ACADEMY OF ECONOMIC STUDIES

FACULTY OF ACCOUNTING AND MANAGEMENT INFORMATION SYSTEM

ACADEMIA DEACADEMIA DED
DEACADEMIA DED

DISSERTATION

Scientific coordinator:

Lecturer Ph.D. Stere Mihai

Graduate:

Radu I. Zoica (Pascu)

Bucharest
2012

ACADEMY OF ECONOMIC STUDIES

FACULTY OF ACCOUNTING AND MANAGEMENT INFORMATION SYSTEM

Working Capital Management

Theory and Applications

Scientific coordinator:

Lecturer Ph.D. Stere Mihai

Graduate:

Radu I. Zoica (Pascu)

Bucharest
2012

Table of Contents
Introduction .................................................................................................................................................2
Chapter 1. Working Capital and its Management-Theoretical Backgrounds.......................................4
1.1.

Concepts of working capital ..........................................................................................................4

1.2.

Determinants of working capital ....................................................................................................7

1.3.

Objectives of working capital management ...................................................................................9

1.4.

Operating Cycle ...........................................................................................................................15

1.5.

Sources of Working Capital .........................................................................................................20

1.6.

The management of inventory .....................................................................................................25

1.7.

The management of receivables...................................................................................................26

1.8.

The management of creditors (suppliers).....................................................................................29

1.9.

The management of cash .............................................................................................................30

Chapter 2. A Case Study in Working Capital Management .................................................................31

2.1.

LOGSTOR: A company overview...............................................................................................31

2.2.

Romanian District Heating Industry ............................................................................................33

2.3.

LOGSTOR (ROMANIA) SRL ....................................................................................................34

2.4.

Working capital management at LOGSTOR SRL .......................................................................38

Chapter 3. Conclusions .............................................................................................................................52

Appendix 1. ................................................................................................................................................57
Appendix 2. ................................................................................................................................................58
Bibliography ..............................................................................................................................................59

Introduction
Choosing to analyse the working capital management within a company starting from
early stages of its existence has been a provocative issue, having in mind the optimization of
assets liquidity in an organization which start its business operations in a crisis period and on
a very instable market. It was a big challenge to analyse the working capital behaviour during
periods, as much as the uncertainty is dominating factor of this part of financial management.
Being deeply interested to understand the inter-dependents between companys health and
working capital management, I start my analysis of working capital components and all
constraints that might influence management decisions related amount and the combination of
current assets and ways to financing them.
The most sensitive process of working capital management includes decisions about
different aspect of cash investment, the maintenance of certain level of inventories and
managing of receivable and payable accounts. As Gitmen sustained in 2009, the main goal of
working capital management is to teach and keep an optimized balance between each
component of working capital, and Filbeck and Krueger said in 2005 that business success
heavily depends on the ability of financial executives to effectively manage receivables,
inventory, and payables. Lamberson in 1995 stated that company can reduce its financing
costs and/or increase the funds available for expansion projects by minimizing the amount of
investment tied up in current assets.
A non-optimal level of current assets and liabilities could be usually found in the early
period of companies and back toward an optimal level it will be a proof of financial
managerial skills, doubled by decisions followed by strict rules applied to all involved staff.
Analysing the levels of current assets its necessary to outline that a higher value would have
a negative effect on the firms profitability whereas a low level of current assets may lead to
lower level of liquidity and stock outs resulting in difficulties in maintaining smooth
operations.
Traditional concept of working capital is the difference between assets and current
liabilities. This definition doesn't provide an accurate concept of company liquidity because
the components of working capital have different levels of liquidity, as some of components
(for example cash investment in marketable securities and treasury bills) have financial
essence with a high liquidity. Other components have non- financial essence with a low
liquidity (for example receivable, payable accounts and inventory). Successfully improving
in working capital management requires a multiple components approach. Companies have to
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search the finest detail to identify the principal drivers of working capital aiming an efficient
cash flow.

Chapter 1. Working Capital and its Management-Theoretical Backgrounds

1.1. Concepts of working capital
There are two important concepts of working capital gross and net.
Gross working capital refers to the amounts invested in the various components of
current assets. This concept has the following practical relevance.
a. Management of current assets is the most important task of working capital
management.
b. It is an important component of operating capital. Therefore, for improving the
profitability on its investment a finance manager of a company must give top priority to
efficient management of current assets.
c. The need to plan and monitor the utilization of funds of a firm demands working
capital management as applied to current assets.
d. It helps in the fixation of various areas of financial responsibility.
Net working capital is the excess of current assets over current liabilities and
provisions. Current liabilities are those claims of outsiders, which are expected to mature for
payment within an accounting year and include creditors dues, bills payable, bank overdraft
and outstanding expenses. Net working capital can be positive or negative. Net working
capital is positive when current assets exceed current liabilities and negative when current
liabilities exceed current assets. This concept has the following practical relevance.
It indicates the ability of the firm to effectively use the spontaneous finance in
managing the firms working capital requirements.
A firms short term solvency is measured through the net working capital position it
commands.
It may be stated that gross and net concepts of working capital are two important facets of
working capital management. Both the concepts have operational significance for the
management and therefore neither can be ignored. While the net concept of working capital
emphasizes the qualitative aspect, the gross concept underscores the quantitative aspect.
Working capital is otherwise known as revolving or circulating capital; it is defined in
ordinary words the difference between current assets and current liabilities, i.e.

Working Capital = Current Asset Current Liability

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Components of Current Assets and Current Liabilities

Current Assets are:

o Inventory
o Account Receivables
o Cash and Bank Balances
o Short term investments
o Advances such as advances for purchase of raw materials, components and
consumables stores, prepaid expenses etc.

Current Liabilities are:

o Account Payable
o Taxation
o Provisions
o Dividends
o Short term loans

Figure 1.1.1.Calculating Working Capital

In order to find the approximate amount of working capital a company should have a
comparison between amount of working capital on the balance sheet and the total sales
(which is found on the income statement - not the balance sheet). A business that sells a lot of
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low-cost items, and cycles through its inventory rapidly (a grocery store) may only need 1015% of working capital per dollar of sales. A manufacturer of heavy machinery and highpriced items with a slower inventory turn may require 20-25% working capital per dollar of
sales. A company such as Coca Cola would probably fall somewhere between the two.
Here is an example:
ABC Ltd provides systems for aircraft as well as manufacturers heavy-duty engines.
Working Capital: $950,000,000 (current assets - current liabilities)
Total Sales (found on the income statement) = $4,500,800,000.
The working capital per dollar of sales is equal to $950,000,000/$4,500,800,000 x 100 =
21.11%. As a manufacturer of heavy duty machinery, ABC Ltd falls within the 20-25%
working capital per dollar of sales range. This reflects that company has sufficient liquidity to
cover the period of lean products sales.

Negative working capital

Some companies can generate cash so quickly they actually have a negative working
capital. This is generally true of companies in the restaurant business.Amazon.com is another
example. This happens because customers pay upfront and so rapidly, the business has no
problems raising cash. In these companies, products are delivered and sold to the customer
before the company ever pays for them.
For a better understanding how a company can have a negative working capital, the next
example is edifying: Wal-Mart, a company which sale DVD, ordered 500,000 copies of a
DVD to Warner Brothers, they were supposed to pay Warner Brothers within 30 days. What
if by the sixth or seventh day, Wal-Mart had already put the DVDs on the shelves of its stores
across the country? By the twentieth day, they may have sold all of the DVDs. In the end,
Wal-Mart received the DVDs, shipped them to its stores, and sold them to the customer
(making a profit in the process), all before they had paid Warner Brothers! If Wal-Mart can
continue to do this with all of its suppliers, it doesn't really need to have enough cash on hand
to pay all of its accounts payable. As long as the transactions are timed right, they can pay
each bill as it comes due, maximizing their efficiency.
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The bottom line: A negative working capital is a sign of managerial efficiency in a

business with low inventory and accounts receivable (which means they operate on an almost
strictly cash basis). In any other situation, it is a sign a company may be facing bankruptcy or
serious financial trouble.

1.2. Determinants of working capital

Working capital requirement as a concern depends on a number of factors, each of

which should be considered carefully for determining the proper amount of working capital.
However it is added that these factors affect differently the different units and these keeps
varying from time to time. In general, the determinants of working capital which are common
to all organizations can be summarized as under:

Nature of business

Need for working capital is highly depends on what type of business the firm operates
in. Some businesses are such, due to their very nature, that their required of fixed capital is
more rather than working capital. These businesses sell services and not the commodities and
that too on cash basis. As such, no founds are blocked in piling inventories and also no funds
are blocked in receivables e.g. public utility services like railways, infrastructure oriented
project etc. there requirement of working capital is less. On the other hand, there are some
businesses like trading activity, where requirement of fixed capital is less but more money is
blocked in inventories and debtors.
Manufacturing concerns stands in between these two extends. Working capital
requirement for manufacturing concerns depends on various factors like the products,
technologies, marketing policies.
The need for working capital arises on account of two reasons:

To finance operations during the time gap between sale of goods on credit and
realization of money from customers of the firm.

To finance investments in current assets for achieving the growth target in sales.

Therefore finance the operations in operating cycle of a firm working capital is required.

Length of production cycle

In some business like machine tools industry, the time gap between the acquisition of
raw material till the end of final production of finished products itself is quite high. As such
amount may be blocked either in raw material or work in progress or finished goods or even
in debtors. Naturally there need of working capital is high. Seasonal industries, which produce
only in specific season, require more working capital as well as industries which produce
round the year but sale mainly in special seasons.

Size and growth of the business

Size of business is another factor to determine the need for working capital.In very
small company the working capital requirement is quit high due to high overhead, higher
buying and selling cost etc. as such medium size business positively has edge over the small
companies. But if the business start growing after certain limit, the working capital
requirements may adversely affect by the increasing size.

Business/Trade cycle

If the company is the operating in the time of boom, the working capital requirement
may be more as the company may like to buy more raw material, may increase the production
and sales to take the benefit of favorable market, due to increase in the sales, there may more
and more amount of funds blocked in stock and debtors etc. similarly in the case of
depressions also, working capital may be high as the sales terms of value and quantity may be
reducing, there may be unnecessary piling up of stock without getting sold, the receivable
may not be recovered in time etc.

Terms of purchase and sales

Sometime due to competition or custom, it may be necessary for the company to extend
more and more credit to customers, as result which more and more amount is locked up in
debtors or bills receivables which increase the working capital requirement. On the other
8

hand, in the case of purchase, if the credit is offered by suppliers of goods and services, a part
of working capital requirement may be financed by them, but it is necessary to purchase on
cash basis, the working capital requirement will be higher.

Profitability

The profitability of the business may be vary in each and every individual case, which is
in turn its depend on numerous factors, but high profitability will positively reduce the strain
on working capital requirement of the company, because the profits to the extent that they
earned in cash may be used to meet the working capital requirement of the company.

Credit policy

The credit policy of the firm affects the working capital by influencing the level of
debtors. The credit term to be guaranteed to customer may depend upon the norm of the
industry to which the firm belongs. But a company has the flexibility of shaping its credit
policy within the constraint of industry norms and practice. The organization should use
discretion in granting credit term to its customers.

Operating efficiency

The efficiency in controlling operating cost and utilizing fixed and current assets leads
to operate efficiency. If the business is carried on more efficiently, it can operate in profits
which may reduce the strain on working capital; it may ensure proper utilization of existing
resources by eliminating the waste and improved coordination etc.

1.3. Objectives of working capital management

Working capital management is concerned with managing the different components of

current assets and current liabilities. A firm must have appropriate working capital neither
excess nor shortage. Maintaining adequate working capital at the satisfactory level is crucial
9

for maintaining the competitiveness of a company. Mismanagement of working capital is

therefore common cause of business failure.
Working capital management as an important part of financial management, its primary
objective is concerned with the congruity of asset and liability movements over time, which
relates to the two main purposes of working capital management; liquidity and profitability.
Profitability refers to the shareholders wealth maximization and liquidity is concerned
with fulfilling financial obligations. A firm must have acceptable returns from its operations
to ensure the realization of this objective. There are a positive correlation between sales and
firms return on its investment. A company earnings depend on the volume of sales made. It
is necessary to ensure adequate investment in assets, keep up with accelerating sales volume.
Firms make sales on credit. There is always a time gap between sale of goods on credit
and the realization of proceeds of sales from the firms customers. Finance manager of a firm
is required to finance the operation during this time gap. Therefore, objective of working
capital management is to ensure smooth functioning of the normal business operations of a
company. The firm has to decide on the amount of working capital to be employed.
If an organization may adopt a conservative policy of holding large quantum of current
assets to ensure larger market share and to prevent the competitors from hanging any market
for their products, such a policy soon will affect the companys return on its investment. As
higher the required amount of investment in current asset, as much funds locked in current
assets will reduce the firms profitability on operating capital.
On the other hand a firm may have an aggressive policy of depending on spontaneous
finance to the maximum extent. Credit obtained by a firm from its suppliers is known as
spontaneous finance. Here a firm will try to reduce its investments in current assets as much
as possible but without affecting the firms ability to meet working capital needs for sales
growth targets. Such a policy will ensure higher return on its investment as the firm will not
be locking in any excess funds in current assets. However, any error in forecasting can affect
the operations of the firm unfavourably if the error is fraught with the down side risk. There is
also another risk of firm losing on maintaining its liquidity position.
Objective of working capital management is achieving a compromise between liquidity
and profitability of operations for the smooth conduct of normal business operations of the
firm, based on ability of the company to improve its profitability but at the expense of tying
up cash, i.e:

Receiving a bulk purchase discount (improved profitability) for buying more inventory

than is currently required (reduced liquidity)

10

Offering credit to customers (attracts more customers so improves profitability but

reduces liquidity)
The opposite situation can be seen where a company can improve its liquidity position
but at the expense of profitability. For example, offering an early settlement discount to
customers. The twin goals of profitability and liquidity will often conflict since liquid assets
give the lowest returns. Cash kept in safe will not generate a return, while a six-month bank
deposit will earn interest in exchange for loss access for the six-month period.
Source: ACCA Paper F9Balancing act
Figure 1.3.1 A careful balancing act-smarter working capital management

The balance sheet of a business provides a snapshot of the working capital position at a
particular point in time
There are two key ratios that can be calculated to provide a guide to the liquidity position of
a business:
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 Current ratio
Acid test (quick) ratio

The current ratio is another test of a company's financial strength. It calculates how
many dollars in assets are likely to be converted to cash within one year in order to pay debts
that come due during the same year. The current ratio is found by dividing the total current
assets by the total current liabilities. For example, if a company has $10 million in current
assets and $5 million in current liabilities, the current ratio would be 2 (10/5 = 2).

An acceptable current ratio varies by industry. Generally speaking, the more liquid the
current assets, the smaller the current ratio can be without cause for concern. For most
industrial companies, 1.5 is an acceptable current ratio. As the number approaches or falls
below 1 (which means the company has a negative working capital), you will need to take a
close look at the business and make sure there are no liquidity issues. Companies that have
ratios around or below 1 should only be those which have inventories that can immediately be
converted into cash. If this is not the case and a company's number is low, you should be
seriously concerned.

Figure 1.3.2 Current Ratio calculation

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Figure 1.3.3 Quick Ratio calculation

Interpreting the Ratios

A business needs to have enough cash (or cash to come) to be able to pay its debts
Obviously, a current ratio comfortably in excess of 1 should be expected but what is
comfortable depends on the kind of business
Some businesses find it hard to turn stock and debtors into cash so need a high current ratio
Some businesses (e.g. supermarkets) turn stock into cash very rapidly and have low debtors
so they can happily exist with a current ratio of less than 1
The acid test ratio is often considered to be a better test of liquidity for businesses with a low
stock turnover.

Limitations of Liquidity Ratios

Liquidity ratios should be used with care.
Balance sheet values at a particular moment in time may not be typical
Balances used for a seasonal business will not represent average values
Ratios can be subject to window dressing or manipulation (e.g. a big push to get
customers to pay outstanding balances by the year end.
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 Ratios concern the past (historic) not the future

Working capital management is very much about ensuring the business has sufficient cash in
the future.
It is being increasingly recognized that inadequacy or mismanagement of working
capital is the main cause of business failure. The purpose of achieving an efficient working
capital management should rely in applying the best practices to ensure the prevention of
revenue leakage, increase speed and reduce costs. Specifically, working capital management
requires managers to decide on what levels of current assets the firm will hold at any point in
time and on how these current assets are to be financed. In common terms, working capital
represents a businesss investment in short-term assets needed to operate over a normal
business cycle. This meaning corresponds to the required investment in cash, accounts
receivable, inventory, and other items listed as current assets on the firms balance sheet.

Inefficiency

Analysing the balance sheet and find a company has a current ratio of 3 or 4, would be
an object to be concerned. A number this high means that management has so much cash on
hand; they may be doing a poor job of investing it. If there is noticed a large pile of cash
building up and the debt has not increased at the same rate (meaning the money is not
borrowed), then is obviously necessary to find out what is going on.
Microsoft current has the biggest cash hoard in the business world. It's current ratio is
in excess of 4. The company has no long term debt on the balance sheet. What are they
planning on doing? No one knows; the software giant may pay a dividend for the first time,
pour the money back into research and development, or buy back shares. Although not ideal,
too much cash on hand is the kind of problem a smart investor prays for.

Overtrading Introduction

Overtrading occurs if a company is trying to support too large volume of trade from too
small working capital base.

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Overtrading happens when a business is unable to meet its debts as they fall due
because cash is absorbed by increasing in non-current assets, inventories and trade
receivables.
Overtrading is particularly common in the early years of a new business if it start-off
with insufficient capital and rapidly expanding businesses. It can be extremely serious, even
fatal to the business.
There are several strategies that are appropriate to deal with overtrading:
introducing new capital: this is likely to be an injection of equity finance rather than debt
since, with liquidity under pressure due to overtrading, managers will be keen to avoid
straining cash flow any further by increasing interest payments.
improving working capital management: overtrading can also be attacked by better control
and management of working capital, for example by chasing overdue accounts. Since
overtrading is more likely if an aggressive funding policy is being followed, adopting a
matching policy or a more relaxed approach to funding could be appropriate.
reducing business activity: as a last resort, a company can choose to level off or reduce the
level of its planned business activity in order to consolidate its trading position and allow time
for its capital base to build up through retained earnings.
Indications that a company may be overtrading could include:
rapid growth in sales over a relatively short period;
rapid growth in the amount of current assets, and perhaps non-current assets;
deteriorating inventory days and trade receivables days ratios;
increasing use of trade credit to finance current asset growth (increasing trade payables
days);
declining liquidity, indicated perhaps by a falling quick ratio;
declining profitability, perhaps due to using discounts to increase sales;
decreasing amounts of cash and liquid investments, or a rapidly increasing overdraft.

1.4. Operating Cycle

A useful tool for the business owner is the operating cycle. According to Moyer,
Mcguigan and Kretlow, (1998), a firms operating cycle consists of three primary activities purchasing resources from suppliers, producing the product internally, and selling the product
to customers. This operating cycle determines a firms working capital investment and its
15

financing needs. The purchase and sales operations create cash inflows and outflows, which
are both unsynchronised and uncertain (Scherr 1989). They are unsynchronised because cash
disbursements (like payments for resource purchases) usually take place before cash receipts
(for example collections of receivables). They are uncertain because future sales and costs,
which generate cash receipts and disbursements respectively, cannot be forecasted with
complete accuracy. Therefore, besides managing the flow of materials and goods, working
capital also plays an important role in the management of these unsynchronised and uncertain
cash flows from purchase of materials and sales of goods.
There are two types of working capital necessary to facilitate the sales and production
process through operating cycle, permanent and temporary.

Permanent working capital

Permanent working capital is the minimum amount of investment required to be made

in current assets at all times to carry on the day to day operation of firms business. This
minimum level of current asset it is also known as fixed working capital. Therefore, this piece
of the working capital should be financed with permanent sources of funds such as owners'
capital, debentures, long-term debt, preference capital and retained earnings: Management
must decide the extent to which current assets should be financed with equity capital and/or
borrowed capital.

Temporary working capital

It is also known as variable working capital or fluctuating working capital. The firms
working capital requirements vary depending upon the seasonal and cyclical changes in
demands for a firms products. The extra working capital required as per the changing
production and sales levels of a company is known as temporary working capital. For
example, a rise in raw materials prices will influence the price level of finished goods and as
well the total funds invested in inventories. In peak season, stock level will increase due to
climbing in demand and would have to be identified ways to support the liquidity
requirement.

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Those two types of working capital - permanent and temporary-are required facilitating
production and sales through the operating cycle, but temporary working capital is arranged
by the firm to meet liquidity requirements that are expected to be temporary.
The operating cycle analyses the accounts receivable, inventory and accounts payable
cycles in terms of days. In other words, accounts receivable are analysed by the average
number of days it takes to collect an account. Inventory is analysed by the average number of
days it takes to turn over the sale of a product (from the point it comes in your door to the
point it is converted to cash or an account receivable). Operating cycle of a firm has the
following elements:
Figure 1.4.1 Working capital operating cycle

Figure 1.4.1 explains the functions of working capital management using the working
capital financing, operations and investment cycle. The flow starts with cash obtained from
internal sources such as collections from operations and retained earnings as well as
externally from suppliers of capital (creditors or owners) which is used to finance the
purchase of materials. The purchase and cash payment operations result in the investment of
materials inventory, which is used in the production process. The production operation endsup in the investment of finished goods inventory, which is sold either for cash (resulting in
investments in cash) or credit, (which results in accounts receivable which is eventually
turned into cash). The cash generated is then used to settle the short-term debts - trade
payables, bank loans and unpaid government tax. Finally, because the ultimate objective of a
firm is the creation of cash value to the owners all or part of this cash is paid to the suppliers
17

of capital in the form of dividends or retained in the firm. This makes the end of a cycle and
the start of another.
The time gap between acquisition of resources and collection of cash from customers is
known as the operating cycle. These five phases occur on a continuous basis. There is no
synchronization between the activities in operating cycle. Cash out flows occur before the
occurrences of cash inflows in operating cycle cash out flows are certain. On the other hand
cash inflows are uncertain because of uncertainty associated. With effecting sales as per the
sales forecast and ultimate timely collection of amount due from the customers to whom the
firm has sold its goods.
Since cash inflows do not match with cash out flows, firm has to invest in various
current assets to ensure smooth conduct of day to day business operations. Therefore, the firm
has to assess the operating cycle time of its operation for providing adequately for its working
capital requirements.
Operating cycle = IC period + RC period
IC period = Inventory conversion period
RC period = Receivables conversion period
Inventory conversion period is the average length of time required to produce and sell
the product.
Inventory Conversion period =

365

Receivables conversion period is the average length of time required to convert the firms
receivables into cash
Receivables conversion period =

365

Accounts payables period is also known as payables deferral period.

Accounts payables period

(Payables deferral period)

Purchases per day =

18

Cash Conversion Cycle: Is the length of time between the firms actual cash
expenditure and its own cash receipt. The cash conversion cycle is the average length of time
a dolar is tied up in current assets.
Operating Cycle = Inventory Conversion Period + Accounts Receivables conversion Period
CCC = ICP + RCP PDP
CCC = Cash Conversion Cycle
ICP = Inventory Conversion Period
RCP = Receivables Conversion Period
PDP = Payables deferral period
Accounts payable are analysed by the average number of days it takes to pay a supplier
invoice. In addition to analysing the average number of days it takes to make a product
(inventory days) and collect on an account (account receivable days) vs. the number of days
financed by accounts payable, the operating cycle analysis provides one other important
analysis. From the operating cycle, a computation can be made of the amount required to
support one day of accounts receivable and inventory and the same amount provided by a day
of accounts payable.
Working capital has a direct impact on cash flow in a business. Since cash flow is the
name of the game for all business owners, a good understanding of working capital is
imperative to make any business successful.
Most businesses cannot finance the operating cycle (accounts receivable days +
inventory days) with accounts payable financing alone. Consequently, working capital
financing is needed. This shortfall is typically covered by the net profits generated internally
or by externally borrowed funds or by a combination of the two.
Most businesses need short-term working capital at some point in their operations. For
instance, retailers must find working capital to fund seasonal inventory build-up between
September and November for Christmas sales. But even a business that is not seasonal
occasionally experiences peak months when orders are unusually high. This creates a need for
working capital to fund the resulting inventory and accounts receivable build-up.
Some small businesses have enough cash reserves to fund seasonal working capital
needs. However, this is very rare for a new business. If a new venture experiences a need for
short-term working capital during its first few years of operation, it will have several potential
sources of funding. The important thing is to plan ahead. If it get caught off guard, it might
miss out on the one big order that could have put the business over the hump.
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1.5. Sources of Working Capital

Working capital is a liquid asset available for use in the production of goods and
services for a business. Sources of money, or financing, to serve in this role can take several
forms. Obtaining money for working capital could consume much time and effort from a
business that is struggling with cash flow. Fortunately, business owners have several sources
from which to choose. There are two types of Sources of working Capital:

Long Term Source of Working Capital

Long term financing is a form of financing which is provided for a period of more than
a year. This financing should be taken from different sources i.e. Issue of shares, debenture,
long term debts and reserves etc.
The problem of small businesses not having ready access to sources of long-term
finance was first identified 70 years ago. However, this problem still persists today and poses
a major obstacle to growth. It seems that small businesses have to overcome a variety of
difficulties when seeking to raise finance. These include :

a lack of financial management skills (leading to difficulties in developing credible

business plans that will satisfy lenders and investors);

a lack of knowledge concerning the availability of sources of finance;

high levels of security required by lenders;

rigorous assessment criteria (for example, a good financial track record over five years);

an excessively bureaucratic screening process for applications.

One consequence of these difficulties can be an excessive reliance on short-term sources

of finance, such as bank overdrafts to fund operations. In addition to the difficulties identified,
it is also worth mentioning that the cost of finance is often higher for small businesses than for
large businesses because of the higher risks involved. However, not all of the problems of
raising long-term finance are imposed externally - some arise from the attitudes of the owners.
It seems that many owners of small businesses are unwilling to consider raising new finance
through the issue of equity shares to outsiders as it involves a dilution of control. It has also
been claimed that some owners do not take out loans because they do not believe in
borrowing. Although obtaining long-term finance is not always easy for small businesses, it is
20

nevertheless true to say that things have improved over the years. Some of the more important
sources of long-term finance now available are considered below:

Venture Capital
Venture capitalists provide finance to small and medium-sized businesses that do not
have access to stock markets. They are interested in businesses that require investments in
excess of 100,000. In many cases, however, the amount invested is considerably above this
figure. The British Venture Capital Association states that the average size of investment
made by venture capitalists during 2010 was 313 million .1
Venture capitalists provide equity and loan finance for different types of business
situations including:

Start-up capital to help provide the finance necessary to commence trading.

Growth capital to help expanding businesses to fund growth plans.

Buy-in and buy-out capital to help management teams acquire an existing business.

Share purchase capital to help finance the acquisition of an existing ownership

interest.

Recovery capital to help turn around the fortunes of a business suffering from poor
performance.
Venture capitalists display a clear preference for investing in growth businesses and

management buy-ins/buy-outs rather than business start-ups. During 2010, 20.5 billion was
invested by UK venture capitalists of which only 46 million was invested in start-up
businesses. Although start-ups may be important to the health of the economy, they are very
high risk - investing in existing businesses is usually a much safer bet. A further point that
venture capitalists consider is that start-up businesses often require relatively small amounts
of finance and so the high cost of investigating and monitoring investment opportunities can
make them unattractive. It is interesting to note that where venture capitalists made
investments in start-up businesses during 2010, the average size of investments was in excess
of 0.71 million.

http://www.bvca.co.uk/home/Home-for-launch/features/VCFactor

21

Business Angels
Business Angels are wealthy individuals that are prepared to invest in small businesses
with growth potential through an equity stake. They are often prepared to invest between
10,000 and 100,000 in start-up businesses or businesses at an early stage of development.
Business angels have often been successful in business themselves and so, in addition to
providing financial assistance, they are often able to draw on a wealth of business and
management experience to help fledgling businesses. They fill an important gap in the market,
as the size of investment required may be too small for a venture capitalist to consider.
Business Angels are an informal source of equity finance and so matching small
businesses that require funds with suitable investors can be a problem. Business Angels are an
important but still under-utilized source of money for new and growing businesses. A typical
Business Angel makes one or two investments in a three-year period, either individually or by
linking up with others to form a syndicate. Some Business Angels invest more frequently.
There are an estimated 18,000 angel investors across the UK, and around 800m is invested
by Angels on an annual basis (National Business Angels Network-NBAN)

, which is

sponsored by various financial institutions and supported by the Department for Trade and
Industry. The NBAN provides a variety of services to its members including:

A monthly bulletin to all its investors which sets out available opportunities.

Experienced associates to examine and develop funding proposals and to bring

together investors and small business owners. An e-commerce service designed to match
small businesses with appropriate investors.
Government Assistance
One of the most effective ways in which the government assist small businesses is
through the Small Firms Loan Guarantee Scheme.3 This scheme is designed to help small
firms that have viable business plans but which are prevented from obtaining a loan through
lack of security. The scheme guarantees loans made over a 2 - 10 year period to small
businesses from lending institutions for sums of 5,000 to 100,000 (increased to 250,000
for businesses that have been trading for at least two years). The government will guarantee

2
3

http://www.bbaa.org.uk/investors/introduction-angel-investing
http://www.bis.gov.uk/files/file40539.pdf

22

up to 70 per cent (increased to 85 per cent for businesses that have been trading for at least
two years) of the amount borrowed.
In addition to other forms of financial assistance such as government grants and
improving tax incentives for equity investors to invest in small businesses (e.g. Enterprise
Investment Schemes and Venture Capital Trusts), the government can help in providing
information concerning the sources of finance available. It was mentioned earlier that lack of
knowledge concerning funding sources can be a real problem for small businesses.

Short Term Source of Working Capital

Short term sources of finance are usually cheaper and more flexible than long-term
ones, due to lower interest rate applied to an over-draft against long term loan. The bad side of
short term source is that borrower faced risk the overdraft wont be renewed or suffered
changes of initial conditions. Short term financing is provided for a period of less than a year.
This financing should be taken from different sources i.e. Banks credit, Trade credits, Public
deposits and Advances from customers etc.

The most common sources of short-term working capital financing:

Equity

If the business is in its first year of operation and has not yet become profitable, then
might have to rely on equity funds for short-term working capital needs. These funds might be
injected from own personal resources or from a family member, friend or third-party investor.

Trade Creditors:

If a particularly good relationship is established with the trade creditors, the company
might be able to solicit their help in providing short-term working capital. If it has paid on
time in the past, a trade creditor may be willing to extend terms to enable the firm to meet a
big order. For instance, if the company receive a big order that it can fulfil, ship out and
23

collect in 60 days, it could obtain 60-day terms from its supplier if 30-day terms are normally
given. The trade creditor will want proof of the order and may want to file a lien on it as
security, but if it enables company to proceed, that shouldnt be a problem.
Factoring
Factoring is another resource for short-term working capital financing. Once the
company have filled an order, a factoring company buys its account receivable and then
handles the collection. This type of financing is more expensive than conventional bank
financing but is often used by new businesses. Factoring turns accounts receivables or
invoices into cash. Companies offering factoring services will either lend money against
invoices that serve as collateral, or they will buy the invoices from the company, turning
promises of future income into immediate working capital
Line of credit:
Lines of credit are not often given by banks to new businesses. However, if the new
business is well-capitalized by equity and it has good collateral, the business might qualify for
one. A line of credit allows the company to borrow funds for short-term needs when they
arise. The funds are repaid once the accounts receivable has been collected, that resulted from
the short-term sales peak. Lines of credit typically are made for one year at a time and are
expected to be paid off for 30 to 60 consecutive days sometime during the year to ensure that
the funds are used for short-term needs only.
Grants
Grants are sums of money awarded, usually with no obligation for repayment.
Organizations or wealthy individuals will award grants as part of charitable and taxdeductable causes, or as part of proportioning themselves through public relations. With little
or no obligation attached to them, grants are popular and many businesses may compete for a
single grant
Bonds
Also called corporate notes, bonds are loans that private investors make to a company.
Unlike a bank, the investors cannot establish the terms of the note, such as the yield, with the
24

company. The investor either buys, or does not buy, a bond with the terms that the company
offers. However, bond purchasers have the flexibility to trade the bonds on an open market,
just like they might trade shares of stock in a company.
Stocks
Investors can purchase a share of ownership, or stock, in a company. Unlike a loan, the
investor is promised no predictable rate of return on the investment. Instead, the owner of
stock is speculating that the value of the company will increase -- thus increasing the value of
the investment in stock as well. The company can receive funds for their sale of stock and use
it as working capital.

Short-term loan
While the new business may not qualify for a line of credit from a bank, then might
have success in obtaining a one-time short-term loan (less than a year) to finance the
temporary working capital needs. If it has established a good banking relationship with a
banker, he or she might be willing to provide a short-term note for one order or for a seasonal
inventory and/or accounts receivable build-up. Banks earn money by making loans to people
and businesses that pay them back with interest. They lose money by making loans to
borrowers who default. So banks want assurance that a borrower can and will pay them back.
If a business has a track record of good credit and revenue growth, a bank will likely be
willing to provide a loan to help the company continue operating.

1.6. The management of inventory

Significant amounts of working capital can be invested in inventories of raw materials,
work-in-progress and finished goods. Inventories of raw materials and work-in progress can
act as a buffer between different stages of the production process, ensuring its smooth
operation. Inventories of finished goods allow the sales department to satisfy customer
demand without unreasonable delay and potential loss of sales. These benefits of holding
25

inventory must be weighed against any costs incurred, however, if optimal inventory levels
are to be determined. Costs which may be incurred in holding inventory include:
holding costs, such as insurance, rent and utility charges;
replacement costs, including the cost of obsolete inventory;
the cost of the inventory itself;
the opportunity cost of cash tied up in inventory.
The management of stocks suffers from lack of financial management skills within
small businesses. The owners of small businesses are not always aware that there are costs
involved in holding too much stock (e.g. additional, storage and handling costs, risks of
obsolescence and opportunities foregone in tying up funds) and that there are also costs
involved in holding too little stock (e.g. loss of sales and goodwill, lost production, higher
purchase and transportation costs to replenish stocks quickly). These costs may be very high
as stocks in some industries such as manufacturing and wholesaling, where stocks account for
a significant proportion of the total assets held.
The starting point for an effective stock management system is good planning and
budgeting systems. In particular, there should be reliable sales budgets available for stock
ordering purposes. However, it seems that not all small businesses prepare budgets. Stock
management can also benefit from good reporting systems and the application of quantitative
techniques (e.g. the Economic Order Quantity model) to optimise stock levels.

1.7. The management of receivables

Credit management is a particular problem among small businesses. Although
approximately one third of total assets employed within small businesses consist of trade
debtors, there is often a lack of expertise and insufficient resources allocated within the
business to manage the trade debts. There is often no dedicated credit control department
within the business and so there may be no proper scrutiny of credit applications or efficient
monitoring and collecting of debts. The slow payments or defaults arising can have very
damaging effects on the cash flows of the business.

26

The risk of bad debts can be minimised if the creditworthiness of new customers is
carefully assessed before credit is granted and if the creditworthiness of existing customers is
reviewed on a regular basis. Relevant information can be obtained from a variety of sources.
New customers can be asked to provide bank references to confirm their financial standing,
and trade references to indicate satisfactory conduct of business affairs. Published
information, such as the audited annual report and accounts of a prospective customer, may
also provide a useful indication of creditworthiness. A companys own experience of similar
companies will also be useful in forming a view on creditworthiness, as will the experience of
other companies within a group.
For a fee, a report may be obtained from a credit reference agency. A credit report may
include a company profile, recent accounts, financial ratios and industry comparisons,
analysis of trading history, payment trends, types of borrowing, previous financial problems
and a credit limit.
Bearing in mind the cost of assessing creditworthiness, the magnitude of likely regular
sales could be used as a guide to determine the depth of the credit analysis.

Credit control system

Once creditworthiness has been assessed and a credit limit agreed, the company should
take steps to ensure the customer keeps to the credit limit and the terms of trade. Customer
accounts should be kept within the agreed credit limit and credit granted should be reviewed
periodically to ensure that it remains appropriate. In order to encourage prompt payment,
invoices and statements should be carefully checked for accuracy and despatched promptly.
Under no circumstances should customers who have exceeded their credit limits be able to
obtain goods.

Late Payment

The problem of late payment may be exacerbated by the enthusiasm of the owners to
increase sales in order to encourage business growth. This can result in providing credit to
high-risk customers and undue reliance on a small number of customers. In addition, where a
small business is selling to a large business, the difference in market power can make it
difficult to impose strict credit terms. Late payments erode profits and can lead to bad debts.
27

One way of dealing with the credit management problem is to factor the outstanding debts.
Under this kind of arrangement, the factor will take over the sales ledger of the business and
will take responsibility for the prompt collection of debts. However, some businesses are too
small to take advantage of this facility. The set-up costs of a factoring arrangement will make
businesses with a small turnover (say 100,000 per annum or less) an uneconomic proposition
for the factor.

Managing Debtors
Slow payment has a crippling effect on business, in particular on small businesses. If
company doesn't manage debtors, they will begin to manage its business as firm will
gradually lose control due to reduced cash flow and, of course, it could experience an
increased incidence of bad debt. The following measures will help financial manager to deal
with company debtors:

Have the right mental attitude to the control of credit and make sure that it gets the
priority it deserves.

Establish clear credit practices as a matter of company policy.

Make sure that these practices are clearly understood by staff, suppliers and
customers.

Be professional when accepting new accounts, and especially larger ones.

Each customer has to be checked before offering credit. Using credit agencies, bank
references, industry sources would give appropriate information to establish it
creditworthiness.

After credit limits is set, monitoring the payment if it is make under agreed term.
Continuously reviewing of these limits when tough times suspecting to come or if
company is operating in a volatile sector. Keep very close to your larger customers.

Invoice promptly and clearly.

Consider charging penalties on overdue accounts.
Consider accepting credit /debit cards as a payment option.
Monitor your debtor balances and ageing schedules, and don't let any debts get too
large or too old.
28

1.8. The management of creditors (suppliers)

In practice, small businesses often try to cope with the late payment of credit customers
by delaying payments to their credit suppliers. However, such a tactic can be very expensive.
To illustrate this point, let us assume that a supplier offers a 2 per cent discount if the amount
due is paid within 30 days and the business decides to delay payment until 50 days after the
invoice date. The cost of this extra 20 (i.e. 50 - 30) days credit will be the 2 per cent discount
foregone. If we annualise this cost, we have 365/20 x 2% = 36.5% (approximate). This annual
cost compares unfavourably with most other forms of short-term financing.
Creditors are a vital part of effective cash management and should be managed carefully
to enhance the cash position.
Purchasing initiates cash outflows and an over-zealous purchasing function can create
liquidity problem. The following aspects should be taken into consideration:

Purchases authorization in the company-is it tightly managed or spread among a

number (junior) people.

Purchase quantity geared the demand forecast.

Uses of order quantities taken on account the stock holding and purchasing costs.
Evaluate the cost of carrying actual stock.
Identify alternative sources of supply or get quotes from major suppliers and shop
around for the best discounts, credit terms and reducing dependence on a single
supplier.

Correlating unavoidable prices increases from suppliers through price increases to

customers.

Arranging deliveries to be executed on a just-in-time basis.

There is an old adage in business that buying well is directly linked to selling well.
Management of creditors and suppliers is just as important as the management of debtors. It is
very important to look after companys creditors slow payment would create an ill-feeling
and can signal that company is inefficient (or in trouble).

29

1.9. The management of cash

Cash management, which is part of the wider task of treasury management, is concerned
with optimising the amount of cash available, maximising the interest earned by spare funds
not required immediately and reducing losses caused by delays in the transmission of funds.
Holding cash to meet short-term needs incurs an opportunity cost equal to the return which
could have been earned if the cash had been invested or put to productive use. However,
reducing this opportunity cost by operating with small cash balances will increase the risk of
being unable to meet debts as they fall due, so an optimum cash balance should be found.
The management of cash raises similar issues to those raised in relation to the
management of stocks. There are costs involved in holding too much cash (e.g. investment
opportunities foregone, loss of purchasing power during a period of rising prices etc) and also
costs in holding too little cash (e.g. interest costs, lost goodwill etc). Thus, there is a need for
careful planning and monitoring of cash flows over time. It was found that cash balances are
generally higher for small businesses than for larger businesses with more than half of those
in the survey holding surplus cash balances on a regular basis. Although this may reflect a
more conservative approach to liquidity among small business owners, it may reflect a failure
to recognise the opportunity costs of cash balances.

30

Chapter 2. A Case Study in Working Capital Management

2.1. LOGSTOR: A company overview
LOGSTOR is a global energy company with a focus on providing better energy
efficiency to its customers. Company is based on years and years of experience and knowhow related to insulation as a means of improving energy efficiency.
LOGSTORs vision: We make the World's energy supply more efficient and reduce
the global energy loss with leading insulation products, improving the environment
for the populations in all continents.
Both district heating and cooling especially co-generation based - are increasing in
popularity as the most energy efficient, safe, well-proven and environmentally responsible
ways to provide heating and cooling to buildings. Pre-insulated pipe systems from
LOGSTOR, conceived around uniquely effective insulation, are designed specifically to keep
energy loss from district heating and cooling systems to the absolute minimum.
Pre-insulated pipe systems from LOGSTOR, conceived around uniquely effective
insulation, are designed specifically to keep energy loss from district heating and cooling
systems to the absolute minimum
Today, LOGSTOR is an international group headquartered in Lgstr, Denmark with
subsidiaries in Sweden, Finland, Germany, Poland, the Netherlands, France, Italy, Austria,
Switzerland, Lithuania, Russia, Romania and China. A network of 30 agents and
LOGSTORs 14 sales offices support the groups sales activities.
LOGSTOR supplies customers in approximately 50 countries and sells its pipe systems
in markets where energy savings and CO2 reductions affect customers choice of how they
heat or cool residential and commercial property and how oil, gas and other liquids are most
efficiently transported.
The LOGSTOR group has approximately 1,250 employees worldwide. Production is
carried out in the groups 10 factories situated in Denmark, Sweden, Finland, Poland,
Romania, China and in its two joint venture locations Dubai and the Republic of Korea.

31

LOGSTOR is owned by Montagu Private Equity.

About Montagu Private Equity
Montagu is one of Europes leading private equity advisors. Headquartered in London,
Montagu also has offices in Dsseldorf, Manchester, Paris, Stockholm and Warsaw. Founded
in 1968, Montagu can look back on 40 years experience in investing in more than 400
transactions.
The primary investment focus of Montagu is on management buyout transactions and
companies that operate in stable niche markets with a transaction value ranging from 100
million to 1 billion.
The firm has an extensive network of contacts and offers its portfolio companies capital,
financial expertise and strategic assistance in order to unleash their full development and
growth potential.
Montagu has over 4 billion of funds and assets under management
Product range
LOGSTOR pre-insulated pipe systems include all the joints, bends, branches and valves
necessary to construct an end-to-end pipe system for moving liquids, to meet all local needs
and specific requirements.
Every single component is designed to ensure that there are no weak points anywhere in
the system. The energy saving properties are as consistent as possible, and the design ensures
easy, rapid installation at minimum cost.
Types of pipe system currently available:

The Single Pipe system

The Twin Pipe system

The Double Pipe system

The Flex Pipe system

32

Curved pipes with diameters up to DN800 are available for al systems. LOGSTOR preinsulated pipe systems are design specifically to keep energy loss to the absolute minimum.
The systems include pipes with three variable insulations thicknesses as standard, to meet
different heat retention requirements. Any energy loss from pipe system, have relatively high
cost impact. A special diffusion barrier is therefor available as standard for flexible pipes and
as an option for straight single pipes. This keeps constant throughout their entire service file.
Quality control and environmental management
Order processing and production of products take place in accordance with a quality and
environmental management system, which contains LOGSTORs quality and environment
policies. The system is administered by the Local Quality and Environment Department,
which is an independent staff function under EVP of production and supply.
The Quality Department is authorized to stop production or delivery the products which
do not comply with the established specifications.
The quality management system is prepared and certified in accordance with ISO 9001,
14001, 18001.

2.2. Romanian District Heating Industry

The Romanian district heating system needs 5 billion EUR worth of investments in the
next 10 years in order to increase its efficiency, reduce losses and comply with the EU
environmental standards, according to the Challenges and Opportunities for the Romanian
district heating system PwC Romania report. The only viable way to perform such
investments in the required timeframe is through increased private involvement in the field
and Public-Private.
Partnerships, as in the current system, which is controlled mostly by local authorities,
the annual amount of investments is of only 30 million EUR, which is totally insufficient.
It is estimated that almost 30% of the thermal energy produced in Romania is lost before it
reaches the consumers, three times higher losses than in other EU countries. As a
consequence of the system inefficiency, the cost for Gcal. in Romania is 20% higher than in
other EU Member States. The Romanian district heating system is highly inefficient and
relies heavily on state subsidies in order to provide thermal energy at an affordable price for

33

the population, stated Bogdan Belciu, Partner, Advisory Services, PwC Romania, one of the
authors of the report.
The average subsidies granted on a national level amount to 40% of the approved
distribution price for the operators per Gcal, which cost the public budget up to 500 million
EUR yearly. In spite of the high subsidies level, most of the operators in the field are running
losses and have high debts, which prevent them from financing the much needed investments
in the rehabilitation and optimization of the system. However, the PwC report states that with
increased private involvement in the field and higher investments, the district heating system
might become economically viable, providing thermal energy at 20% to 40% lower costs than
in an individual heating system and with substantially fewer carbon emissions. In the past 15
years, the number of towns and villages connected to the district heating system fell from over
300 municipalities in 1996 to just 100 in 2010, out of which 83 are town and 17 villages.
Overall, just 18.37% of the Romanian population has access to the thermal energy
provided by the district heating system. Bucharest alone accounts for 37% of the thermal
energy distributed on a national level, while Central Romania is the region with the lowest
penetration rate for the district heating system.
The Romanian district heating system has a huge potential for increasing efficiency
and optimization. From choosing the most cost-efficient fuels, to improving processes,
adopting the co-generation model and revamping its distribution networks, there are multiple
ways to reform the system and transform it into a successful model that provides affordable
heating in an environmental friendly way. However, running the system in a business as usual
manner is a non-go and public authorities must change their approach towards this issue in a
radical fashion as soon as possible4, concluded Bogdan Belciu.

2.3. LOGSTOR (ROMANIA) SRL

LOGSTOR continued its international growth strategy and taken-over production and
sales from the competitor Stizo Termo SA in Bucharest .
The acquisition strengthened LOGSTORs business foundation and market position in
Romania as well as in the entire Balkan region. LOGSTOR taken over the activities including
38 employees as of 1 March 2009. LOGSTOR acquired the major part of the Stizo Termo
4

PwC report: Private investments and Public-Private Partnerships-viable solutions to optimize the district
heating system, 15.06.2011.

34

activities and as of 1 March 2009 continued the 100% owned company by the name
LOGSTOR S.R.L. with a view to supporting the growth in energy efficient solutions in the
entire Balkan region. The central location of the factory in Bucharest makes it ideal for
developing the business further, transport and logistics playing an important role when it
comes to handling the bulky and often very heavy products. Stizo Termo was one of the first
local manufacturers of pre-insulated pipes in Romania and has since 1997 up till 2009 mainly
produced these pipes intended for the district heating sector. Stizo Termo was a well-reputed
company in the Romanian market, which today counts about 5 local manufacturers of pipes
for district heating.
Market share at the end of 2008, before LOGSTOR SRL start its business operations is
analysed in figure 2.3.1.
Figure 2.3.1 Market share analysis at the end of 2008.

The new born company LOGSTOR SRL (a subsidiary of Logstor Holding A/S, as
single shareholder) had to face a strength competition, doubled by crisis period. Like many
new traders, its early years of trading were not profitable. Its equity was dramatically
diminished through periods, due to taking bad trades, using low prices to penetrate the market,
incurred expenses projects fees that promised to unlock the door to successful trading.
Sales of LOGSTOR SRL have mushroomed since the firm began in 2009-from kRON 4,499
for the first year of operations to kRON 36,029 for 2011. The original capital of the company
has not been sufficient to support this volume of business activity. A large part of the
financing has come from funds that have been made available due to the fact that the firms
accounts payable (intercompany) are prolonged payment term and a long term loan of kEUR
35

1,300 received from shareholder (LOGSTOR HOLDING A/S).The firms difficult initial
years, resulted in meagre profitability. At the end of 2011, even the result has negative like in
previous two, fixed costs were stabilized, organisational chart reflects functionality and
adaptability to changes occurring in production activity level through the year, greater market
penetration (the company achieved 55% of Romanian District heating market share at the end
2011) put the basis for future profitability. Basically, a law contribution margin, quality and
differentiations were the values which LOGSTOR SRL (LORO- the acronym) promoted
during its first years in the industry in order to have a powerful place on the market.

Table 2.3.1 Key figures-historic development of LOGSTOR SRL and its comparable
All amounts are in kRON
PROFIT AND LOSS ACCOUNT

2009

2010

2011

Net turnover
Direct material
Production wages
Cost of sales
Contribution margin

4499
3645
452
4097
515

19200
17983
594
18577
623

36029
31605
822
32427
3602

average
industry
19898
13918
1340
15258
4640

11

10

23

517
343
1303
650
2813

1092
818
884
913
3707

1235
1585
928
770
4518

2911

243

457

-2298

-3327

-1373

1729

297
297

363
363

386
386

660
660

EBITA
EBITA (%)
EBIT
EBIT (%)

-2595
-20%
-2595
-20%

-3690
-6%
-3690
-6%

-1759
-49%
-1759
-49%

1069
23%
1069
23%

Financial expenses (revenue)

Earning for the period

246
-2841

366
-4056

453
-2212

-69
1138

Contribution Ratio (%)

Fixed costs
Production
Sales
Administration
Building expenses
Total Fixed Cost
Intercompany fee
EBITDA
Depreciation machinery and
vehicles
Depreciations

36

Analysing the figures provided in the table above, its relevant the exponential growing
in the last year.

Table 2.3.1 Key figures-historic development of LOGSTOR SRL and its comparable
(continuing)
All amounts are in kRON
2010

2011

2014
2014
915
1866

1451
1451
5587
28523
1630
136
1055
36931

2640
2640
1649
7303

166
295
3242

1699
1699
3460
14587
37
18
819
18921

5256

20620

38382

12459

2465
-2841
-376
2214
2626
300
5140

7638
-6896
742
3348
3796
6116
13260

7638
-9108
-1469
9433
21026
2838
33297

1051
580
1631
8697
0
768
9465

492

6618

6554

1363

5256

20620

38382

12459

Assets
Plant and Equipment
Total Fixed Assets
Inventories
Accounts Receivable
Accounts Receivable intercompany
Other Receivables
Cash at bank and in hand
Total Current Assets
Total Assets
Liabilities and Equity
Share Capital
Retained Earnings
Total Stockholder's Equity
Accounts Payable
Accounts Payable (Intercompany)
Other Current Liabilities
Total Current Liabilities

average
industry

2009

BALANCE SHEET

Long Term Debt

Total Liabilities + Equity

124
743
9819

In the first year of trading LORO managed to have a slice of 17% from market share
and start breathing in its competitors neck. Even it was a little bit far from their turnovers
performance, due to an invasive strategy put the basis of future growth. Analysing the cost of
material against average industry, we can notice an important deviation from its comparable,
in 2011 direct cost with materials was about 88% from sales turnovers, 94% in 2010

and

81% in 2009, towards 70% shown in average sector industry. Direct wages seems to be under
sector average, gradually diminishing from year to year, from 10% of sales turnover, to 3% in

37

2010 and about 2% in 2011 against its comparable of almost 7%, demonstrating an important
improvement in production efficiency.
Penetration prices policy is visible from far in year 2010, when LOGSTOR SRL has the
lowest contribution margin. That period is the reference when company start applying the
long term strategy which will enable its growth in subsequent years. Even its contribution
margin is less than half of its comparable, the sign of future improvement is almost shown on
EBITDA, which slowed down its negative trend in the last year.

2.4. Working capital management at LOGSTOR SRL

Working Capital analysis
Working capital measures what is leftover once its subtracting the current liabilities
from current assets, and can be a positive or negative amount. The working capital is available
to pay company's current debts, and represents the cushion or margin of protection give to
companys short-term creditors. Positive Working capital is essential for company to meet its
continuous operational needs. The availability of working capital influences the company's
ability to meet its trade and short-term debt obligations, as well as to remain financially
viable. If the current assets do not exceed the current liabilities, the risk of being unable to pay
short term creditors in a timely fashion is unavoidable.

Table 2.4.1 Statement showing change in working capital for LOGSTOR SRL and its
comparable

Inventories
Accounts Receivable
Accounts Receivable
intercompany
Other Receivables
Cash at bank and in hand
Total Current Assets
Accounts Payable
Accounts Payable
(Intercompany)
Other Current Liabilities
Total Current Liabilities
WORKING CAPITAL

2009

2010

915
1866

3460
14587

average
industry
5587
1649
28523
7303

166
295
3242
2214

37
18
819
18921
3348

1630
136
1055
36931
9433

124
743
9819
8697

2626
300
5140
-1898

3796
6116
13260
5661

21026
2838
33297
3634

0
768
9465
354

38

2011

Analysing the working capital behaviour through the years, an improvement against
first year is quite easy to notice. The average sector industry working capital ratio (1.04)
deeply reflects the huge problems of liquidity which exist in the area. In comparison with its
industry segment, LOGSTOR SRL has a Current Ratio of 1.11 in 2011 and 1.4 in 2010. Of
course, year 2009 has a negative value and other investigation revealed that in the first year of
trading, the company passed through many periods of lack of cash due to insufficient
capitalisation at the beginning of its business. To support day-to-day operations, LORO
received short term loans from shareholder, which were capitalised by the end of the year
2009, by increasing share capital from 200 RON to 2,465 kRON.

Current Ratio for 2009

3242/5140

= 0.63

Quick Ratio for 2009

(3242-915)/5140

= 0.43

The ratios reflect the weakness of the company and its need for liquidity, manifested
during the entire year 2009, a sign that company was facing to serious financial troubles.

Current Ratio for 2010

Quick Ratio for 2010

18921/13260

= 1.43

(18921-3460)/13260

Current Ratio average industry 9819/9465

= 1.17

= 1.04

Quick Ratio average industry (9819-1649)/9465 = 0.86

Quick Ratio in average industry is negative and outlined once again the difficulties
faced by companies from district heating sector in receive long term financing in order to
cover periods of lack of cash due to postponing payments from State Budget. In that sector,
most of the workings are financed from Local Public Authorities as far the district heating
infrastructures are State monopoly. Many companies from the industry became insolvent
because they havent received the money owed by Local Councils. There seems to be a need
to put an end to the current practice of financing from local municipalities, since district
heating has an important function in Romanias national energy system, its problems should
be regulated by national policies.
Due to non-wise policy manifested by the political decedents, many on-going projects
were stopped due to lack of funds, leaving these investments to degrade until to the
39

reallocation of funds. Because of this, companies have been executed because lack of funds
and many of them couldnt continue their business.
Based on that reality of district heating industry, to be concerned towards future
development of the industry, its the first thought that should cross an investor mind.
Leaving those issues presented above, which were emphasised just for a better
understanding of missing liquidity in the sector and how those cash need is spread out to each
company in the industry, more or less, we go back to LOGSTOR SRL working capital
analysis.
Year 2011 was marked by a huge increasing in turnover, the trend was outlined
especially in the second semester of the year. Working capital requirements were so high and
the easiest way to financing raw materials and day-to-day operations, was to rolling forward
the amounts owed to intercompany suppliers. Its easy to notice that payables intercompany
balance is more than two times higher than domestic suppliers balance.
Accounts receivables balance climbing to a peak by the end of 2011, being 2 times
higher against previous year, in correlation with sales turnover and almost 4 times greater than
sector average. The ratio between average sector turnover and receivables balance is 2.7
towards 2011 ratio between sales turnover of LOGSTOR SRL and its receivables, of 1.2.
We can say the company is overtrading, all the above information emphasise the symptoms
as:
insufficient capital to fund the increase
a rapid increase in turnover
a rapid increase in assets being financing by credit
a dramatic drop in liquidity ratio (see below)

Current Ratio for 2011

Quick Ratio for 2011

36931/3329

= 1.11

(36931-5587)/33297 = 0.94

Even Quick Ratio its a little bit higher than its comparable, it still remain negative, with
concerning that company is unable to sustain short term payables if they fall due at once.
If company wont rely on credit used from sister companies and would be forced to pay the
outstanding invoices to them, the risk of insolvency will be unavoidable. Due to previous cost
gaps, the financial position of the company is not trustable for bank in order to receive a short
or long term loan or an over-draft.
40

An opportunity in increase liquidity would come from an invoice discounting, but here
is doubt that banks would discount invoices that have to be paid by one of the State
Companies (even rating agencies are not giving to those company, any credit limit appraisal).
Inventory analysis

Inventories are held for various reasons, as follows:

Demand for the firms product varies over time and inventories allow smooth
production

Production takes time so that inventory in the form of partially completed product must
exist.

Buying raw material in bulk is cheaper than purchasing and shipping small quantities,
and therefore holding raw material inventories is costly but less than the buying of small
quantities.
Moreover, often it is important to analyse separately the components of inventory, such

as raw materials, work in progress and finished products, rather than their amount in order to
understand the inventory demand and policies of the company.
Inventory consists in four categories in LORO as follows:
-raw materials
-semi-finished goods
-finished goods
-trading goods

There are two related ratios used to analyse inventory levels:

Inventory days =

Inventory turnover =
=

41

When the inventory doesnt change over the period, the inventory turnover is just the
inverse of inventory days (with a scaling factor of 365). Therefore, an analysis of one ratio is
very similar to analyse of the other.
The ability to consider the economics of the ratios is useful in interpreting its level and
mostly in projecting future inventory levels that reflect our perception of changes in the
industry.
Due to information available regarding components of inventory in LORO, Trading and
Finished Goods are reported separately from Raw Materials and semi-finished products. The
inventory ratios are calculated separately for the components of the Inventory, as well. As far
the information from average industry consists of bulk inventories, the materials will be split
by categories only for LOGSTOR SRL.

Table 2.4.2 Inventory days analysis for LOGSTOR SRL and its comparable
Fiscal year

Cost of goods sold

Trading and Finished Goods
Inventory days
Raw materials and semi-finished products
Inventory days
Inventory total
Inventory days

LORO
kRON
kRON
kRON
kRON

2011

2010

28439
2456
32
2179
28
4635
60

17760
1164
24
1024
21
2188
45

average
2009 industry
3984
161
15
629
58
790
72

13918

1649
43

The inventory days ratios of LORO, for both components and the total, varied
considerably over the period 2009 through 2011. The explanation is the improvement
occurred in 2011 turnover, against 2010 and 2009.
Understanding of the business and sales cycles specific to the product category helps
one manage inventories better. For example, in case of LOGSTOR SRL, where some
products are manufactured on customer request, its very likely to not fulfil the client
requirements or from odd reasons the material wont be delivered. If that scenario happened,
its much predictable that materials would become obsolete stock, sooner. From this point of
view, its quite necessary for sales manager to consult technical department in respect of
choosing proper products to fit customers need. Analysing inventory days, the stock level
could become suspicious of redundant materials wont write down, lately.
42

This helps identify those stocks which are required to be managed at a micro level and
identify the high value and fast moving items that need to be always on the radar to avoid
stock outs.
It does not help for example to carry standard stocks of all items including low value
items as well as high value items. If the low value items are locally available and the leadtime is less, one can cut down on the inventory and change the buying pattern. Similarly high
value items too can be managed by cutting down the delivery lead times and in turn reducing
inventory.
It helps to periodically study the past data and extrapolate the same to identify slow
moving and obsolete items. The dead stocks should be flushed out and active catalogue items
should be made available.

Table 2.4.3 Inventory turnover analysis for LOGSTOR SRL and its comparable
Fiscal year

Cost of goods sold

Trading and Finished Goods
Inventory turnover
Raw materials and semi-finished products
Inventory turnover
Inventory total
Inventory turnover

LORO
kRON
kRON
kRON
kRON

2011

2010

31605
2456
13
2179
15
4635
7

17983
1164
15
1024
18
2188
8

average
2009 industry
3645
161
23
629
6
790
5

13918

1649
8

Inventory level have been increasing year by year. The growth is significantly based on
company growing itself. So far, inventory days are over sector average, with an improvement
in 2010, when inventory days exceed sector average with just 2 days. Given the rapid increase
in sales revenue (88%) in 2011, LORO expecting a continuing increasing in the future, based
on expansion in Balkan Area, and may have built up inventories in preparation for this, as
inventory level reflect future sales rather than past sales. From the other side, the liquidity of
firm is blocked in inventories which will make longer the cash conversion cycle but will be
better from raw materials availability point of view.
Giving the preceding trends at LORO and its industry, an inventory ratio of 40 days is a
more reasonable expectation for future inventory levels than the average inventory days ratios
in past years.
43

We can project inventory levels by converting the project level of the cost of goods sold
(COGS) to the project level of inventory:

projected COGS

Projected Inventory =

If COGS include no fixed costs, projected COGS will be based on sales projections and
on the ratio of the COGS to Sales. In this case we can substitute for projected COGS and get

projected

Projected Inventory =
Sales, which can also be written as:

(1-projected Gross Margin)

Projected Inventory =
projected Sales

For example, the project of 32,000k RON, gross Margin to be 25 per cent and total
inventory to represent the cost of 70 days of sales. This means that we expect LOROs
inventory at the end of the year 2012 to be:
(70/365)

(1-25%)

RON 32,000,000

The expectation of a 4,605 million inventory at the end of 2012 reflects from our
perception of LOROs production efficiency, through the projected Gross margin.

Account Receivables analysis

Account Receivables (A/R) are borne from credit sales. In turn, the change in A/R
determines the difference between sales and collections. The amount of A/R that a firm has is
strict related to its credit policy and of the portion of its sales done on credit: The more credit
gave to clients, the larger would be the amount of A/R and greater would be the risk of
outstanding debts. The best part of that policy would be an increasing in sales due to low
restrictive credit term.A ratio used in the analysis of relation of A/R to Sales is the average
collection period. The average collection period is the number of days of sales that are
represented by the year end A/R and is calculated as the ratio of A/R to average daily sales:
44

Average collection period =

365

The average collection period of the firm is compared to the collection period of its
comparable and to the firms ratio in the past.

Table 2.4.4 Average collection period of LOGSTOR SRL and its comparable
kRON
Fiscal year

Net Sales
Account Receivables (A/R)
Average collection period

LORO
kRON
kRON

2011

2010

2009

average
industry

36029
15076
153

19200
9275
176

4499
1142
93

19898
7303
134

The domestic market is dominant in sales turnover, transactions with sisters companies
are made at a low level.
Company policy of debtors used to be as not as strict it's required, because of on-going
struggle to beat the competitors offers, the credit terms gave to customers are much longer,
from 90 to 120 days and those terms are usually delayed by clients with other 30 or more
days. A high balance of debtors always presents a great exposure to risk of bad debts,
especially when customers are involved in contracts financed from State Budget, which is
known as the worst payer.
Outstanding debts increased proportional with the Account receivables balance along
the years. There is a good sign of improvement in debtors days occurred in 2011, against
2010. Even its too far from 93 days of 2009, due to higher percentage of collection period
shown in the average sector industry, there are strong chances that LORO would decrease
collection period under the industry percentage, based on credit policy more restrictive that
will be applied to customers. As far LORO achieved 55% from the market, its much easily
now to encourage severe credit policy to its clients in order to improve companys liquidity.
Another factor that we should consider in examining the economics of the average collection
period, as well as other ratios, is seasonality in the business being analysed. LORO as well the
other companies from the industry, have a peak season starting with summer months and
decreasing from December to April. Due to seasonality of the business, there are periods with
lower sales which affect future amount to be collected, with negative influence in liquidity of
45

the company. Analysing collection period will be very useful for future estimation of cash
flow.
Given the nature of the industry- goods are mostly sold to contractors who are strict
related to works for district heating infrastructures, financed mainly from Local Budgets, the
collection period is very long.

Cash and bank balance analysis

Cash is called the most liquid and vital current assets, it is important component of
working capital. In a narrow sense, cash includes notes, bank draft, cheque, promissory notes
etc while in a broader sense it includes near cash assets such as marketable securities and time
deposits with bank. Cash management is a broad term that refers to the collection,
concentration, and disbursement of cash. The goal is to manage the cash balances of an
enterprise in such a way as to maximize the availability of cash not invested in fixed assets or
inventories and to do so in such a way as to avoid the risk of insolvency. Factors monitored as
a part of cash management include a company's level of liquidity, its management of cash
balances, and its short-term investing strategies. In some ways, managing cash flow is the
most important job of business managers.
If at any time a company fails to pay an obligation when it is due because of the lack of
cash, the company is insolvent. Insolvency is the primary reason firms go bankrupt.
Obviously, the prospect of such a dire consequence should compel companies to manage their
cash with care. Moreover, efficient cash management means more than just preventing
bankruptcy. It improves the profitability and reduces the risk to which the firm is exposed.
Cash management is particularly important for new and growing businesses. Cash flow can be
a problem even when a small business has numerous clients, offers a product superior to that
offered by its competitors, and enjoys a sterling reputation in its industry. Companies
suffering from cash flow problems have no margin of safety in case of unanticipated
expenses. They also may experience trouble in finding the funds for innovation or expansion.
It is, somewhat ironically, easier to borrow money when you have money. Finally, poor cash
flow makes it difficult to hire and retain good employees.
It is only natural that major business expenses are incurred in the production of goods or
the provision of services. In most cases, a business incurs such expenses before the
corresponding payment is received from customers. In addition, employee salaries and other
expenses drain considerable funds from most businesses. These factors make effective cash
46

management an essential part of any business's financial planning. Cash is the lifeblood of a
business. Managing it efficiently is essential for success. When cash is received in exchange
for products or services rendered, many small business owners, intent on growing their
company and tamping down debt, spend most or all of these funds. But while such priorities
are laudable, they should leave room for businesses to absorb lean financial times down the
line. The key to successful cash management, therefore, lies in tabulating realistic projections,
monitoring collections and disbursements, establishing effective billing and collection
measures, and adhering to budgetary restrictions.

Table 2.4.5 Cash funds of LOGSTOR SRL and its comparable

kRON
Fiscal year

Petty cash
Bank accounts

LORO
kRON
kRON

TOTAL CASH FUNDS

2011

2010

2009

6
1048
1055

15
804
819

4
291
295

average
industry
10
733
743

Analysing the above table we find an increasing trend, explaining from one side the
company's growth (huge sales turnover in 2011) against previous year and the receiving cash
in bulk tendency, by the end of the year, due to late payments during year and cash transferred
by Local Councils only at the year end, as a specific of domestic District Heating industry, on
the other side. The cash level rising from year to year and in the end of 2011 has a
comfortable amount towards average sector industry.

Current Liabilities Analysis

Current liabilities represent a company's debts or obligations that are due within one
year. Current liabilities appear on the company's balance sheet and include short term debt,
accounts payable, accrued liabilities and other debts.
Trade credit is the simplest and most important source of short-term finance for many
companies. Delaying payments to suppliers is the most common source of finance and of
course, the cheapest. But on reverse, delaying too long may cause difficulties for the company
in the long term, due to diminished firms reputation and credibility.
47

Favourable credit terms are one of several factors which influence the choice of
supplier. Furthermore, trade credit may be seen as a source of free credit, there will be costs
associated with extending credit taken beyond the norm, lost discounts, loss of supplier
goodwill, more stringent terms for future sales.
In order to compare the cost of different sources of finance, all costs are usually
converted to a rate per annum business. The cost of extended trade credit is usually measured
by loss of discount, but the calculation of its cost is complicated by such variables as the
number of alternative sources of supply and the general economic conditions.
It is a mistake to reduce working capital by holding on to creditors money for a longer period
than is allowed as, in the long-term, this will affect the suppliers willingness to supply goods
and raw materials, and cause further embarrassment to the firm.
The ratio often used in the analysis of the account payables is the average payable
period, which is a variant of the average collection period used in the analysis of account
receivables.

Average payable period =

365

Table 2.4.6 Account Payables credit period of LOGSTOR SRL and its comparable
kRON
Fiscal year

average
2009 industry

2011

2010

Account Payables (A/P) domestic (average)

Purchase domestic
Average credit period
Account Payables (A/P) intercompany (average)

6537
15406
155
13898

3217
10120
116
4366

2310
6358
133
1377

Purchase intercompany
Average credit period
Account Payables (A/P) total (average)
Purchase total
Average credit period

21836
232
20435
37242
200

7910
201
7583
18030
154

826
608
3687
7184
187

LORO

kRON
kRON

8697
20480
155

An exponential increasing in current liability expressed both the extended terms of

payment allowed by suppliers and a low capacity of the company to make the payments of
time as a result of poor collection from customers. In 2011, the amount owed to subsidiary
48

climbing in a dramatic way and particular outlined the liquidity difficulties within the firm.
Because the purchase credit had been substantially in the last quarter of 2011 in order to
sustain the orders placed by customers, the balance of trade creditors growth with 140% from
2010 and 333% from 2009, showing a huge increased in level of activity within company.
Its obviously, the company is using the amount from sisters companies related to credit
invoices, to finance day-to-day cash needs. Almost 260% is the increasing of IC payable in
2011 against 2010 and almost 700% from 2009.
Average credit period in the sector its quite large due to outstanding amounts owed by
contractors, especially from budgetary funds. An increasing in credit period to 45 days more
than industry in 2011, could lead to difficulties between the company and its suppliers if it is
exceeding the credit periods they have specified. There is no increasing in long term debt and
perhaps the company is facing undercapitalised (overtrading).
Other short term payable comprise the provisions, deferred income, taxes and
contributions related salaries and payable VAT. It fall by 120% in 2011 against 2010 because
of deferred income related to invoices issued in advance for concluded contracts at the end of
the year, asked by LOROs customers with the purpose of receiving special financing from
Local Councils for subsequent years, a custom in the industry, encountered at companies
which have contracts financed from State Budget. Those kinds of contracts were much less in
2011 than those signed in 2010, this is the explanation of the diminished value of other short
term payable more than twice against previous year 2010.

Cash operating cycle analysis

The cash operating cycle is the length of time between the companys outlay on raw
materials, wages and other expenditures and the inflow of cash from sale of goods.
The cash conversion cycle simply indicates the amount of time, in days, it takes the firm to
convert its activities requiring cash back into cash. The period or cycle varies by industry and
the individual company. But, as with most ratio analysis, its important to view the cash
conversion cycle in a trend. A downward trend is positive, indicating that the operating cycle
is shortening, while an upward trend is negative, indicating that the cycle is lengthening, that
is tying up cash for a longer period.
We analyse the cash operating cycle of LOGSTOR SRL below, taken into consideration
that intercompany suppliers are acting as a long term loan, the analysis is done with and
without them.
49

Table 2.4.7 Cash operating cycle (without intercompany suppliers) at LOGSTOR SRL and its
comparable
kRON
Fiscal year

2011

2010

59
-155
153
57

45
-116
176
105

average
2009 industry

LORO
Inventory holding period
Payables' payment period
Receivables collection period
Cash operating cycle

72
-133
93
32

43
-155
134
22

Not taken on account Payables intercompany period, the cash operating cycle shown an
improvement against 2010, but is more than double towards sector cash operating cycle. We
can notice that payables payment period in 2011 equals the sector average, but receivables
collection period exceed with 3 weeks the average of industry, conducting to a worse cash
conversion period.

Table 2.4.8 Cash operating cycle (with intercompany suppliers) at LOGSTOR SRL and its
comparable
kRON
Fiscal year

2011

2010

59
-200
153
12

45
-154
176
67

average
2009 industry

LORO
Inventory holding period
Payables'payment period (included intercompany)
Receivables collection period
Cash operating cycle

72
-187
93
-22

43
-155
134
22

Spectacular rising in Accounts Receivables in 2011 due to huge increasing in sales

turnover in the last quarter of the year, put the company in an ingrate position because of
insufficient funds to fulfil the raw materials needs in order to cover customers orders. A short
term loan of 300k EUR received from Lynx Holding A/S was an oxygen breath to LORO and
helped the company to manage its overdue invoices owed to domestic pipe suppliers mainly.
The loan has been re-paid until the end of December, with one month delay against payment
term.

50

Inventories holding period, as well receivables collection period are above sector
average and their conversion cycle is supported mostly by payables intercompany. The Cash
Operating Cycle is influenced in a positive way, due to postponing payments to sister
companies, the cycle is visible diminished, by increasing payables days.
Based on financing support received from intercompany subsidiary consisting in late
payment, the company shorted its cash conversion cycle by 46 days, which favoured its cash
position against other companies in the industry which are financed from local resources.
Analysing the cash operating cycle within the industry, its demonstrated with no doubt,
that payment to suppliers is one on the last priority of companies in the district heating
industry. Even the market has a great development potential, due to crisis period, much more
project were slowed down or even stop with very bad effects on industry traders. Forced by
those circumstances, each company searching ways to survive in that difficult environment
and hope the Government policy will be changed and enable investment in the district heating
system on a large scale would favoured beyond companies from industry, the Romanian
citizen, who is the last receptionist of district heating benefit.

51

Chapter 3. Conclusions

This study looked at three early years of LOGSTOR SRL operations on Romanian
District Heating industry and covered the toughest period of crisis, which particularly
influenced that business segment. The company started its existence in a very unfriendly
environment, due to strong competition and limited resources. Under that threatens, an
important mission of executive managers was to assessed the strategic position in order to
achieve an important rank on the market. Based on penetrating prices and product
differentiations policies, the company seized an important slice of the industry. The worse
side of that strategy has been translated in a low margin which conducted to a cost gap in the
first years. Having the Group support, LOGSTOR SRL managed to pass through periods of
lack of cash (manifested during peak season, when available liquidities have to be invested in
inventory due to increasing in demand).
Working capital management is mainly influenced by sector weaknesses, which forced
the companies to struggle with long periods of missing liquidities due to large outstanding
debts of Local Councils which financed district heating projects.
Effective working capital management lies at the heart of successful company, playing a
crucial role in maximisation of shareholder wealth and the achievements of benefits from
capital investment. Analysing the management of working capital at LOGSTOR SRL, with no
doubt, the early stages of its trading is dominated by poor resources which relate to a negative
working capital at the end of first year. LOGSTOR SRL started trading with the lowest share
capital allowed by law. It is obviously, its start under those circumstances shown to be not as
good they expected. Insufficient knowledge about Romanian District Heating market, made
LOGSTOR Group to not take objective and smart decisions in respect of new subsidiary,
LOGSTOR SRL.
The Stizo Termo (the company taken over by LOGSTOR Holding) employees were not
as skilled as they supposed to be, as well the management. So, in the first year of trading, the
company had to replace the executive managers (including the financial director) with the
new ones, who demonstrate superior capabilities to perform attributable tasks on a high level.
Having the right skilled people, company open its way for success. Step by step, production
efficiency had been improved, due to an efficient management; costs had been reduced to an
acceptable level due to contracts renegotiation or by identifying new opportunities to cut
costs. Many tenders won outlined the LOGSTOR products superiority against competitors.
52

Year by year, the working capital is showing an improvement. Even the company is using
intercompany trade credit as a short-term finance, which seems to be transformed in a longterm loan, there are strong chances to reduce the outstanding amounts in the year to come,
based on collection from customers.
Its obviously that company will need to formulate clear policies concerning the various
components of working capital. Key polices areas relate to the level of investment in working
capital for a given level of operations and the extent to which working capital is financed
from short-term funds (in case of LOGSTOR SRL, intercompany payables act as a short term
loan, but possible threat of not be supplied in the future by sisters companies until debts is
paid, is high).
A healthy improvement in equity of LOGSTOR SRL (as well in working capital) would
be if shareholder will decide to convert the long term loan in share capital, following the next
route: after company collect the outstanding amount from its customers would be able to
repaid the loan to LOGSTOR Holding A/S, who will transfer back the amount as increase in
share capital. After that, the received amount will be transferred to LOGSTOR Poland, the
greater intercompany suppliers of LOGSTOR SRL in order to clear part of outstanding
invoices.
Those consecutive transactions will have as final result the following benefits: risen
equity (from -1,469 kRON will become +5,085 kRON), cut-off the cost with loan interest,
and reduce part of outstanding amount owed to LOGSTOR Poland (the exchange rate
differences will be matched if all the cash transactions will be made in the same day, by using
urgent payment status).
As like the other manufacturing company from industry, LOGSTOR SRL needs to
invest heavily in spare parts and components and owed large amounts of money by its
customers.
The company has to identify the relevant levers of working capital management and
ways to applied them. In effect, receivables and payables are just different ways of financing
inventories. Succeeding to manage all three components simultaneously across the value
chain would enable fundamental reductions in asset levels. In strict relation with industry,
competition, country specifics and regulation, the company should concentrate on the most
promising actions that will not impair flexibility and performance, finding some typical (but
just exemplary) levers as are:

53

Reduce inventories

Excess inventory is one of the most overlooked sources of cash and almost half of the
savings from working capital optimization project. Through simplification processes within
the companyas well as processes involving suppliers and customerscompanies can
minimize inventory throughout the value chain.

Improved forecast accuracy and regular updates of customer demand lead to a much

more reliable planning process and would help company not only to reduce its inventory but
also to improve the ability to deliver.

In order to keep inventories at lower level, establish advanced and demand-driven

logistics concepts with its suppliers, such as vendor-managed inventory, just in time (JIT) or
just in sequence (JIS), and collaborate with its suppliers in terms of a holistic supply chain
management with mutual benefits.

Speed Up Receivables Collection

LOGSTOR SRL has cash flow problems caused by mismatch in timing between costs
incurred and customer payments. Therefore, efficient management of receivables is crucial.
An optimization can yield significant potential.

Invoicing cycle: The main target in this respect is to get invoices to the customers as

quickly as possible. Processes and systems should be aligned to allow invoicing promptly
after dispatch or service provision. All disruptions of the process by unnecessary interfaces
should be eliminated. Furthermore, company should reduce invoicing lead times by
multiplying its invoicing runs.

Early reminders/dunning cycles: Experience shows that a number of customers seem to

postpone their payments to the receipt of the first payment reminder. Early reminders and
short dunning cycles thus have a direct impact on late payments.

Payment terms: Renegotiated payment terms will lead to reduced days sales

outstanding. The first step is often a harmonization and reduction of available conditions to
decrease discretionary application. When preparing negotiations, company should analyse its
customers bargaining power and specific preferences in order to identify improvement
potential in the terms and conditions for payments.

Payment schedule: Companies operating in project business should introduce more

advantageous payment schemes that cover costs incurred. Percentage of completion (POC)
54

accounting helps to define relevant payments along milestones. For LOGSTOR SRL, when
small series productions occurred, the introduction of prepayments and advances can
significantly improve liquidity.

Rethink Payment Terms with Suppliers

Even its very hard to receive a payment term longer than 60 days, its most common

fact in the industry where LOGSTOR SRL operates to postpone the overdue amounts with
more than 30 days after due date, using unpaid payables as a source of financing . Concern
over the likely response of supplier and risk to supply following a unilateral decision to
extend payment term should be taken on account. As well bad publicity if extended payment
times is applied, particularly for smaller suppliers, would have a negative impact in the
organization reputation.

Payment cycle: Payment runs for payables should be limited to the required frequency.

Here, of course, country- and industry-specific business conventions apply. Moderate

adjustments of payment runs just require some changes in the accounting systems, and tend to
be a quick hit.

Avoidance of early payments: Payments before the due date should be strictly avoided.

Payments should be accomplished with the next payment run after the due date (ex post).
Switching from ex ante to ex post payments is common practice and entails an easily
implemented lever for increasing payables.

Payment conditions: An increase in payment term when the company supplied greater

quantity can often be achieved by renegotiating payment conditions with suppliers. Bestpractice approach here is to first get an overview of all payment terms in use and to define a
clear set of payment terms for the future. Renegotiations with suppliers are based on these
new standard terms. It is critical to take into account supplier specifics. For those with
liquidity constraints the focus should lie on prices, whereas for suppliers with high liquidity
the payment term can often be extended.

Product acceptance conditions: Connecting the settlement of payables to the fulfilment

of all contractual obligations may result in significant postponements of respective payments.

Enforcing supplier compliance to stipulated quality, quantity, and delivery dates is also the
basis for optimized, demand-oriented supply concepts.

Back-to-back agreements: Balancing the due dates of receivables and payables helps to

avoid excessive pre-financing of suppliers and can even lead to a positive cash balance.
55

Since working capital optimization affects many areas of the company, detailed
planning and a holistic approach are crucial for future success of the business.
Optimizing the three components of operative working capital simultaneously not only
accelerates the cash conversion cycle but also goes hand in hand with further improvements.
However, applying the right measures will not only increase value added by lowering capital
employed. Improved processes will also lead to reduced costs and higher earnings before
income and taxes (EBIT).
There are four main aspects to successfully anchoring working capital management into
an organization and making it sustainable:

Commitment and resources (sponsorship by top management, clear responsibilities,

dedicated teams, internal experts as multipliers).

Communication and enabling (conveying motivation and necessity, fostering know-how

exchange and best-practice sharing, providing training on working capital management

principles).

Incentives (inclusion in budget planning, linking variable salary to target achievements,

recognizing jobs well done).

Controlling (integration into existing reporting formats, tracking target achievement and

implementation progress).
While working capital forecasting is critical to the companys ability to make informed
strategic business decisions, many financial managers struggle with the process because of a
lack of control and real insight into the underlying drivers of their capital needs. By
empowering the entire organizations to understand the companys true working capital needs,
the financial risk will be successfully reduced by preparing for uncertainty and create a ready
cash reserve that will provide flexibility and security during difficult times.

56

Appendix 1.
Independent explanatory variable

Variable name

Definition

IC
RC
CCC
ICP
RCP
PDP
A/R
A/P
LORO
EBITDA
EBITA
EBIT

Inventory conversion
Receivables conversion
Cash Conversion Cycle
Inventory Conversion Period
Receivables Conversion Period
Payables deferral period
Account Receivables
Account Payables
LOGSTOR (ROMANIA) SRL
Earnings before interest, tax, depreciations and amortisation
Earnings before interest, tax and amortisation
Earnings before interest and tax

57

Appendix 2.
List of figures and tables
Figures:
Figure 1.1.1
Figure 1.3.1
Figure 1.3.2
Figure 1.3.3
Figure 1.4.1
Figure 2.3.1

Calculating Working Capital

A careful balancing act-smarter working capital management
Current Ratio calculation
Quick Ratio calculation
Working capital cycle
Market share analysis at the end of 2008

Tables:
Table 2.3.1
Table 2.4.1
Table 2.4.2
Table 2.4.3
Table 2.4.4
Table 2.4.5
Table 2.4.6
Table 2.4.7
Table 2.4.8

Key figures-historic development of LOGSTOR SRL and its comparable

Statement showing change in working capital for LOGSTOR SRL and its
comparable
Inventory days analysis for LOGSTOR SRL and its comparable
Inventory turnover analysis for LOGSTOR SRL and its comparable
Average collection period of LOGSTOR SRL and its comparable
Cash funds of LOGSTOR SRL and its comparable
Account Payables credit period of LOGSTOR SRL and its comparable
Cash operating cycle (without intercompany suppliers) at LOGSTOR SRL and
its comparable
Cash operating cycle (with intercompany suppliers) at LOGSTOR SRL and its
comparable

58

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www.mfinante.ro

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www.logstor.com

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www.icap.ro

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www.ase.ro

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