Working capital

Financial planning and control processes are closely related to strategic planning.

Financial planning and control involve the use of projections based on standards and the development of a feedback and adjustment process to increase performance.

The results obtained from the projection of all these cost elements are reflected in the income statements.

Below I present some definitions and concepts of terms used in financial administration.

It is the investment of money made by the company or business to carry out its economic and financial management in the short term, understood as short term periods of time not exceeding one year.

The criterion that Working Capital is nothing more than the difference between Current Assets and Current Liabilities is generalized by most specialists and specialized literature.

CT = AC - PC (1)

Where:

CT = Working capital

AC = Current assets

PC = Current liabilities

The work that follows sets out a group of considerations that demonstrate that such statement is not true, which is of vital importance for the maximization of company profits.

See the following graph

Where:

AC´ = Part of the PC subtracted from the AC

AF = Fixed assets

PLP = Long-term liabilities

C = Stockholders' equity

As can be seen, if what is expressed in (1) is assumed to be true, the yellow shaded area constitutes the Working Capital that the company has to carry out its economic and financial management, obtaining its financing in the PLP, which is characterized by having high interest rates, that is, a high cost.

Gross working capital

Working capital (also called current capital, working capital, rotating capital, revolving fund or working capital), is a measure of the ability of a company to continue with the normal development of its activities in the short term.

It is calculated as the surplus of short-term assets over short-term liabilities.

Net working capital

It is defined as the difference between current assets and short-term liabilities, with which the company counts. If assets exceed liabilities, the company is said to have a positive net working capital. In general, the greater the margin by which current assets can cover the company's short-term obligations (short-term liabilities), the greater the company's ability to pay its debts as they mature.

Such relationship results from the fact that current assets are a source or source of cash inflows, while short-term liabilities are a source of cash disbursements.

Cash disbursements involving short-term liabilities are relatively predictable. When the company contracts a debt, it is often known when the debt will expire.

Another definition of Net Working Capital

Net Working Capital can also be thought of as the proportion of current assets financed by long-term funds. Understanding as long-term funds the sum of the long-term liabilities and the share capital of a Company.

Since the short-term liabilities represent the origins of the Company's short-term funds, provided that the fixed assets exceed the short-term liabilities, the amount of said excess must be financed by the term funds even longer.

Business profitability concept

Profitability is a relationship (a rate expressed in%) that compares net profit either with net sales, with total assets or economic profitability, with equity or own capital or with investment.

• The return on sales is internationally called ROS (return on sales).

• The economic return on total assets is called ROA (return on assets).

• The patrimonial or financial profitability is called ROE (return on equity)

• The return on investment is ROI (return on investment).

Return on investment

The profitability of any investment must be sufficient to maintain the value of the investment and to increase it. Depending on the investor's objective, the profitability generated by an investment can be left to maintain or increase the investment, or it can be withdrawn to invest it in another field.

To determine profitability it is necessary to know the value invested and the time during which the investment has been made or maintained.

Basically there are two types of investment: the fixed return or the variable return.

Fixed return is one that is agreed upon when making the investment such as a CDT, bonds, debt securities, etc. This type of investment ensures the investor a return, although it is not usually high.

Variable return is typical of stocks, fixed assets, etc. In this type of investment, profitability depends on the management of those responsible for its administration.

In the case of shares, depending on the profit of the company, it will also be the amount of profits or dividends to be distributed.

Example of profitability determination

There are two financial indicators that allow determining the profitability generated by the assets and assets of a company or person.

To better illustrate the difference and why of the two types of profitability, we will work on the same example, assuming that a company has assets of RD $ 10,000,000.00 liabilities of RD $ 3,000,000.00 and equity of RD $ 7,000,000.00 The net profit of this company in any year is of RD $ 6,000,000.00

Return on assets Return on assets = (Net profit / Assets) * 100 Return on assets = (RD $ 6,000,000.00 / RD $ 10,000,000.00) * 100 Return on assets = 60%.

From what can be said that the company's assets for a year generated a 60% return.

Return on equity Return on equity = (Net profit / Equity) * 100 Return on equity = (RD $ 6,000,000.00 / RD $ 7,000,000.00) * 100 Return on equity = 85.7%

This means that the company's assets during the year obtained a profitability of 85.7%.

As can be seen, the return on equity is more than 25 percentage points higher than the return on assets. The reason is that the equity is less, and despite being less, the same profit was obtained (RD $ 6,000,000.00).

This occurs because the true capital invested is not the assets but the equity, since part of the assets are financed by third parties. The investor, of the RD $ 10,000,000.00 of assets, has only financed RD $ 7,000,000.00, and that is his effective investment.

Profitability compared to sales

It is also known as the productivity index; measures the relationship between net profits and sales revenue.

The formula to calculate this indicator is as follows:

Leverage

It is the relationship between own capital and credit invested in a financial operation. By reducing the initial capital that must be contributed, there is an increase in the profitability obtained.

The increase in leverage also increases the risks of the operation, since it causes less flexibility or greater exposure to insolvency or inability to meet payments.

Financial appeceament

It is the effect that indebtedness introduces on the profitability of own capital. The variation is more than proportional than that produced in the return on investments. The necessary condition for amplifying leverage to occur is that the return on investments is greater than the interest rate on the debts.

Financial leverage is the effect that occurs in the profitability of the company as a consequence of the use of debt in its financing structure.

It is important to specify what is meant by profitability, in order to understand whether this effect is positive or negative, and in what circumstances. As is known, profitability is not synonymous with accounting result (profit or loss), but result in relation to the investment.

Negative leverage

When obtaining funds from loans is unproductive, that is, when the rate of return that is reached on the assets of the company is less than the interest rate that is paid on the funds obtained from the loans.

Positive financial leverage

When obtaining funds from loans is productive, that is, when the rate of return that is reached on the assets of the company is higher than the interest rate that is paid on the funds obtained from the loans.

Favorable leverage

Favorable leverage is said to occur when the company uses the funds raised at a fixed cost to obtain more than the fixed financing costs paid.

Unfavorable leverage

Unfavorable leverage occurs when the company does not obtain as much as the fixed financing costs.

Leverage advantages

• Requires low affective capital for the entity that makes the investment.

• Synergy gains. Applying operations outside the own business or entity.

• Efficiency gain, eliminating the effects of value destruction from excessive diversification.

• Improved leadership and management.

Disadvantages of leverage

• The government receives less income from the payment of taxes paid by inmates paid, since these are deductible.

Liquidity

Liquidity represents the quality of assets to be converted into cash immediately without significant loss of value.

In such a way that the easier it is to convert an asset into money, the more liquid it is said to be.

In economics, it is defined as the degree of availability with which different assets can be converted into money (the most liquid means of payment of all existing ones). A checking account in a bank has much more liquidity than a real estate property. An individual or company that has all of its assets in cash, or in readily available securities or negotiable instruments, has a liquidity position.

Capital structure

Permanent long-term financing of the company represented by long-term debt, preferred capital and stockholders 'equity (stockholders' equity consists of share capital, capital surplus and retained activities).

The capital structure is different from the financial structure because the latter also includes short-term liabilities and reserve sales.

The capital structure is closely related to the long-term financial situation of the company, even to finance and plan its future operations.

The funds that the company owns can be divided into those that are contributed by the partners and those that are obtained from third-party loans, taking into account that the former will always be related to the amount of time that the resources are held by the entity, on income and business assets while it remains in operation and participation in decision-making.

Types of capital

Capital contributions:

It consists of all the long-term funds that the owners supply to the company.

This has three main sources of obtaining resources: preferred shares, common shares and retained earnings, each with a different cost and associated with each of them.

Debt capital

This includes any type of long-term funds obtained by loans, with or without collateral, through the sale of bonds or negotiated.

A company can only use a given amount of debt financing because of the fixed payments related to it.

The origin of capital

To make a precision of this topic, the origin of the funds and the capital in a company must be distinguished, between its own and that of third parties or third parties.

Own capital is that which was deliberately limited for the constitution of a company, and which, in principle, does not have to be repaid.

The foreign capital is made up of funds loaned by elements outside the company, debts of the latter and vis-à-vis suppliers, etc.

Capital is the financial means of obtaining a means of production. Capital is constituted by saving, that is, by the use of a part of production for later productive purposes, such capital is consumed by the end of the period of use of the goods that are purchased or by the loss of their economic efficiency.

As for circulating capital, it is consumed in the same way or considering its monetary aspect or equivalent, it may also be transformed into mobilized capital.

The capital receives a remuneration called interest, and can be fixed or variable depending on the results of its exploitation or the progress of the company.

From being a simple remuneration of capital, interest also goes on to perform two basic functions: stimulating savings and using capital.

Common actions

Title or value that represents the economic right of an investor in a corporation through capital stock.

Each common share grants identical rights to all its holders.

Preferred stock

Title or patrimonial value that has priority over common shares in relation to the payment of dividends.

The dividend rate of these shares is fixed at the time of issue, and can be fixed or variable.

Bonds

Fixed income securities, registered or to order, that accrue periodic interests and that can be issued by entities of the public or private sectors with a term equal to or greater than one year.

conclusion

Financial planning is a key tool for the success of any business since it allows determining how much money the company will need, determining how much money the company will generate, and determining external financing requirements.

In this age, when capital is expensive and economic uncertainty is high, financial planning is essential in order to reduce risks.

Given all these factors it is advisable to have full knowledge of all the accounting terms of a company and the facilities that this represents at any given time.

Bibliography