Working Capital Report - Finance Dept. DU

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TERM PAPER
WORKING CAPITAL ANALYSIS OF

AGRICULTURAL MARKETING CO. LTD.
UNIVERSITY OF DHAKA
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Agricultural Marketing Company Limited (AMCL) was incorporated in Bangladesh on 15th May 1985 as Private Limited Company under the Companies Act, 1913 and subsequently on 22nd June, 1993 the company was converted into Public Limited Company (PLC). The shares are listed in the Dhaka and Chittagong Stock Exchange. The principal activities of the company throughout the year continued to be trading, processing of fruits, vegetables and other agro products and the activities of the company segmented into different units as shown below:
Unit Unit 1 & 3 Unit 2 Unit 4 Activities Processing & Marketing of Agro & Non Agro Products Farming / Horticulture Discontinued Mineral Water, Fruit Drinks & Fruit Juice Processing
AMCL (PRAN) is the largest grower and processor of fruits and vegetables in the country. It is marketing its products throughout the years with consistent quality home and abroad. It has adopted ISO: 9001 certificate as the model for their quality management system.
Financial Performance:
Net Asset Value Per Share 2000 42.20 258.39 2001 52.48 284.60 2002 54.26 312.82 2003 55.48 343.39 2004 50.39 362.27 2005 50.96 386.55 2006 36.18 396.11 All figures in BDT (Bangladeshi Taka) Year Earning per share Net Profit After Tax (mn) 33.76 41.99 43.41 44.39 40.31 40.77 28.95 Price Earning Ratio 9.87 7.05 6.91 7.67 13.31 7.86 10.67 % Dividend 20 20 25 24 24.00 26.00 26.00 % Dividend Yield 4.80 5.41 6.67 5.64 3.87 6.49 7.00
CHAPTER
1
Cash & Liquidity Management
Our focus on:
Fund Analysis Cash Balance Model (Miller-Orr) Measurement of Liquidity
Cash and Liquidity Management Fund Analysis: A fund analysis enables to take a total view of the financial structure of an enterprise. The fundamental distinction between funds and cash is that the former is a liability and the latter is an asset. In the ultimate analysis, fund is nominal in nature; it has no physical existence- it is a pool of promises made by the enterprise to various parties including the shareholders who deliver certain assets including cash to the enterprise. Of course, the promises include agreement to return the assets or their cash equivalents with or without interest (profit) on a specified or unspecified date. So there shall be a funds inflow whenever there is an increase in liability or decrease in assets. These phenomena can be captured in the following diagram: Sources Liabilities () Uses Liabilities ()
Assets ()
Assets ()
Sources
Uses
Figure: Sources and uses of fund
A finance manager, who is concerned with the management of liquidity of the business, would like to see how the funds flow during the year has affected its working capital position. This is predominantly focused by making a funds flow presentation of the balance sheets of the AMCL in the Exhibit 1. One of the principles of financial management is that the long-term funds would not only finance entire long term assets, it should also contribute reasonably towards financing the working capital requirement of the enterprise. This contribution is located in the funds statement of AMCL (Exhibit1) as net working capital (E) which is the corresponding part of net current assets (H).
Balance Sheet of AMCL (Funds flow concept) 30.06.2007 [Exhibit 1] 30.06.2006 30.06.2005 30.06.2004 30.06.2003
Capital and long term funds

Share capital Share premium Reserve and surplus Proposed dividend A. Shareholders fund Deferred tax liability 80000000 40000000 187127749 20800000 327927749 18790827 80000000 40000000 179012885 20800000 319812885 18378860 80000000 40000000 189237953 20800000 330037953 80000000 40000000 169815238 19200000 309015238 80000000 40000000 154713711 19200000 293913711
Long term debt B. Long term loan fund C. Total long term fund (A+B)
113999905 132790732 460718481 265240679 15280000 280520679 180197802 483346039 59711981 100749301 32660159 676467480 50102521 413406543 12723372 7339692 15850 817653 3534006 6519324 1810717 496269678 180197802 0.27
152592058 170970918 490783803 300381409 16480000 316861409 173922394 496023771 45504079 92771180 39484215 673783245 44209923 424111655 12891489 6304038 169468 4471647 2582715 3539686 1580230 499860851 173922394 0.26
165941504 165941504 495979457 316812646 18210000 335022646 160956811 491608049 42501462 93291132 33184149 660584792 46533312 418762505 13055263 8413189 76119 5210687 4870216 2706690 499627981 160956811 0.24
156153798 156153798 465169036 327236429 18880000 346116429 119052607 493278897 29956569 76235298 22781135 622251899 41875000 417645508 13609529 20263963 109713 3443926 5027030 1224623 503199292 119052607 0.19
185979959 185979959 479893670 344755402 18680000 363435402 116458268 456605572 15220740 90619101 18026597 580472010 45625000 386748095 8276626 16246147 1645449
Application of long term funds

Property, plant and equipment Investments D. Total long term assets E. Net working capital (C-D)
Short term assets

Inventory Trade debtors Advance, deposits and prepayments Cash and cash equivalents F. Total short term assets
Short term resources

Current portion of long term loan Short term loan from bank Liabilities for goods Liabilities for expenses Liabilities for other finance Interest payable Worker's profit participation fund Income tax payable Unclaimed dividend G. Total short term resources H. Net current assets (F-G) Net Working Capital Ratio
4468825 1003600 464013742 116458268 0.20
Major source of liquidity problem is the mismatch between current payments and current receipts. This mismatch is not unlikely to happen in any business payment of accounts receivable on due date. Net working capital provides that important cushion in the event of such an eventuality. It protects the enterprise against liquidity crisis on an ongoing basis. A decrease in NWC indicates depletion of such protection. To calculate the net working capital ratio, the following formula is usedNWCR = Net working capital / Gross current assets Fundamental analysis of AMCL reveals some important facts about it-- There is an increasing trend of net working capital of AMCL over the five years. In 2005 the NWC increased about 35% from year 2004. And in year 2007 the rate of increase is 3.61%. Current assets in 2007 increased .40% from year 2006 whereas current liabilities decreased about .71% from the previous year. These two together pushed up the NWC to the present level.
How far the company is from facing the impending liquidity crisis can be judged by making a comparison of the net working capital ratio. NWCR have been increasing from the last three years. This is a good notion about cushioning the companys liquidity crisis. Approach in Determining Optimum Cash Balance: We use Miller-Orr model to ascertain the desired level of cash for AMCL.
Miller-Orr Model We also found out that the cash flow relationship can also be explained through MillerOrr model. The basic assumptions on the other hand for the Miller-Orr model are as follows-
(a) Yield curve is flat i.e. no apparent change in investment rate of return. (b) Fixed transaction cost irrespective of size. (c) Investment and divestment can be made any time or point of time. (d) The cash flow under this model has a normally distributed pattern with a zero mean and that the standard deviation does not very across the time. (e) The firm sets its minimum cash balance which is exogenous to the model but is added to the required volume of the cash flow which according to this model will maximize profit or minimize cost of holding cash.
In this regard the cost of cash management is determined with the help of three variables namely(a) Transaction cost for investment (deposit) and disinvestment (withdrawal) which is denoted by b (b) Opportunity cost of holding cash balance which is denoted by i (c) Variability in cash flow which is denoted by s
2
The model operates in terms of upper and lower control limits and a target cash balance. AMCL allows its cash balance to wander randomly within the lower and the upper limits. As long as the cash balance is between higher limit and lower limit, the firm makes no transaction. When the cash balance reaches higher limit, the firm buys H-Z units of (or
dollars) of marketable securities. This action will decrease the cash balance to Z. In the same way, when cash balance fall to L (Lower limit), the firm should replenish the cash balance to Z by selling Z-L units (Dollars) of marketable securities. Trading cost per period is dependent on the expected umber of transactions in marketable securities during the period. Similarly, the opportunity costs of holding cash are a function of the expected cash balance of the period.
The cash manager has to follow the following steps to effectively use the Miller-Orr model. These steps are as follows-
1. Set the lower limit: We assumed the lower limit Tk. 185969 based on the operating cash flow of year 2007.We divided the cash flow by 365 to get daily average cash flow.
2. Estimate the standard deviation of daily cash flows: We analyzed the cash flows for the year 2007 and calculated the variance of the cash flows. The calculation of variance of cash flows is given belowDay cash flow (x)
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 s
2
190458 259875 -114520 147348 184528 -497865 -278596 567813 296374 168598 192736 187635 185428 -378142 216376 7438753
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3. Determine the daily interest rate:
We determined the daily interest rate
.0002307. It is the daily interest rate of 1 year maturity t-bill rate which rate is 8.42% annually. We considered it as the return of holding marketable securities. 4. Estimate the trading cost of buying and selling marketable securities: We assume the trading cost of selling marketable securities Tk 120 per transaction.
Determination of Optimum Cash Balance Determination of desirable cash balance depends on the opportunity cost of capital, variance of daily cash flow and fixed cost of trading. We calculated those factors earlier. Now the formulae for the optimum cash flow is as follows Z* = 3 (3bs /3i) +L Where, Z* = Optimum cash balance b = Fixed cost of transaction i = Daily rate of opportunity cost of capital
2
s2 = Variance of daily cash flows

L = Lower limit of the cash balance
fgggggggggggggggg Therefore, desired cash balance of AMCL is
Z* = 3 (3bs /4i) +L = 3 (3*120*7438753 /4*0.0002307) + 185969 =Tk. 658943
Higher limit of the cash balance H= 3Z*+L H = 3*658943 + 185969 H = 2162798
According to the cash flows of AMCL the figure of Miller-Orr model will be as follows
Cash
Tk. 2162798
Tk. 658943
Tk.185969 Time Figure: Miller-Orr model Applied to the cash flow of AMCL
Measurement of Liquidity:
Name of measurement criterion
Current ratio Quick ratio Accounts receivable turnover ratio Inventory turnover ratio Accounts payable turnover ratio Cash conversion cycle Net liquid balance Uncertainty factor (Lambda)
30.6.2007
1.36 0.39 15.50 1.48 46.65 256 0.03 12.95
30.6.2006
1.35 0.36 19.05 1.35 43.74 276 0.04 13.87
30.6.2005
1.32 0.34 18.77 1.21 36.90 305 0.03 15.01
30.6.2004
1.24 0.26 25.88 1.16 36.17 302 0.02 14.02
30.6.2003
1.25 0.27 49.45 1.22 65.37 287 0.02 12.79
PRAN AMCL Ltd. Level of Aggregate Liquidity Every firm is concerned with the effects of the uncertainty on the management of the firms current assets and liabilities. The gross hedge is important because it occurs via the relationship between total short-term assets and total short-term liabilities. The overall relationship between current assets (which produce cash inflows) and current liabilities (which require cash outflows) will determine the size of the gross hedge. If current assets provide much cash than is needed for current liabilities then the chance of a cash stock
out is lessened we call this overall relationship between a firms potentially available cash and its potential cash needs the firms aggregate liquidity position. Why measure and manage aggregate liquidity? The management of aggregate liquidity starts with the measurement of the size of the hedge for various potential financial strategies. The measurement of liquidity can be applied to make credit granting decision. Aggregate liquidity is an important determinant of the probability of default.
Traditional measures of the aggregate liquidity of the firm: Liquidity can be thought of as the firms ability to quickly generate cash versus the firms need for cash on short notice. Several financial ratios can be used as a measure of liquidity. Commonly used ratios include: Current Ratio: This is the ratio of current assets to current liabilities. The higher the ratio, the more the liquid the firm is said to be. This ratio is widely used by practitioners. The problem of current ratio is that it mixes assets and liabilities that are in reality, quite different in terms of their nearness to cash. Current Ratio = Current Assets / Current Liabilities The current ratio of the company is increasing over the years. It means the over all liquidity position of the company is increasing. As the company expands its business sales is increasing so as the accounts receivable. Accounts receivable has become double in four years. Current Ratio
1.40 1.35 1.30 1.25 1.20 1.15 1 2 3 Year 4 5 Series1
Quick Ratio: This is also called the acid test ratio. Here, inventories are deducted from the current assets account and the result is divided by current liabilities. The interpretation of quick ratio is similar to the current ratio.
Quick Ratio = (Current Assets Inventories) / Current Liabilities The quick ratio or the acid test ratio of the company is increasing over the years. It indicates that the short-term cash-generating ability of the firm is in balanced situation.
Quick ratio
0.40 0.35 0.30 0.25 0.20 0.15 0.10 0.05 0.00 1 2 3 year 4 5
Series1
Accounts Receivable Turnover Ratio: This ratio is usually calculated by sales divided by accounts receivable. The higher the turnover (and the lower the average collection period) the quicker is a receivable turned into cash and the more liquid is the firm said to be. Accounts Receivables Turnover Ratio = Sales / Accounts Receivables Accounts receivable turnover ratio is decreasing over the years. As it is decreasing over the years, it will take more time to convert accounts receivable into cash. The liquidity in this regard is decreasing for the company.
A/R turnover ratio
50.00 40.00 30.00 20.00 10.00 0.00 1 2 3 year 4 5 Series1
Inventory Turnover Ratio: This ratio is usually computed as cost of sales divided by inventory. The basic difficulty with the inventory turnover ratio as liquidity measures is that it focuses on only one
assets nearness to cash. So it does not tell much about the firms overall liquidity position. Inventory Turnover Ratio = Cost of Goods Sold / Inventory Inventory turnover ratio of the company is increasing on an average. It is indicating that the companys ability to convert inventory into cash has increased. Though the ratio decreased slightly in year 2004 and 2005.
Inventory turnover ratio
1.60 1.40 1.20 1.00 0.80 0.60 0.40 0.20 0.00 1 2 3 year 4 5
Series1
Accounts Payable Turnover Ratio: This ratio is usually computed as purchase divided by accounts payables. The higher the turnover ratio the more the company is being financed by the creditors. Accounts Payable Turnover Ratio = Purchase / Accounts Payable In 2003, accounts payable turnover ratio was 65.37. But it became 36.37 and 36.90 in the next two years. It increased in 2006 and stood at 43.74 and 46.65 in 2007. It means that the company now has to pay its liability earlier than the previous years. Improved Indices for measuring Aggregate Liquidity: Cash Conversion Cycle (CCC): The cash conversion cycle (CCC) is the net time interval between the expenditure of cash in paying the liabilities and the receipt of cash from the collection of receivables. The lower the cash conversion cycle the more the firm is said to be. It is calculated as the firms average collection period plus its inventory conversion period minus the payment deferral period. Cash Conversion Cycle (CCC) = Operating Cycle + Payment Deferral Period
An average situation is found in cash conversion cycle. In 2003, it was 287 days. But in the next two years it increased by 15 and 18 days. As it lowered in 2006 and 2007 the more liquid the company is said to be. Comprehensive Liquidity Index: In calculating the comprehensive liquidity index, the dollar amount of each current asset or liability is multiplied by one minus the inverse of the asset or liabilitys turnover ratio. Net Liquid Balance: This measures center on the firms balance of cash and marketable securities. This balance represents the firms true reserve against unanticipated cash needs, since other remedies for cash shortages can be very costly. If net liquid balance is negative it indicates depending on outside financing and indicative of minimum borrowing line required. Net Liquid Balance (NLB) = (Cash + Mkt. Securities Notes Payable) / Total Assets The net liquid balance of the company was increasing for consecutive four years and it represents the companys true reserve against unanticipated cash needs is in good situation. It decreased slightly in 2007.
Lambda Index: It is another measure of liquidity where the measure of uncertainty of cash flow is used. Lambda can be interpreted as a measure of the probability of having insufficient resources to cover operating cash outflows. The formula for Lambda Index is as follows-
Uncertainty factor (Lambda) = (Initial reserve + Expected cash flow) / Where, Initial reserve = cash + marketable securities + credit line Expected cash flow = EAT + depreciation = uncertainty of operating cash flow (standard deviation) Assumptions for calculating Lambda index for AMCL: We consider only cash and cash equivalents as the initial reserve as there are no marketable securities in their balance sheet. We found no information regarding AMCLs credit line in their financial statements.
The calculations are given below

Year 30.6.2007 30.6.2006 30.6.2005 30.6.2004 30.6.2003
EAT 29331413 27119354 40771757 40309136 44386931
Depreciation 38547306 41026308 42554329 45739954 36898232
OCF (EAT+Dep) 67878719 68145662 83326086 86049090 81285163
Avg. OCF 77336944
(OCF-Avg.OCF)
SD ()
Uncertainty factor (Lambda)
12.95
13.87
15.01
89458020150625 84479664803524 35869821896164 75901487925316 15588433271961 301297428047590 14.02 12.79
7762698
Interpretation: From the five years Lambda index of AMCL, we can derive in the decision that the index is much higher and it indicates the probability of AMCL of running out of cash is much lower. This index measure provides significant basis of the companys strong liquidity position.
CHAPTER
2
Inventory Management
Our focus on:
Overview of Inventory Inventory Projection
Inventory Management Five year inventory of AMCL is shown in the table below: Year 2003 2004 2005 2006 2007 Inventory 456605572 493278897 491608049 496023771 483346039 Current Asset 580472010 622251899 660584794 673783245 676467480 % of current assets .79 .79 .74 .74 .71
From the above table it can be clearly seen that the inventory level for AMCL is decreasing over the year. This indicates that the firms sale is increasing and less finished goods are kept idle. Inventories are carried at the lower of cost and net realization value. Cost is determined on a weighted average cost basis. This method corrects the distortion of the simple average by considering the number of units purchased in each lot. It is calculated by first multiplying the unit cost with each lot size, i.e. the number of units in each lot and then dividing the resultant figure by the total number of units purchased. This is superior to simple average method because price fluctuations are evenly distributed and, if the period under consideration is not very lengthy then both the cost of goods sold and the periodend inventory will be closer to the market. Inventory projection: year 03 Inventory 456605572 % of sales Mean growth rate, R =.611 Table: probability distribution of various levels of possible growth in inventory in 2008 and computations of standard deviation. Expected Chances of Weighted growth in occurring(in inventory Ri- R) Ri-R)2 Pi(Ri-R)2 inventory (%) decimal (1*2) (4) (5) (6) (1) points)(pi) R (2) (3) -2.9 .05 -.145 -3.511 12.33 .6165 -.57 .10 -.057 -1.181 1.39 .139 -.15 .20 -.03 -.761 .579 .1158 -1.67 .30 -.186 -2.231 4.977 1.493 3.7 .20 .74 3.089 9.542 1.908.357 2.5 .10 .25 1.889 3.568 .357 .78 .05 .039 .169 .029 .0015
04 493278897 8.03%
05 491608049 -.34%
06 496023771 .90%
07 483346039
=.611 SD= Pi(Ri-R)2
=4.63
= 4.632 = 2.15 Table: Inventory projection for AMCL in 2008
Scenario Best Most likely Worst
Growth rate -1.539% .611% 2.761%
Inventory(in taka) 475902510 486299283 49669128
CHAPTER
3
Accounts Payable Management
Our focus on:
Disbursement Float Management Principles of Managing Accounts Payable
Accounts Payable Management
Management of Disbursement float

Management of disbursement float is necessary because a firm can earn a lot of money by effectively managing the disbursement. We could not collect any information about disbursement float management from AMCL They did not disclose any kind of internal information in this respect. But in this report, we suggested some recommendation about effective disbursement management.
Delay in payment process can earn a lot of money if the opportunity cost is too high and the size of payment is bigger. AMCL can follow the following recommendations in managing the disbursement float.
1. Hold payment for several days after postmarked in office. 2. Call suppliers to verify statement accuracy for large amounts. 3. Mail from post office that requires huge handling.
We only consider the disbursement float management. There may be other policies to delay the payment such as zero balance account, use of promissory notes in payment procedure etc. But that may be too technological inconsistency in payment procedure in a country like Bangladesh.
AMCL follows the following rules in managing its accounts payable: AMCL has a clear, consistent policy that it pays bills in accordance with the contract. The purchase and finance department are both aware of this policy and adhere to it.
Agree payment terms at the outset of a deal and stick to them. Not extend or alter payment terms without prior agreement. Provide suppliers with clear guidance on payment procedure. AMCL has a system for dealing quickly with complaints and disputes and advice suppliers without delay when invoices or parts of invoices are contested.
CHAPTER
4
Accounts Receivable Management
Our focus on:
Collection Cost Analysis
In this part, we tried to track out the policy and procedure followed by AMCL to organize their accounts receivables. We also showed an evaluation model of different collection programs to arrive at an optimal solution for AMCL. Collection Cost Analysis: There is always a monetary cost involved in running collection machinery. But there is also an indirect (opportunity) cost associated with collection activities. Due to stricter collection efforts, sales might be lost, and hence the profitability. As against these costs, the benefits of a well organized collection department are reduction of bad-debt losses and shorter collection period that results into reduction in the average holding of receivables- both adding to the profitability of the enterprise. The goal of a collection policy is therefore, to strike a balance between costs and benefits, or in other words, to search for an optimal solution to the problem. We have evaluated different collection programs to arrive at an optimal solution for AMCL. We generated three alternative programs of AMCLs collection policy. The features of the present status and the proposed programs are given below--Present Status Average collection period is 23 days Monthly average accounts receivable is Tk. 4975998 Bad debt loss is 3% of sales There is no cash discount given by AMCL We assume 389532 Tk. as monthly collection expenditure Program I Average collection period is 20 days Monthly average accounts receivable = (77124903/365)*20 = Tk. 4226022 2% cash discount is given 2.75% of bad debt loss 1.5% increase in the collection cost Program II Average collection period is 18 days Monthly average accounts receivable = (77124903/365)*18 = Tk. 3803420 2.5% cash discount is given 2.5% of bad debt loss 1.57% increase in the collection cost Program III Average collection period is 15 days Monthly average accounts receivable = (77124903/365)*15 = Tk. 3169517 3% cash discount is given 2% of bad debt loss
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1.65% increase in the collection cost The general assumptions for all these four conditions are We consider monthly sales of year 2007 which is Tk. 77124903. We also assumed that despite the increasing intensity in collection efforts in the three programs, AMCL will be able to hold on to the existing level of sales. So sales are constant in present status in all the three programs. Return on sales is 22.65% which is the gross profit margin of year 2007.
Evaluation of Alternative Collection Program [Exhibit 2]
Present Status
1. Sales (2007 monthly) 2.Collection period 3.Monthly accounts receivable 4.Cost of carrying receivables 5. Cash discount 6. Bad debt loss 7. Collection Expenditure A. Total Cost (4 to 7) B.Return on Sales@22.65% Profit (B - A) 77124903 23 4859925 419974 2313747 389532 3123253 17468791 14345538
Programme I
77124903 20 4226022 356676 1542498 2120935 584298 4604407 17468791 12864383
Programme II
77124903 18 3803420 321009 1928123 1928123 611565 4788819 17468791 12679972
Programme III
77124903 15 3169517 267507 2313747 1542498 642728 4766480 17468791 12702310
The analysis made in exhibit 2 clearly indicates that the present status of AMCLs collection procedure is the optimal solution where the resultant profit is highest. It may also be seen from the exhibit that total cost of the alternative program raises with the intensity in collection efforts. Optimal solution lies where profit is maximized.
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WORKING CAPITAL ANALYSIS OF

Our focus on:

Fund Analysis Cash Balance Model (Miller-Orr) Measurement of Liquidity

Figure: Sources and uses of fund

Capital and long term funds

Application of long term funds

Short term assets

Short term resources

4468825 1003600 464013742 116458268 0.20

3. Determine the daily interest rate:

We determined the daily interest rate

s2 = Variance of daily cash flows

Z* = 3 (3bs /4i) +L = 3 (3*120*7438753 /4*0.0002307) + 185969 =Tk. 658943

Higher limit of the cash balance H= 3Z*+L H = 3*658943 + 185969 H = 2162798

The calculations are given below

EAT 29331413 27119354 40771757 40309136 44386931

Depreciation 38547306 41026308 42554329 45739954 36898232

OCF (EAT+Dep) 67878719 68145662 83326086 86049090 81285163

Avg. OCF 77336944

Uncertainty factor (Lambda)

89458020150625 84479664803524 35869821896164 75901487925316 15588433271961 301297428047590 14.02 12.79

Our focus on:

Overview of Inventory Inventory Projection

=.611 SD= Pi(Ri-R)2

= 4.632 = 2.15 Table: Inventory projection for AMCL in 2008

Scenario Best Most likely Worst

Growth rate -1.539% .611% 2.761%

Inventory(in taka) 475902510 486299283 49669128

Our focus on:

Disbursement Float Management Principles of Managing Accounts Payable

Accounts Payable Management

Management of Disbursement float

Our focus on:

Collection Cost Analysis

BBA 10th batch

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Z* = 3 (3bs /4i) +L = 3 (31207438753 /4*0.0002307) + 185969 =Tk. 658943

Higher limit of the cash balance H= 3Z+L H = 3658943 + 185969 H = 2162798