Management of Working Capital Case Study: “George’s Trains”

 

Management of Working Capital Case Study: “George’s Trains”

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Management of Working Capital Case Study: “George’s Trains”

Working capital is the money, which a business has at its disposal. According to Baker and English (2011), capital budgeting is a series of steps involved in generating long-term investments (Baker & English, 2011). George Olieux got the initial capital for his business from loan. He had a good relationship with his bank therefore acquiring the loan was not difficult. That is a good practice because he agreed with the bank on a reasonable payback period (PBP). PBP is the period in which a loan is supposed to be paid. The good relationship established with his bank shows how reliable he is. As a result, he is able receive favors and grants from the bank in future.

He anticipates sales judging from events and plans for orders in appropriate amounts. He uses a previous event to plan for the next and this gives him an advantage of knowing what is expected in terms of income before hand. This reduces losses made due to products overstaying in the shop and losing value. This is a good strategy because it utilizes his capital well and gains returns thus maximizing on profits.

He also thinks about paying all bills before purchasing any inventory or expanding. Research by Dayananda, Irons, Harrison, Herbohn and Rowland (2002) shows that decisions made in capital budgeting have an effect on the value of business (Dayanada, Irons, Harrison, Herbhon, & Rowland, 2002). Expanding and having excess inventory might be a good gesture but it increases the amount of bills and reduces capital. This is a good strategy because it enables good planning of the future. When all bills are paid, he is able to focus on making profits without worrying if the business will be closed.

George also improved the quality of materials used to make his products. The business depended heavily on plastic trains but he enhanced them by adding metal in various parts. This increased sales because he had a variety of products to sell according to customer preferences. It also gave products a better look, which attracts customers to purchase.

The success of George’s Trains is attributed to his capital budgeting practices. However, he should beware of some pitfalls. He should note the fluctuating rates of interest and inflation. These factors affect the market greatly. If the economy is weak, he will be at risk of losing market because demand for his inventory will reduce. Inflation also has negative effects on market because it reduces long-term profits.

Another pitfall that George should be aware of is the failure of the business to deliver expected profits. This failure could occur due to poor accounting or inaccurate estimation of profits. It also occurs if initial estimation of the project’s success was not done correctly. This brings difficulties in monitoring cash flow. It also shows that errors will be made in managing the business.

He needs to be aware of any business relations that he has with foreign countries. The relationship could be in form of imports or overseas loans. This means that he will be affected indirectly by crises of other countries for example, rough politics and harsh exchange rates. Harsh exchange rates could cause the business to gain less profit than loss. Political unrest affects growth of the business and leads to failure.

George’s Trains is a successful business and has the capability of achieving even more. He does not deal in a wide range of inventory to sell. He should be diverse and buy what the customer wants, not according to events. This will improve his profit margins because customers will have options in case they miss a specific product. He should make a personal investment elsewhere to add capital that already exists in the business. This increases strength of the business because it ensures that its total income covers all losses.

It is important to know how to increase working capital. Working capital enables businesspersons to anticipate and plan their profits and losses and act accordingly. It also helps in the smooth running of the business. In order to increase capital, he should avoid credit facilities. If the business offers them, he should ensure that a good relationship with customers is established first, to a point where they accept his terms and conditions for payment.

He should not delay in collecting his payments. Collecting payments quickly adds on to working capital. At the same time, it is important to maintain good terms while requesting for payment. This secures his customers and maintains good buyer-seller relations. It is important for George not to be using his working capital to purchase fixed assets. That should be done using profits or money generated elsewhere but not from capital. According to Peterson and Fabozzi (2002), long-term assets should not be maintained using capital (Peterson, & Fabozzi, 2002).Using up capital to expand the business is risky to because it exposes it to various financial crises.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

George’s Trains

Cash Flow Statement
For the year ended 31/ 12 / 2012
  $
Cash flow from operating activities  
Receipts from customers 10000
Payments to suppliers (3000)
Payments to employees (1500)
Interest payments (500)
Interest received 2000
Taxes paid (500)
Net cash flow from operating activities 6500
   
Cash flow from investing activities  
Purchases of equipment (10500)
Purchases of property (20000)
Proceeds from sale of equipment 20500
Proceeds from sale of property 15000
Net cash flow from investing activities 4500
   
Cash flow from financing activities  
Proceeds from borrowings 15000
Payments of borrowings (repayment of principal) (17000)
Investment into business 100000
Drawings from business investment (26000)
Net cash flow from financing activities 72000
   
Net increase (decrease) in cash held 83000
Cash at beginning of period 50000
Cash at end of period 33000

 

 

 

 

 

 

 

 

References

Baker, H. K., & English, P. (2011). Capital budgeting valuation: Financial analysis for today’s investment projects. Hoboken, N.J: Wiley.

Dayanada, D. (2002). Capital budgeting: Financial appraisal of investment projects. Cambridge, UK: Cambridge University Press.

Peterson, D. P., & Fabozzi, F. J. (2002). Capital budgeting: Theory and practice. New York, NY: Wiley.

 

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