How to Manage working Capital in Hotel-Basic accounting principles #9 by Dino Leonandri

1. How to Manage
Working Capital
in Hotel’s
Industries
By
Dino Leonandri

2. What Is Working Capital ?
• Working capital typically means the available current or short-
term assets of a firm such as cash, receivables, inventory and
marketable securities that are used to finance its day-to-day
operations.
• These items are also referred to as «circulating capital».
• Corporate executives devote a considerable amount of
attention to the management of working capital. Positive
working capital is required to ensure that a firm is able to
continue its operations and that it has sufficient funds to
satisfy both maturing short-term debt and upcoming
operational expenses.

3. Example Company
Balance Sheet
December 31, 2010
ASSETS LIABILITIES
Current Assets Current Liabilities
Cash $ 2,100 Notes Payable $ 5,000
Petty Cash 100 Accounts Payable 35,900
Temporary Investments 10,000 Wages Payable 8,500
Accounts Receivable - net 40,500 Interest Payable 2,900
Inventory 31,000 Taxes Payable 6,100
Supplies 3,800 Warranty Liability 1,100
Prepaid Insurance 1,500 Unearned Revenues 1,500
Total Current Assets 89,000 Total Current Liabilities 61,000
-
Investments 36,000 Long-term Liabilities
Notes Payable 20,000
Property, Plant & Equipment Bonds Payable 400,000
Land 5,500 Total Long-term Liabilities 420,000
Land Improvements 6,500
Buildings 180,000
Equipment 201,000 Total Liabilities 481,000
Less: Accum Depreciation (56,000)
Prop, Plant & Equip - net 337,000
-
Intangible Assets STOCKHOLDERS' EQUITY
Goodwill 105,000 Common Stock 110,000
Trade Names 200,000 Retained Earnings 229,000
Total Intangible Assets 305,000 Less: Treasury Stock (50,000)
Total Stockholders' Equity 289,000
Other Assets 3,000
-
Total Assets $770,000 Total Liab. & Stockholders' Equity $770,000
The notes to the sample balance sheet have been omitted.

4. Working Capital Management
• Decisions relating to working capital and short term financing are
referred to as working capital management. Short term financial
management is concerned with decisions regarding to CA and CL.
• Management of Working Capital refers to management of CA as
well as CL.
• If current assets are less than current liabilities, an entity has a
working capital deficiency, also called a working capital deficit.
• These involve managing the relationship between a firm's short-
term assets and its short-term liabilities.

5. Working Capital Management
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, for example has paid off some short-term
creditors.
The fundamental principles of working capital
management are reducing the capital employed and
improving efficiency in the areas of receivables,
inventories, and payables.

6. Working Capital Management
• 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.
• Businesses face ever increasing pressure on costs and financing
requirements as a result of intensified competition on globalized
markets. When trying to attain greater efficiency, it is important
not to focus exclusively on income and expense items, but to also
take into account the capital structure, whose improvement can
free up valuable financial resources

7. Working Capital Management
• Active working capital management is an extremely
effective way to increase enterprise value. Optimising
working capital results in a rapid release of liquid
resources and contributes to an improvement in free
cash flow and to a permanent reduction in inventory
and capital costs, thereby increasing liquidity for
strategic investment and debt reduction. Process
optimisation then helps increase profitability.

8. ©2006byNelson,
adivisionofThomsonCanada
Limited
8
Objective of Working Capital
Management
• To run firm efficiently with as little money as possible tied up
in Working Capital
• Involves trade-offs between easier operation and cost of carrying
short-term assets
• Benefit of low working capital
• Money otherwise tied up in current assets can be invested in activities
that generate higher payoff
• Reduces need for costly financing
• Cost of low working capital
• Risk of shortages in cash, inventory

9. Working Capital Trade-offs
Inventory
High Levels Low Levels
Benefit:
• Happy customers
• Few production delays (always have needed parts
on hand)
Cost:
• Expensive
• High storage costs
• Risk of obsolescence
Cost:
• Shortages
• Dissatisfied customers
Benefit:
• Low storage costs
• Less risk of obsolescence
Cash
High Levels Low Levels
Benefit:
• Reduces risk
Cost:
• Increases financing costs
Benefit:
• Reduces financing costs
Cost:
• Increases risk

10. Working Capital Trade-offs
Accounts Receivable
High Levels (favorable credit terms) Low Levels (unfavorable terms)
Benefit:
• Happy customers
• High sales
Cost:
• Expensive
• High collection costs
• Increases financing costs
Cost:
• Dissatisfied customers
• Lower Sales
Benefit:
• Less expensive
Accounts Payable and Accruals
High Levels Low Levels
Benefit:
• Reduces need for external finance--using a
spontaneous financing source
Cost:
• Unhappy suppliers
Benefit:
• Happy suppliers/employees
Cost:
• Not using a spontaneous
financing source

11. Need for Working Capital
• As profits earned depend upon magnitude of sales and
they do not convert into cash instantly, thus there is a
need for working capital in the form of CA so as to deal
with the problem arising from lack of immediate
realization of cash against goods sold.
• This is referred to as “Operating or Cash Cycle” .
• It is defined as «The continuing flow from cash to
suppliers, to inventory , to accounts receivable & back
into cash».

12. Need for Working Capital
• Therefore needs for working capital arises from cash or
operating cycle of a firm.
• Which refers to length of time required to complete the
sequence of events.
• Thus operating cycle creates the need for working
capital. Its length in terms of time span required to
complete the cycle is the major determinant of the firm’s
working capital needs.

13. ©2006byNelson,
adivisionofThomsonCanada
Limited
13
The Cash Conversion Cycle
(Operating Cycle)
• Firm begins with cash which then becomes inventory and
labour
• Which then becomes product for sale
• Eventually this will turn into cash again
• Firm’s operating cycle is time from acquisition of inventory
until cash is collected from product sales

14. Product is
converted into
cash, which is
transformed into
more product,
creating the cash
conversion cycle.
The Cash Conversion Cycle
(Operating Cycle)

15. Time Line Representation of the Cash
Conversion Cycle

16. Equity Capital vs Debt Capital
DEBT
CAPITAL
EQUITY
CAPITAL

17. Operating cycle with borrowed money
Cash is borrowed from banks
Cash is used to buy raw materials
Raw materials become products and services
Products and services become trade receivables
Receivables become cash again
Raw
Materials
Banks Cash
Finished
Goods
Accounts
Receivable
Equity Capital vs Debt Capital

18. Time & Money Concepts in
Operating Cycle
• Each component of working capital (namely inventory, receivables
and payables) has two dimensions ........TIME ......... and MONEY, when
it comes to managing working capital.
• You can get money to move faster around the cycle or reduce the
amount of money tied up. Then, business will generate more cash or
it will need to borrow less money to fund working capital.
• As a consequence, you could reduce the cost of bank interest or
you'll have additional free money available to support additional sales
growth or investment.
• Similarly, if you can negotiate improved terms with suppliers e.g. get
longer credit or an increased credit limit, you effectively create free
finance to help fund future sales.

19. If you Then ......
Collect receivables (debtors)
faster
You release cash from the
cycle
Collect receivables (debtors)
slower
Your receivables soak up
cash
Get better credit (in terms
of duration or amount) from
suppliers
You increase your cash
resources
Shift inventory (stocks)
faster
You free up cash
Move inventory (stocks)
slower
You consume more cash

20. While a company has usually a quite
stable level of Fixed Assets
(buildings, machines…) the
level of Inventories, Receivables
and Payables is volatile and has
sometimes a typical seasonal pattern.
Working Capital levels
shrink and expand.
The only way to flexibly finance
the WC cycle is to adjust the Net Debt.
Conclusion:
Rising Working Capital sucks out cash from the company !
Lowering Working Capital frees up cash for the company !
Fixed
Assets
Working
Capital
Equity
Provisions
Net Debt
(Financial
Position)
Invested
Capital
Financing
Working Capital Management means
Cash Management

21. Management Of Cash
Importance of Cash
When planning the short or long-term funding requirements
of a business, it is more important to forecast the likely cash
requirements than to project profitability etc.
Bear in mind that more businesses fail for lack of cash than
for want of profit.

22. Cash vs Profit
Sales and costs and, therefore, profits do not necessarily
coincide with their associated cash inflows and outflows.
The net result is that cash receipts often lag cash payments
and while profits may be reported, the business may
experience a short-term cash shortfall.
For this reason it is essential to forecast cash flows as well as
project likely profits.

23. Calculating Cash Flows
A projection should be made about whether to expect a
cumulative positive net cash flow over several periods or,
conversely, a cumulative negative cash flow.
Cash flow planning entails forecasting and tabulating all
significant cash inflows relating to sales, new loans, interest
received etc., and then analyzing in detail the timing of
expected payments relating to suppliers, wages, other
expenses, capital expenditure, loan repayments, dividends, tax,
interest payments etc.

24. Income Statement: Month 1
Sales ($000) 75
Costs ($000) 65
Profit ($000) 10
CFs relating to Month 1:
Amount in ($000)
Month 1 Month 2 Month 3 Total
Receipts from sales 20 35 20 75
Payments to suppliers etc. 40 20 5 65
Net cash flow (20) 15 15 10
Cumulative net cash flow
(20) (5) 10 10

25. MANAGING CASH FLOWS
Afterestimating cash flows,effortsshould be made to
adhereto the estimatesof receiptsand payments of
cash.
Cash Managementwillbe successful only if cash
collections are accelerated and cash payments
(disbursements), as far as possible, are delayed.

26. Methods of ACCELERATING CASH INFLOWS
• Prompt payment from customers (Debtors)
• Quick conversion of payment into cash
• Decentralized collections
• Lock Box System (collecting centers at different locations)
Methods of DECELERATING CASH OUTFLOWS
• Paying on the last date
• Payment through Cheques and Drafts
• Adjusting Payroll Funds (Reducing frequency of payments)
• Centralization of Payments
• Inter-bank transfers
• Making use of Float (Difference between balance in Bank
Pass Book and Bank Column of Cash Book)
MANAGING CASH FLOWS

27. FACTORS DETERMINING
WORKING CAPITAL
1. NatureoftheIndustry
2. DemandofIndustry
3. Cashrequirements
4. NatureoftheBusiness
5. Manufacturingtime
6. VolumeofSales
7. TermsofPurchaseandSales
8. InventoryTurnover
9. BusinessTurnover
10. BusinessCycle
11. CurrentAssetsrequirements
12. ProductionCycle
contd…

28. WorkingCapitalDeterminants(Continued…)
13. Creditcontrol
14. Inflationorpricelevelchanges
15. Profitplanningandcontrol
16. Repaymentability
17. Cashreserves
18. Operationefficiency
19. Changesintechnology
20. Firm’sfinanceanddividendpolicy
21. Attitudetowardsrisk

29. THANK YOU
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