Capital working

A financial report contains two important documents—the balance sheet and the income statement. Two other documents that appear in the financial report are the accumulated retained earnings and the changes in working capital. All these documents are discussed in the following sections using a fictitious company. 

Balance Sheet The balance sheet represents an accounting view of the financial status of a company on a particular date. Table 9-3 is an example of a balance sheet for a company. The date frequently used by corporations is December 31 of any given year, although some companies are now using June 30 or September 30 as the closing date. It is as if the company s operation were frozen in time on that date. The term consolidated means that all the balance sheet and income statement data include information from the parent as well as subsidiary operations. The balance sheet consists of two parts assets are the items that the company owns, and liabilities and stockholders equity are what the 

Assets are classified as current, fixed, or intangibles. Current assets include cash, cash equivalents, marketable securities, accounts receivable, inventories, and prepaid expenses. Cash and cash equivalents are those items that can be easily converted to cash. Marketable securities are securities that a company holds that also may be converted to cash. Accounts receivable are the amounts due a company from customers from material that has been delivered but has not been collected as yet. Customers are given 30, 60, or 90 days in which to pay however, some customers fail to pay bills on time or may not be able to pay at all. An allowance is made for doubtful accounts. The amount is deducted from the accounts receivables. Inventories include the cost of raw materials, goods in process, and product on hand. Prepaid expenses include insurance premiums paid, charges for leased equipment, and charges for advertising that are paid prior to the receipt of the benefit from these items. The sum of all the above items is the total current assets. The term current refers to the fact that these assets are easily converted within a year, or more hkely in a shorter time, say, 90 days. 

Fixed assets are items that have a relatively long life such as land, buildings, and manufacturing equipment. The sum of these items is the total proper, plant, and equipment. From this total, accumulated depreciation is subtracted and the result is net property and equipment. Last, an item referred to as intangibles includes a variety of items such as patents, hcenses, intellectual capital, and goodwill. Intangibles are difficult to evaluate since they have no physicm existence e.g., goodwill is the value of the company s name and reputation. The sum of the total current assets, net proper, and intan tes is the total assets. 

Liabilities are the obhgations that the company owes to creditors and stockholders. Current liabilities are obhgations that come due within a year and include accounts payable (money owed to creditors for goods and services), notes payable (money owed to banks, corporations, or other lenders), accrued expenses (salaries and wages to employees, interest on borrowed funds, fees due to professionals, etc ), income taxes payable, current part of long-term d t, and other current liabilities due within the year. 

ROA provides a general proxy for the overall operational efficiency of a company—that is its ability to utilize assets (input) to generate profits (output). Since inventory capital is included in the total assets, reducing inventory capital may increase ROA for the same annual income, as long as it decreases assets in total (see Working Capital below for details). 

Working capital is the difference between a company s short-term assets (e.g., cash, inventories, accounts receivable) and its short-term liabilities (e.g., accounts payable, interest payments, and short-term debt). Thus, working capital—particularly the portion reflected by cash—represents the amount of flexible funds available to the company to invest in R D and other projects. Increasing inventory turns, therefore, can shift working capital toward cash, thereby freeing up funds for immediate use in profit-generating activities and projects. 

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Working capital is what must be invested to get the process into productive operation. This is money invested before there is a product to sell and includes... 

Ultimately, the process might be permanently shut down or given a major revamp. This marks the end of the project, H. If the process is shut down, working capital is recovered, and there may be salvage value, which would create a final cash inflow at the end of the project. 

The development and improvement of scientific-technical level of NDT and TD means for safety issues is connected with the necessity to find additional investments that must be taken into account at the stage of new technogenic objects designing, when solving new arising problems in social, economic, ecological and medical safety. It is not accidental, that the expenses for safe nuclear power plants operation cover 50% of total sum for construction work capital investments. That is why the investments for NDT and TD have to cover 10% of total amount for development and manufacturing of any product. 

Ref 91. Discounted cash-flow models account for use of capital, working capital, income taxes, time value of money, and operating expenses. Real after-tax return assumed to be 12.0%. Short-rotation model used for sycamore and poplar. Herbaceous model used for other species. Costs ia 1990 dollars. Dry tons. 

The economic importance of an ore deposit itself is largely affected by mineral or metal prices. Mine closures and reopenings are a common event in the mineral iadustry for this reason. Economics can also be affected by the ore composition, for example, by unacceptable levels of penalty elements ia the ore. The assessment of overall economics of exploiting a given ore deposit is similar to that for any large-scale industry. The various cost components are those associated with equipment, labor, utiUties, contingencies, operation and production, transportation, working capital, suppHes, maintenance. 

Capital Investment Cost. The capital investment involved in a proposed project is important because it represents the money that must be raised to get the project started, is used in profitabiUty forecasts, and is reflected in the estimated manufacturing cost of a product. The capital investment is classified herein as fixed capital, working capital, and land cost. Sample capital investment estimate forms provide for separate materials (M) and labor (L) categories, or just combined M L figures. 

Working Ca.pita.1, Working capital is the money required for the day-to-day operation of the venture over and above the fixed investment. The amount varies daily, may be cycHcal, and can be a significant part of the investment in some cases. In the accounting sense, working capital is the difference between current assets and current HabiUties. 

The working capital includes the cost of inventories, such as raw materials, materials-in-process, products, etc as well as suppHes, accounts receivable less accounts payable, prepaid expenses, other cash needs such as payroll, and some start-up expenses, eg, materials and wages. Typical inventories can be taken as one month s supply of raw materials, products, and materials-in-process. The materials-in-process can be valued at one month s sales. Other operating cash can be estimated as the actual cash need for one month. 

Methods are available for making detailed estimates of working capital (15). Shortcut ratios for estimating working capital are 15—20% of the fixed capital, 15% of the total capital, or 10—30% of annual sales. 

Raw material costs should be estimated by direct computation from flow rates and material prices. The flow rates are deterrnined from flow sheet material balances. The unit prices are obtained from vendors, company purchasing departments, or the Chemical Marketing Reporter. For captive raw materials produced internally, a suitable transfer price must be estabHshed. Initial catalyst charges can be treated as a start-up expense, working capital component, or depreciable capital, depending on the expected catalyst life and cost. Makeup catalyst is frequendy treated as a raw material. 

The investment consists of the fixed capital, eg, equipment, buildings, and faciUties land cost and working capital. Interest charges during constmction are frequently considered part of the fixed capital. This is called capitalization of the constmction interest expense. Part of the start-up costs are occasionally treated in the same manner. 

The nondepreciable investments, ie, land and working capital, are often assumed to be constant preoperational costs that are fully recoverable at cost when the project terminates. Equipment salvage is another end-of-life item that can represent a significant fraction of the original fixed capital investment. However, salvage occurs at the end of life, can be difficult to forecast, and is partially offset by dismantling costs. Eor these reasons, a zero salvage assumption is a reasonable approximation ia preliminary analysis. 

Fnd-of-Tife Items. The end-of-life items are working capital return, sale of land, and salvage. If there is a capital gain on land sale or salvage, above the remaining tax-basis asset value, then this gain is treated as taxable ordinary income ia the United States historically, capital gains were taxed separately at a... 

Working capital Total capital Sales revenue... 

Capital Costs The total capital cost Cfc of a project consists of the fixed-capital cost Cpc phis the working-capital cost Cn c, phis the cost of laud and other nondepreciable costs Cp ... 

Working capital may vaty from a very small fraction of the total capital cost to almost the whole of the invested capital, depending on the process and the industiy For example, in jewelry-store operations, the Fixed capital is veiy small in comparison with the working capital. On the other hand, in the chemical-process industries, the working capital is hkely to be in the region or 10 to 20 percent of the value of the fixed-capital investment. 

Estimated salvage value of plant items S = 20,000 Working capital C yc = 10,000 Cost of land Cj, = 20,000... 

In the final year of the project, the working capital and the laud are recovered, which in this case cost a total of 100,000. Thus, in the final year of the project, Afc = — 100,000 and —Afc = + 100,000. From Eq. (9-4), it is seen that any capital recoveiy makes a positive contribution to the net annual cash flow. 

Example 2 Net Present Value for Different Depreciation Methods The following data descrihe a project. Revenue from annual sales and the total annual expense over a 10-year period are given in the first three columns of Table 9-5. The fixed-capital investment Cpc is 1,000,000. Plant items have a zero salvage value. Working capital C vc is 90,000, and cost of land C/ is 10,000. There are no tax allowances other than depreciation i.e., is zero. The fractional tax rate t is 0.50. 

At the end of Year 10, the working capital (C vc = 90,000) and the cost of land (Cl = 10,000) are recovered, so that the annual expenditure of capital Atc in Year 10 is — 100,000 per year. Hence, the net annual cash flow (after tax) for Year 10 must reflect this recovery. By using Eq. (9-4),... 

This example is a simplified one. The cost of the working capital is assumed to be paid for in Y ear 0 and returned in Y ear 10. In practice, working capitalincreases with the production rate. Thus there may be an annual expenditure on working capital in a number of vears subsequent to Y ear 0. Except in loss-making years, this is usually treated as an expense of the process. In loss-making years the cash injection for working capital is included in the At for that year. 

The difference is + 27,779, which is numerically greater than the money lost by the end of Year 3 for project H. Thus project H should be scrapped, and the new project 1 adopted if only economic reasons need to oe considered. Recovery of working capital and the cost of... 

With a cost of capital of 10 percent the various cash flows can be discounted and summed. Thus for the base cases Z Af = 2,815,600, Z Ajp/d = 754,716, Z Aofd = 614,457, and Z C c/d = 61,446. With corporate taxes payable at 50 percent the aftertax cash flows of the first three items are (1 — 0.50) of the sums calculated above. The discounted working capital and the fixed-capital outlay are not subject to tax. These most probable values are listed and summed in Table 9-11 and, after adjustment for tax, give the modal value of the (NPV) as 276,224. 

They suggested that each project should pay an insurance premium i to guarantee the expected profits. The magnitude of b is proportional to the amount of capital to be risked. It is also a function of the degree of risk involved. Working capital and capital for auxiliary facilities are assumed to be risk-free. Thus, the risk rate is applied only to the fraction of the capital investment hkely to be lost it the project is unexpectedly terminated. 

A further duty of accountants and management is to ensure that the company always has sufficient working capital to enable it to cany on its business. 

Clearly, (FATR) is of less value than (ATR) when applied to companies that use relatively large amounts of working capital. The (FATR) is the inverse of the capital ratio (CR) for single projects. (CR) is defined as... 

The interest-rate equivalent of the cash discounts is 2 percent per month, since this discount could he obtained every month if payment were to he made at the beginning of the month rather than, as at present, at its end. Since the hills are settled monthly, the notional interest is paid monthly and should not he compounded. The discount is equivalent to 12 monthly simple-interest payments per year. Hence, from Eq. (9-31) the effective annual interest rate on discounts = (12)(0.02) = 0.24 = 24 percent. It would, therefore, he a good use of surplus cash to reduce this debt as quickly as possible. This would require cash equivalent to one-sixth of the annual hills due, or 16,700, to he avadahle. It can, therefore, he assumed that this level of liquidity is not available for capital projects, either as working capital to reduce the debt or for fixed-capital projects. Further, since the new project will not increase sales, it cannot generate further debt of this kind. Hence, this source is not available to capitahze the new project. 

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