flow.
It also recommends that Flashy product Ltd. Company has to control the inventory level
and regulate the inventory in fixed time interval. It helps them to reduce the maintenance cost of
the company which ultimately increases the cash flow. The control of trade receivables and trade
payables also help the organisation to reflect positive working capital and pay the short term
expenses on time and increases the cash level in organisation.
PART-2
1.a Explaining the component that each of the ratio depicts in relation to financial performance
Sales growth- It refers to the increase or the decrease in the sales of an entity from one
period to another (Choi and et.al., 2018). It reflects the percentage of the revenue growth that is
been gained by Flashy products Ltd. It helps in determining the revenue trend of the business
over the time. Higher the percentage of the sales growth, reflects more profitability within the
business.
Gross profit ratio- It refers to the profitability ratio which indicates the relationship in
between the net sales and the gross profit. It is the most useful tool in evaluating the operational
efficiency of Flashy products Ltd.
Operating profit ratio- It indicates the amount of the profits that is been earned by the
company after making the payment of its variable cost. This ratio states the percentage of the

profits earned by Flashy products Ltd by keeping the control over the expenses and the cost with
respect to the business operations.
Gearing ratio- It is a kind of the financial ratio which focuses on comparing the debts of
the company with that of its equity (DeBord and et.al., 2017). Gearing ratio represent the
leverage position of the company.
Interest coverage ratio- It referred as the ratio that helps in determining the interest
obligation of Flashy products against its net income. It also depicts the leverage position of an
enterprise. This ratio is used to identify the risk that is associated relating to the current debt and
the future borrowings of an organization.
Liquidity ratio- This ratio reflects the liquidity position of the firm and act as the
financial metric in respect of determining the ability of Flashy products in meeting their current
obligations.
Return on equity- It is the measure of the financial performance that reflects the extent to
which the management of Flashy products is making use of its assets in order to generate profits.
This ratio depicts the income generated against shareholders funds of an organization
(Fallahpour, Lakvan and Zadeh, 2017).
Return on capital employed- It is the profitability ratio which measures the profits that
are been earned by the firm through the use of its capital employed.
1.b. Computing the ratios for 3 years.
Ratio Analysis
Particulars Formula Amount
2009 2010 2011
Sales 75 83 96
Sales growth
Current year -
base year/base
year 0 10.67% 15.66%
Gross profit 48 53 57
Net sales 75 83 96
Gross profit Gross profit/net 64.00% 63.86% 59.38%

margin sales*100
Operating profit 23 21 10
Net sales 75 83 96
Operating profit
ratio
Operating
profit/Net
sales*100 30.67% 25.30% 10.42%
Long term debts 39 53 75
Total assets 108 135 168
current liabilities 6 10 21
Capital employed
Total assets-
current liabilities 102 125 147
Gearing ratio
Long term
debts/capital
employed*100 38.24% 42.40% 51.02%
Earning before
interest and tax 23 21 10
Interest 2 2 3
Interest coverage
ratio
Earnings before
interest and
tax/interest 11.5 10.5 3.33
Liquidity ratio
Current assets 14 24 20
Current liabilities 6 10 21
Current ratio
Current
assets/current
liabilities 2.33 2.4 0.95

Net income 17 9 -1
Shareholders
equity 63 72 72
Return on equity
Net
income/sharehol
ders equity *100 26.98% 12.50% -1.39%
Operating profit 23 21 10
Capital employed 102 125 147
Return on capital
employed
Operating
profit/capital
employed*100 22.55% 16.80% 6.80%
1.c. Interpreting the results by showing the reasons for the change in each of the ratio over the
years.
Sales growth- The above table indicating that the trend of the sales in increasing over the
years of Flashy products Ltd as the ratio rises from 5% that is 10.67% in 2010 to 15.66% in
2011. This reason behind the increase in the revenue is its effective marketing strategy which
attracts the large number of customers towards its sports equipments.
GP Margin- This ratio is showing a decreasing trend which means that operational
efficiency of the company is declining over the years. This is because the cost of the sales is
increasing over the years with a high margin.
OP Margin- It is also decreasing over the three years because of the increase in the
operating expenses and the depreciation on its fixed assets (Loomes, Hull and Mandy, 2017).
This could be improved by lowering down the operating expenses and by selling of the irrelevant
assets.
Gearing- This ratio is showing an increasing trend as the long term liabilities and the
capital employed is been increasing over the years. This shows that the leverage position of the
company is not the efficient as its debts are increasing from one accounting period to another.
Interest coverage- Resulting a decline in the interest coverage ratio is also not a good
sign for Flashy products Ltd because it reflects that the income of the company is decreasing

over its interest obligation is increasing (Uechi and et.al., 2015). This indicates that the leverage
position of the firm is not better.
Liquidity ratio- In the year 2009 and 2010, the liquidity position of Flashy products is
depicting an ideal results which means that company is effectively managing its current assets
and has the capability in meeting its short term liabilities. However, in the year 2011, its current
ratio is declining which affects the liquidity of the company.
ROE- Higher the return on equity ratio, better is the performance of the firm but the ROE
of Flashy products is reducing and reaching to negative results in the year 2011 (Yeh and et.al.,
2016). This clearly states that the net income of an organization is declining towards negative
outcome against the increase in the shareholders funds.
ROC- It is also decreasing over the years due to the decline in the operating profits as the
expenses are greater than revenue.
2. Assessment and the recommendations in respect of the financial performance of an entity
Overall the financial performance of Flashy product is not good because its net profits
and the operating profits are declining from one period to another. Its liquidity and the leverage
position is also not reflected as sound because its debts are increasing and its interest expenses
are also increasing with decrease in its earnings. Flashy products must take corrective measures
in order to improve its financial performance by eliminating the activities that are unprofitable,
looking for the new customers, reducing the expenses and the cost, reviewing the present pricing
structure and maintaining appropriate inventory for better working capital.
CONCLUSION
The report summarizes the various financial reports and their importance in company
decision making process. It can be concluded from that the evaluation of financial statement help
the organisation to manage the inventory, purchasing and credit. It also helps to minimize the
waste and maintain the performance of the firm. Different financial ratio such as liquidity ratio,
profitability, solvency etc. help the company to analyse the financial position. The growth in
sales, operating profit margin, ROE etc. are the reason behind the changing ratio.

REFERENCES
Books and journals
Mathuva, D., 2015. The Influence of working capital management components on corporate
profitability.
Muhammad, H., Rehman, A.U. and Waqas, M., 2016. The relationship between working capital
management and profitability: A case study of tobacco industry of Pakistan. The
Journal of Asian Finance, Economics and Business (JAFEB), 3(2). pp.13-20.
Robinson, D.T. and Sensoy, B.A., 2016. Cyclicality, performance measurement, and cash flow
liquidity in private equity. Journal of Financial Economics, 122(3). pp.521-543.
Choi, K.B. and et.al., 2018. Amplification ratio analysis of a bridge-type mechanical
amplification mechanism based on a fully compliant model. Mechanism and Machine
Theory. 121,. pp.355-372.
DeBord, J. and et.al., 2017. Profiling of heroin and assignment of provenance by 87Sr/86Sr
isotope ratio analysis. Inorganica Chimica Acta.468. pp.294-299.
Fallahpour, S., Lakvan, E. N. and Zadeh, M. H., 2017. Using an ensemble classifier based on
sequential floating forward selection for financial distress prediction problem. Journal of
Retailing and Consumer Services. 34. pp.159-167.
Loomes, R., Hull, L. and Mandy, W. P. L., 2017. What is the male-to-female ratio in autism
spectrum disorder? A systematic review and meta-analysis. Journal of the American
Academy of Child & Adolescent Psychiatry. 56(6). pp.466-474.
Uechi, L. and et.al., 2015. Sector dominance ratio analysis of financial markets. Physica A:
Statistical Mechanics and its Applications. 421. pp.488-509.
Yeh, C.C. and et.al., 2016. A hybrid detecting fraudulent financial statements model using rough
set theory and support vector machines. Cybernetics and Systems. 47(4). pp.261-276.

Online
Cash Flows from Operating Activities. 2019. [online]. Available through
:<http://news.morningstar.com/classroom2/course.asp?
docId=145092&page=3&CN=COM>.
Are a Firm's Cash Flow and Profit Different. 2019. [online]. Available through
:<https://www.thebalancesmb.com/are-a-firm-s-cash-flow-and-profit-different-393585>.
Working capital finance. 2019. [online]. Available through
:<https://www.fundingoptions.com/knowledge/working-capital-finance/>.