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Chapter 6: Working Capital Management

Working Capital is the money used to make goods and attract sales.
The less Working Capital used to attract sales, the higher is likely to be
the return on investment. Working Capital management is about the
commercial and financial aspects of Inventory, credit, purchasing,
marketing, and royalty and investment policy. The higher the profit
margin, the lower is likely to be the level of Working Capital tied up in
creating and selling titles. The faster that we create and sell the books
the higher is likely to be the return on investment. Thus when we have
been using the word investment in the chapter on pricing, we have
been discussing Working Capital.

In the earlier chapter on Accounting concepts we showed a sample


Balance Sheet. The Balance Sheet comprises Long term Assets (real
estate, motor vehicles, machinery) and Net Current Assets. The word
Working Capital is often used for Net Current Assets. In this chapter we
will exclude Cash in Bank from our definition. Thus our Balance Sheet
appears as follows:

Long Term Assets 6,000


Working Capital 28,000
Cash in Bank 1,000
Total Capital 35,000

We defined Net Current Assets as Total Current Assets less Total


Current Liabilities. In this book we shall subtract current liabilities items
from current assets as follows:

Young
Inventory 15,000
Receivables 17,000
Prepayments 6,000
Payables (9,000)
Customer Prepayments (1,000)
Working Capital 28,000

Using this format we can state than any reduction in the Working
Capital figure, other than for provisions for write-offs and write-downs,
will generate the same amount of cash. Thus if a customer pays US$
500 that he owes to the organisation, the Working Capital figure will
fall be US$ 500, and the cash figure will be increased by the same
figure. This revised format is useful when designing spreadsheet
financial planning models for business plans or for internal reporting.

The Working Capital cycle, or Cash Conversion cycle as it is also called


is usually expressed in terms of the number of days. This figure is the
average time that it takes to turn investment in books into cash and
profit. We studied Payback in the previous chapter. Payback expresses
the number of days required to recoup the original investment on a
single title. In the organisation’s Balance Sheet there will be the costs
of paper, titles still under development, author advances of books
already and not yet published. In addition there will be the cost of
stocks of unsold books, Accounts Receivable, and Accounts Payable.

Example: Osiris publishers

In order to illustrate the concept I have adapted slightly the example


used in the chapter on Accounting concepts. The Young scenario has
the same Income Statement but I have adapted the Prepayments
figure within the Balance Sheet in order to illustrate more elements of

Working Capital. I have divided the Prepayments figure of 6,000 into


Prepayments to authors and Prepayments to printers. The totals are
the same.

Income Statement Osiris


Turnover 100,00
0
Cost of Sales (57,000
)
Royalties (18,000
)
Gross Profit 25,000
Distribution costs (5,000)
Promotion (2,000)
Write-offs (3,000)
Administration costs (10,000
)
Operating Profit 5,000
Analysis
Balance Sheet Osiris Working Capital / 28.00%
Sales %
Inventory 15,000 Inventory in days 96
Receivables 17,000 Receivables in days 62
Prepayments: authors 3,000 Prepayments in 61
days: authors
Prepayments : printers 3,000 Prepayments in 19
days : printers
Payables (9,000) Payables (36)
Customer Prepayments (1,000) Customer (4)
Prepayments
Working Capital 28,000 Working Capital 198
Cycle in days

Explanation of the calculations

Working Capital Explanation


figure
Inventory in days (Inventory / Cost of Sales) x 365 = 96 days.
More correctly the purchases figure, if available
should be used, in this case excluding royalties.
Thus the publisher holds approximately 2
months of unsold inventory
Accounts receivable in (Receivables / Turnover) x 365 = 62 days.
days Assuming the turnover is phased evenly
throughout the year, this means the on
average customers take 62 days to pay
Prepayments in days – (Prepayment: authors / Royalties) x 365 = 61
authors days. In practice royalties will be earned that
reduce this figure while new advances are also
paid to other authors.
Prepayments in days – (Prepayment: printers / Cost of sales) x 365 =
printers 19 days. In practice part of the Cost of Sales
figure would be new title pre-press costs not
carried out at the printer. This item relates to
cases where advance payments are made to
printers as a deposit or for paper. The
purchases figure if available would give a more
accurate figure.
Accounts Payable in (Payables /(All purchases) x 365
days
(9,000 / (57,000 + 18,000 + 5,000 + 2,000 +
10,000) x 365 = 36 days

The purchases (investment) rather than the


cost of sales figure should be used if available. I
have assumed that this figure includes money
owed to authors (see prepayment: authors)
Customer (Customer Prepayments / Turnover) * 365 = 4
Prepayments days
Working Capital cycle 96 + 62 + 61 + 19 - 36 - 4 = 198
in days
Working Capital / Sales 28,000 / 100,000 = 28%
%

Explanation of the figures

• On average it takes Osiris 198 days to turn an investment into


cash and profit.
• New tiles will use more Working Capital than reprints
• On average Working Capital equates to 28% of turnover
• The percentage of Working Capital to turnover varies according
to the type of publishing
• Trade publishing in developed countries may have a figure of
between 35- 45 % of turnover. Academic publishing is higher.
Professional publishing uses a lower Working Capital % figure
• Working Capital is also a measure of risk

This figure may include new titles, reprints, foreign language


coeditions, licence sales. The figure would be different for each of
these. Within the total Balance Sheet, the Working Capital figure will
vary throughout the year according to the phasing of new titles and
the sales cycle. Publishers should know the typical Working Capital
cycle and the level of Working Capital as a % of turnover for each
market or distributor, for each category of book.

The relevance of Working Capital to publishing in young


economies

In the FSU Working Capital levels were controlled at government rather


than factory level. Invoices were settled on standard credit terms. Non
or slow payment was not a major problem for printers and publishers.
Risk was a government problem. Authors were paid standard royalty
rates and terms. Inventory levels and print runs were according to a
formula: in textbook publishing, 150% of the textbook requirement
would be printed in year 1, the remaining 50% would be used for
replacement copies in subsequent years. Publishers, printers and
distributors would negotiate for annual cash budgets but did not have
to concern themselves about Working Capital questions except where
budget moneys were delayed.

Printing capacity was sufficient to produce local and other agreed


requirements. Thus textbook printing would commence in November
for the following September. In a competitive open economy printers
would have to offer discounts and credit to persuade publishers to take
the risk of early ordering. Schools would demand the latest up-to-date
editions. Publishers would have to borrow money from the bank or
shareholders to pay for the inventory.

For young economies, the implications are as follows.

1. In young economies the first industries to develop are those with


low or negative Working Capital % to sales. Negative Working
Capital is where the organisation uses supplier credit or
customer Prepayments to fund their day to day needs.
E.G. banks and financial services, retailers, distribution, industries
with cash sales or advance payments on signature of contract
(e.g. printers). Organisations with negative Working Capital use
the money from their customers with which to invest and to pay
suppliers.
2. Competition is fiercest among industries with low or negative
Working Capital / sales % figures. Financial entry barriers are
lower and these industries are easier to expand. However profit
margins are often lower because of the competition (but not
always!) and the failure rate among such industries among
developed countries is usually higher.
3. Banks are attracted to industries with low or negative Working
Capital / sales % figures as cash and profits are earned more
quickly
4. Entrepreneurs are attracted to industries with low or negative
Working Capital % figures
5. Most marketing innovations in book publishing have come about
through the application of the above Working Capital concepts to
creating additional sales and expanding the market. Most of the
innovations introduced at the end of the previous chapter were
created by reduced the level of Working Capital and the time
schedule of creating and selling books.
6. The customers, suppliers and authors of book publishers also
want to operate to a low or negative Working Capital / sales %.
Thus printers ask for advance payments e.g. for paper,
distributors will try to withhold payment until they have received
money from their customers.
7. Printers are loath to change from their dominant position where
they could dictate prices and schedules according to price scales
formulated at state level. These price scales were geared to
maximum production output, not to satisfying publishers and
their customers under national or international competition. 4-
colour printing would cost 4-times the cost of single colour
printing, despite the introduction of modern 4-colour sheet-fed
presses. Printers will change their attitude to pricing and print-
runs only in a crisis. In many young economies printers have not
co-operated with publishers (partly the fault of the publishers)
and faced near collapse as publishers have purchased printing
overseas.
8. In developed countries publishers have sometimes allowed retail
groups extra credit (= higher Working Capital for publishers) in
order to encourage them to expand into new outlets or sell more
books. It is essential to distinguish between genuine expansion
cases and opportunistic entrepreneurs. The more a publisher is
actively engaged in marketing and distribution, the less likely is
the publisher to have to rely on offering credit as an incentive.
9. The concept applies equally to state enterprises and non-profit
making organisations. If cash and profits are generated more
quickly, new titles can be commissioned sooner, staff and
suppliers paid promptly. Bank interest is reduced.
10. Where producers are dominant, their customers will have to
accept higher levels of Working Capital. Where customers are
dominant, the producers have to accept a greater burden. In
some young economies, the government may have a policy of
holding key organisations in the state sector or as majority
owned state enterprises rather than encouraging a “free-for-all
enterprise policy. This may affect printers, publishers and
distributors. This policy will affect the evolution of the Working
Capital cycle and may tilt it more in favour of producers.

Working Capital levels in book publishing in developed


countries

Working Capital is a major problem in book publishing. Most publishers


solve the question on a temporary basis by negotiating credit with
printers and other suppliers. Their own customers solve the problem by
negotiating credit with publishers or demanding “sale or return” terms.
“Sale or return” terms make planning and cash forecasting much more
difficult. Most publishers rightly prefer to offer a slightly higher
discount for a firm sale. Retailers will argue that they would not
purchase many new titles without their risk being mitigated by a “sale-
or-return” policy”

The central issues, which must be solved, are:

• Investment decisions rely too heavily on economies of scale e.g.


in printing prices, by amortising first edition costs against larger
print runs
• Publishers produce too many titles, which receive too little
promotional effort and thus sell slowly or not at all.
These can be solved only through long term changes in publishing
strategy and greater attention to the “value chain” where suppliers,
publishers, wholesalers and retailers co-operate to mutual benefit and
shared risk. On demand publishing may reduce inventory levels but
does not solve the marketing aspects.

Many publishers have studied the publishing of music CD’s and


cassettes, and of greeting cards with a view to finding solutions. While
lessons can be learned, there are major differences:

CD’s, cassettes and greeting cards

• Are all high margin projects


• Carry much heavier promotion budgets and commitment to
marketing
• Are standardised in format
• Enjoy few economies of scale so short run and on-demand
manufacture are the norm
• Sell to a more wide variety of retailers
• Sell on a less seasonal basis

Paperback publishers have adopted some of these aspects and have


fought successfully to overcome the low price perception of
paperbacks. Paperbacks can now sell in many cases at the same price
as a hardback edition. The creation of “hit-parades” or “Top 10”
listings has been adopted for books of different categories and has
attracted significant media attention thus making books more
fashionable. As a result books may sell faster, perhaps at higher prices
and thus reduce Working Capital levels.

“Book Packagers”

Book packagers create books under contract to publishers, bookclubs


or foreign distributors. They evolve as part of the specialisation
process especially when publishers become larger and more
bureaucratic. Publishers buy the rights for a territory for a period of
years or number of printings (provided that the title stays in print). The
financial attraction to publishers is that they can buy smaller print runs
at economic cost. Most publishers will make advance payments to the
packagers but may be able to approve the content and design. Most
packagers prefer to sell finished books rather than licence titles on a
film and royalty basis.

Packagers buy at low prices from printers because they create only a
small number of titles but each title will have a large print run.
Packagers often stay loyal to printers who reward them with long credit
and, in many cases, lower printing prices than those paid by their
publisher customers.

In the TV world many program companies will create programs for


several networks while TV companies concentrate on distributing the
programs. The production companies will retain the rights and earn
fees for repeat-shown programs. A similar situation exists in the
multimedia field.

Thus packagers are specialists who are not involved in marketing and
distribution. Subsequently a small number of them have decided to
become publishers and done so very successfully after re-financing.
Most stay as packagers. Compared with publishers, these packagers
have little market value in acquisition terms.

Thus packagers are very similar to many private publishers in young


economies but with important differences as the table below shows:

Book Packagers Private publishers in young


economies
- Founders are creatively - Founders are creatively rather than
rather than market driven; market driven; enjoy “freedom”
enjoy “freedom”
- International printers offer - Printers tend to give better prices to
them low prices and credit; established publishers
printers have often offered -
credit to allow packagers to
start up, sometimes with dire Some publishers may be closely linked
results for the printer with a printer. The printer may
demand advance payment
- Packagers usually allow - Publishers will not involve customers
publishers to approve content in the book content except in special
cases e.g. textbooks and Ministry of
Education, University Publishing
Houses
- Receive advance payments - Are paid after delivery
from publishers
- Hold no Inventory but reprints - Will often sell the total print run to a
make high profits single or small number of distributors
- Purchase rights from authors - Sell books with no transfer of rights
and designers, and sell
territorial or other rights to a
number of customers
The Working Capital cycle in both cases is similar in both cases. The
reason is perhaps the same. Neither the book packager nor the young
private publisher is adequately financed; both enjoy the creative
aspects but do not want to expand if it means losing control. There are
few potential buyers for book packagers.

The cost of starting such organisations is much lower. Working Capital


is lower because they are involved only in creating the books. They
influence distributors, retailers and consumers only so long as they
generate saleable new ideas. While book packagers can of course sell
foreign rights, their potential to sell reprints is lower.

Making more efficient use of Working Capital

The table below lists items, which influence Working Capital levels
favourably and adversely

Items that reduce Working Items that increase Working


Capital levels for publishers Capital levels for publishers
- Increased profit margins - Lower profit margins
- Customers who pay promptly - Long print runs except where all
- Advance payments by customers the books are required on
publication e.g. School and
university textbooks
- Inventory which is sold and paid - Slow authors who deliver late
for quickly by customers after and whose manuscripts require
publication substantial editing
- Lower Inventory levels by - Holding paper stock unless
reducing print quantities and market conditions demand and
working with printers who will the savings are large
deliver quickly and produce low - Slow schedules for the
print runs economically development of new titles
- Successful promotion that speeds - Making advance payments to
up the rate of sale printers
- Seasonal sales except where the
publishers prints only for the
season
- Licensing (but problematic in
young economies)
- Paying suppliers on completion
with credit
- Authors who deliver manuscripts
on disk ready for computer make-
up
- Incentives to staff , authors ,
suppliers, customers , sales staff
and agents to speed up the rate of
sale and of developing new books,
delivering manuscripts on
schedule

The attention of readers is again drawn to the examples at the end of


the previous chapter, which illustrate ways in which publishers have
produced affordable books through a marketing initiative. The
concepts of this chapter apply in each example.

The danger of averaging Working Capital levels

Osiris has a Working Capital to Sales figure of 28%. However the figure
will be the average of the organisations different activities. Let us
assume that there are three divisions that produce different types of
books for different markets and use different methods of distribution.
The table below shows how each division generates much Net
Contribution and also how much Working Capital is used in each
division. The cost of sales, royalty, distribution, promotion costs and
write-off figures differ in each case as a percentage of sales although
not all the costs are necessarily variable. The term Net Contribution is
the amount of money that each division generates towards the central
administration cost of the company and hence to profit. Items below
Net Contribution is not relevant to our analysis unless administration
cost vary according to each market. Interest on bank loans could
however be usefully charged against each division to give an even
more meaningful figure. Although a Balance Sheet item, Working
Capital is shown under Net Contribution to highlight the relevance of
comparing Net Contribution and Working Capital levels by division.

Income Statement Division A Division B Division C Total


Turnover 60,000 30,000 10,000 100,000
Cost of Sales (33,000) (18,000) (6,000) (57,000)
Royalties (10,800) (6,200) (1,000) (18,000)
Gross Profit 16,200 5,800 3,000 25,000
Distribution costs (3,900) (1,000) (100) (5,000)
Promotion (1,100) (900) 0 (2,000)
Write-offs (1,700) (1,100) (200) (3,000)
Net Contribution** 9,500 2,800 2,700 15,000
Working Capital 19,200 7,800 1,000 28,000
** Gross Profit less distribution, promotion and write-offs. The contribution to
administration costs and profit from publishing activities

The analysis of the above sheds useful light on profitability and use of
Working Capital by division. This is discussed in detail below.

Analysis of the net contribution

The table below shows each cost item included in the Net Contribution
calculation expressed as a percentage of turnover.

Division Division Division Averag


A B C e
Cost of Sales % to Turnover 55.0% 60.0% 60.0% 57.0%
Royalty % to turnover 18.0% 20.7% 10.0% 18.0%
Gross profit margin % 27.0% 19.3% 30.0% 25.0%
Distribution % to turnover 6.5% 3.3% 1.0% 5.0%
Promotion % to turnover 1.8% 3.0% 0.0% 2.0%
Write-off % to turnover 2.8% 3.7% 2.0% 3.0%
Net Contribution % to 15.8% 9.3% 27.0% 15.0%
turnover
Working Capital / Turnover 32.0% 26.0% 10.0% 28.0%
%

Turnover

The turnover figure is the sum of the sales invoices issued during the
year by division. Any returns or invoice queries would be shown
separately under write-offs in order to highlight to management the
extent of returns and invoices queries. The company will invoice either
by charging an agreed discount off the recommended retail price, or
by using an agreed unit price. If transport is included in the invoice
price, the charge for transport will be shown as an expense under
distribution. Free samples or extra jackets may also be included in the
invoice price.

Cost of sales

The percentage to turnover is influenced by the sales mix, the balance


of new and reprint titles, and the length of print runs. A larger print run
might increase the gross margin % but also increase Working Capital
levels and hence reduce the cash in bank figure.
Some organisations will charge new title costs in different percentages
to each market. The aim is to demonstrate that certain markets are
profitable, but only on a marginal costing basis. If an organisation has
to increase prices to local bookshops as a result of charging all new
title costs against the home market, the organisation runs the risk of
losing market share and profitability in the home bookshop market

Other publishers, often the more progressive, may therefore regard


new title costs as research and development, and charge e.g. 1/12th
each month following publication against the Income Statement. This
policy means that inventory is valued at a cost excluding new title
costs and reduces the need for write-offs. This policy also gives a
better view of trends in gross margins, as the figure is not distorted by
changes in the new title / reprint mix. The Net Income will fall.
Countries may have specific policies for writing off first edition costs
against profits, as they are similar in concept to research and
development expenditure.

Royalty figures

The royalty figures differ because in the case of division A and B, the
royalty is charged on the basis of the retail price, while in the case of
division C, the royalty payable is based on net receipts, i.e. the unit
price charged net of discounts. As markets expand, the need to
negotiate royalty terms based on net receipts will grow in order that
publishers exploit new markets. Without such author contractual
terms, publishers might have to reject otherwise profitable deals. Thus
the author might lose also. It is common for net receipts royalty rates
to be agreed for deals above a certain discount rate, e.g. bookclub,
export deals, coeditions, and licences.

Gross margin

Definition: Turnover minus cost of sales and royalties payable.

Gross margin, the percentage of gross profit to turnover is widely used


in book publishing as a parameter for book pricing. Where an
organisation produces books with a similar cost profile, in similar print
runs, and with a constant sales mix, gross profit may be a useful
criterion. Here the figures highlight also that the use of gross margin
as a criterion is not always useful and can be misleading although the
division C, with the highest gross margin, also has the highest net
contribution. Use of gross margin ignores distribution, promotion and
write-offs, which will usually differ by division or type of book.
Distribution costs

Distribution costs will include the following:

• Cost of own warehouse in handling the year’s sales


• Cost of using someone else’s warehouse for the same purpose
• Using a contractor who handles your organisation’s distribution
on a percentage of turnover basis for warehousing, transport,
packing, invoicing but not selling.
• Transport and postage costs
• Packing materials
• Handling returned copies
• Sales invoicing and credit collection (in some developed
countries)

The percentage cost will vary according to the method of market


distribution used. If the books are sold to a distributor who buys the
books on a firm-sale basis and who will sell, warehouse and transport
the books to customers, then distribution costs will be low or nil. The
publisher’s influence and control over the market will also however be
low or zero also. In the case of a bookclub, the bookclub will demand
delivery to their warehouse in bulk and distribution costs for the
publisher will thus be limited to transport costs to the bookclub’s
warehouse.

Promotion costs

This includes the costs of promotion and selling whether carried out by
the publishers or by other companies who carry out the publisher’s
instructions.

The following will be included:

• Publisher’s own sales force


• Sales commission to agents who sales on a commission basis
only or to sales staff who are paid partly by salary, partly on
commission
• Advertising agency costs
• Some publishers may include samples under this heading

Write-offs

Write-offs are provisions against things that are likely to go wrong. The
rule is that bad news has to be charged to the Income Statement as
soon as known whereas good news e.g. a large sales order for future
delivery is not shown as a profit until “realised”
The following would be included

• Doubtful debt provisions


• Bad debts
• Inventory that will not recover the cost of producing it
• Sales invoice queries
• Returned books (these are often shown separately as part of the
turnover figures e.g.

Gross turnover 105,000


Returns provision 5,000
Sales turnover 100,000

• Currency losses (or gains) on sales and purchase invoices


• Royality advance write-offs

Net Contribution

Definition: Gross profit minus distribution and promotion


costs, and write-offs

The Net Contribution shows the contribution from publishing activities


of each division or market. While the figure is immensely useful, the
percentage figure must be used with caution as both fixed and variable
costs have been deducted from turnover.

Licensing Income would also be shown, if significant, as a separate


item and not necessarily as part of turnover. While licensing can be
risky in young countries, it is a significant part of publishing in
developed countries where the legal system or local publishing
association will be active in protecting publishers ‘ rights. Showing
licensing Income as part of turnover has misled publishers for years
over the value of rights income to profitability and to an acceptable
return on capital %.

Net Contribution from Book Sales 15,000


Licensing Income (net of royalties payable) say 500
Total Net Contribution from publishing activities 15,500

Analysis of Working Capital levels by division


After a rather long diversion we now revert to Working Capital using
the same example. The table below shows how efficient each division
is in using Working Capital.

Division Division Division Averag


A B C e
% Sales Turnover 60.0% 30.0% 10.0% 100.0%
% Net Contribution /total Net 63.3% 18.7% 18.0% 15.0%
contribution
% Working Capital 68.6% 27.9% 3.6% 100.0%
Net Contribution / Working 49.5% 35.9% 270.0% 53.6%
Capital %
Net Contribution per 1 USD 49.48 35.90 270.00 53.57
Working Capital

Explanation using division C as an example

While generating only 10% of total turnover, but 18% of total Net
Contribution, Division C uses only 3.6% of the total Working Capital
tied up in the company. Division C makes US$ 2.70 Net Contribution
for every 1 US$ of Working Capital used in Division C.

For both entrepreneurs and for publishers unable to borrow more


money from the bank or shareholders, the Net Contribution per 1 US$
of Working Capital is vital. If we were to add the Working Capital cycle
(198 days in the case of Osiris earlier in the chapter) for each division,
the report that we have just studied would be even more useful.

Growth opportunities

The following analysis of the same data shows the importance of


Working Capital levels in generating cash as well as profit. Using the
above data we can extract the following

Impact of USD 1,000 Division Division Division Average


increase in sales volume A B C
Increase in Contribution 158 93 270 150
Increase in Working Capital 320 260 100 280

For every additional US$ 1,000 of turnover, US$ 320 of Working Capital
is required in Division A, US$ 260 in division B, and only US$ 100. It is
rare that the division with the lowest Working Capital requirement will
also have the highest net contribution % but that is what division C
offers. Division C might perhaps consist of reprints or foreign language
editions only.

Calculating cashflow using Working Capital

We can project future cashflows using the Working Capital data. We


are assuming that there are no additional purchases of long term
assets involved. Any other additional items of expenditure that are
required to support the change would also be included e.g. an
additional editor, a new personal computer.

(a) using the Osiris average net contribution and Working


Capital / turnover percentages

In the first case we will calculate the future cashflows over a three-year
period using the average net contribution percentage and average
Working Capital % for Osiris. It shows the impact on cashflows starting
with sales of US$ 1,000 in the first year.

Assumption
Turnover growth % 10% 10%
Net Contribution % 15% 15% 15%
Working Capital % to turnover 28% 28% 28%

Osiris Analysis xxxx1 xxxx2 xxxx3


Turnover 1,000 1,100 1,210
Net Contribution 150 165 182
Working Capital 280 308 339
Cashflow (130) 137 151
Bank figure (130) 7 158

As we are studying the cashflow on an incremental basis, the opening


Working Capital figure, as for a new project, would be zero. The
calculation for cashflow in the first year is as follows:

Cashflow: year 1 = Net Profit Contribution** plus increase in Working


Capital **
= 150 +0 – 280 = (130)
Cashflow: year 2 = 165 +280 – 308 = 137
Cashflow: year 3 = 182 + 308 – 339 = 151
** Plus any purchases of long term assets and additional administration expenses
required as a result of the decision. Net profit contribution is used instead of profit
because we are studying the impact on cashflow of increasing sales turnover. Only
incremental costs and sales are included.

(b) using the net contribution and Working Capital / turnover


percentages for Division C which has both the highest net
contribution % and the lowest Working Capital / turnover %

Assumption
Turnover growth % 10% 10%
Net Contribution % 27% 27% 27%
Working Capital % to turnover 10% 10% 10%

Division C Analysis xxxx1 xxxx2 xxxx3


Turnover 1,000 1,100 1,210
Net Contribution 270 297 327
Working Capital 100 110 121
Cashflow 170 287 316
Bank figure 170 457 773

Thus an expansion in Division C of USD 1,000 in turnover, and


thereafter an increase of 10% per year cumulative, generates USD 773
of additional cash as compared with USD 158 in the average scenario
for Osiris. The difference is explained as follows:

Increase in Bank figure: Osiris average 158


Additional net contribution from division C 397
Cash improvement due to lower Working Capital % in division C 218
Closing Bank figure for division C : year 3 773

Most of the increase in the bank position is the resulting of higher


profits but the lower level of Working Capital in division C also results
in an additional cashflow improvement of US$ 218.

Notes on the Cashflow calculations

In practice we would add back to the net contribution figures that part
of write-offs that was included for future problems. This is because
such provisions do not affect cashflow.

We can apply the same concepts for the preparing of spreadsheet-


generated Business Plan forecasts. In such cases all Income Statement
and Balance Sheet items would be included. Cashflow can be forecast
using the Balance Sheet rather than through a tale of Receipts and
payments. The resulting cashflow figure will be the same under either
method. Using the Balance Sheet figure above, different scenarios can
be studied, as the spreadsheet model can be “parameter” driven. Thus
changes in credit terms, inventory levels, margins can be studied
quickly.

Pareto's Law - the 80/20 rule

This “rule” states that invariably time, sales, costs, or problem areas
occupy a disproportionately high percentage of time or money. In
publishing we might use the rule as follows:

• 80% of inventory held is for only 20% of the titles published


• 80% of our profits are made by 20% of the titles we publish
• 80% of our turnover is made from 20% of our customers
• 80% of our slow payments are caused by 20% of our customers
• 80% of our Working Capital relates to 20% of our list or 20% of
sales turnover.
• 80% of out time is spent on 20% of our titles

This general rule can be applied in so many ways to financial


management in book publishing.

A detailed Look at the elements of Working Capital

Inventory

Inventory will consist of:

• Un-printed paper
• Flat printed sheets
• New books and reprints under development
• Finished Inventory
• Publishing plant (discussed in chapters 4 and )

Unprinted paper

In young economies paper may represent 40-50% of the price of a


book while in developed countries the percentage may be 10 – 15% of
the selling price. Thus in young economies, economic purchase of
paper is a major issue. In some countries paper is a scarce commodity
with prices at a premium.
In developed countries publishers will uses several printers in different
countries. The normal procedure for book publishers, except for
publishers of standard format paperbacks is to negotiate prices with
printers, which include an agreed paper specification. Newspaper and
magazine publishers, who print to a single format using reels will
normally purchase paper in order to secure the lowest possible prices
and in order to guarantees supplies.

Paper is a commodity, but, unlike most commodities, is not traded on


commodities' exchanges across the world. Attempts are being made to
develop a Futures Market for pulp. As a result there is no “market
price” for each paper grade. Large users will negotiate significant
discounts on published price lists. but such data is not published. Only
for newsprint is there an open discussion on prices. Countries with
strong economies and currencies will negotiate the best prices, while
countries with no local pulp industries will distort price levels by panic
buying.

Young ambitious economies will require increasing levels of paper, as


education, packaging and advertising become high priorities. Where a
country has an indigenous pulp and papermaking industry, this
increase in demand causes paper shortages and leads to higher prices.
Consumers become more demanding and require higher quality
papers, which are not available locally. Controlled paper distribution
means that local users may pay a higher price for local paper than
their counterparts in developed countries. Unless subject to special
trade agreements or supported by their local governments e.g. for
credit risk, foreign pulp and paper mills may charge higher prices to
young economies because of the credit risk and because they do not
always represent a major market to the mills. Local distributors are
unlikely to inform publishers that world paper prices are falling. Local
distributors will often seek to limit alternate sources of supply. There is
thus often a large difference between prices charged by local
distributors and those charged by the foreign paper mills who are
prepared to supply direct.

Many publishers in young economies will not purchase paper through


the printer for two key reasons. Printers will often make a surcharge of
up to 25% as well as demanding advance payment. In addition printers
may give priority to customers prepared to pay higher prices for
printing and paper and thus jeopardise printing schedules.

Thus publishers in young economies face three problems:

• Paying no more than market prices for paper (with guaranteed


quality)
• Guaranteeing supplies of paper and thus books. Printers may
give priority to publishers with paper stocks.
• Finding cash or loans to pay for the paper

Much of the comment on book inventory applies also to paper stocks. It


is cheaper and less risky to hold an inventory of paper than of books.

Flat printed sheets

These are flat printed sheets, which can be bound as hardback,


paperback or other editions at a later date. By not binding immediately
the publisher also delays the cost of binding but will usually have to
pay the printer for storage. Wastage rates are higher when the binding
is not carried out as a single run.

Many publishers of short run editions will print extra 4-colour covers for
later printings. A further use is where 4-colour illustration sheets are
printed for later over-printing in other languages.

New books and reprints under development (Work-in-Progress


or WIP)

This represents all the costs of creating new titles and reprints up to
the stage where the books ready for sale. Editorial and design salaries
will be included. As competition among publishers increases,
publishers are forced to create more added value to manuscripts and
this increases the amount of new title costs and also WIP levels.

Faster schedules will reduce WIP levels. This can be achieved by better
scheduling, use of in-house DTP and scanning equipment, offering
incentives to authors (for supplying manuscript on disk) or to staff and
supplier for shorter lead-times. One publishing survey indicated that
those publishers who worked to short schedules also had the lowest
levels of typesetting corrections. Seeing the finished book on which
they have worked motivates certainly many publishing staff.

Finished Inventory

Entrepreneurs and bankers are not attracted to many types of


publishing because of the high Inventory levels. In developed countries
these are still high, but falling, for the following reasons:

• Profit margins in publishing are not high


• Printers offer significant economies of scale for longer print runs.
Publishers are persuaded to print too many copies for too long a
sales period. Publishers believe that book prices must rise if they
pay a higher unit cost for printing. Most publishers in the FSU
also share this view
• Publishers will not always look at the Cashflow and Balance
Sheet implications when making decisions on print runs
• Publishers price books on the basis of a single printing
• Publishers are optimists
• Publishers do not invest heavily in promotion
• Most publishing courses teach full-cost costing for the pricing of
investment decisions
• Book sales are highly seasonal
• Production staff are chosen for their design and technical rather
commercial skills. The trend in most industries is for professional
buyers, not (printbuying) specialists in a particular industry

In younger economies publishers face a different scenario. Publishers


in developed economies will print in several countries either for
financial reasons or in order to print at a source close to customers e.g.
North America; Asia for the Australasian markets.

Printers in young economies will seek to export printing to developed


countries to earn hard currency In order to break into these markets
they will quote low prices on short print-runs in order to enter the
market. However, their local publishers are often forced to operate to
the printer’s terms of trade and pay higher prices. In order not to lose
sales by being out-of-stock, publishers may print excessively large
print runs. In addition, the culture of printing for 3 or 5 years as was
the norm in the FSU, prolongs these attitudes especially among state
publishers.

The subject of inventory levels and optimum print runs is so central to


book publishing that it is discussed in great detail in chapter 7

The following will assist in reducing inventory levels:

Ways of reducing Explanation


Inventory
Closer co-operation with Publishers co-operate closely with one or 2
“partnership” printers printers; contract on an annual basis;
forward plan together. A partnership but
with no final investment in the other
partner.
Market Research and Pre-selling before books are printing allows
advance selling publishers to fix more exact print runs
Increased promotional Promotion and greater sales effort in less
activity promotion obvious areas e.g. smaller towns, may cost
less than interest payments to banks
Use of series and The use of standard (or a small number of)
standard formats formats means that capacity can be booked
with printers, paper purchased in bulk. The
exact print quantities per title are fixed later
on a monthly basis.

This is used for standard format paperbacks.


This policy is as much about purchasing
policy as printing machinery constraints.
Selling stock firm to an This was the procedure in the FSU. Today
exclusive distributor most of these state distributors have
collapsed or split up. Distributors will
demand large discounts for carrying the risk.
In many cases they will sell in the capital city
and large towns only. The distributor is
needed for expanding sales into smaller
towns and rural areas. The use of more than
a single channel of distribution encourages
competition and improved sales
Sales Incentives, It may be appropriate to offer larger
discounts discounts or incentives to customers and
distributors
Printing contracts The negotiation of price schedules with
equal emphasis on low make-ready costs

Accounts Receivable

Obtaining money promptly from customers is a major problem in


publishing (and all industries) worldwide. Market leaders and dominant
organisations will be paid more promptly as their customers fear losing
the profits that they earn from such sales.

In many countries over 10,000 new titles are published each year.
Bookshops will sell several thousand titles. The rate of sale of books is
slow.

In order to encourage booksellers to stock titles credit is offered. With


newspapers and magazines the product has a short shelf life but the
cash cycle is short. In addition there are only a small number of
magazines or newspapers relative to the number of books published.
Customers ask for their regular magazine or newspaper.
When selling to more distant customers e.g. in another country, credit
is offered to take account of the time required to transport and
distribute the books.

In some countries the supplier has the statutory right to demand


interest on overdue invoices. These schemes are in practice less useful
than they appear as customers may use suppliers as a bank.

Another key reason is that most customers in the book trade are
under-financed. Rather than raise additional share capital or bank
loans, they use trade credit with their suppliers, the publishers. This is
partly because many customers may be privately owned but also
because the low return on capital from bookselling does not attract
investment easily.

In order to encourage booksellers to buy new books, publishers will


often offer to sell on a “sale-or-return” or “sale and exchange” basis.

Under sale-or-return basis the bookseller may send back stock not sold
after an agreed number of months. The bookseller must settle the
invoice on the agreed date and will subtract returns from subsequent
invoices. In the case of “sale-or-exchange” the bookseller may return
unsold titles in exchange for purchasing the same number of similar
new titles. This is used widely for paperbacks and is particularly
prevalent in North America for hardback editions also. The Accounts
Receivable figure must take account of the fact that the amount
invoiced may exceed the amount that will later be paid. This makes
cashflow forecasting difficult. Most publishers prefer to agree larger
discounts but sell firm.

Booksellers who pay late are in fact taking a larger discount. If the
publisher earns a 25% Return on Capital, or approximately 2% a
month, the bookseller is thus taking an additional 2% discount for
every month that payment is delayed.

Incentives are frequently offered for prompt or early payment. Many


customers will pay late and take the discount, however!

The value of such discounts can be assessed either by using the IRR or
NPV function on a spreadsheet or by the following formula:

The supplier offers credit terms of 30 days from delivery and


acceptance. The supplier will accept a 2.5% discount of the invoice
amount if the invoice is settled in 7 days.
The following ways of reducing Receivables are used in book publishing
and other industries in developed countries

Method Comment
High Margin products If Retailers make a large profit from selling a
supplier’s goods, they may lose that profit if
they do not pay on time
Market leadership As for high margin products
Credit checking before This checks the credentials of the customer.
the contract is Many Associations of Publishers operate a
accepted credit committee for their members. Banks
offer a credit reference service also
Frequent and prompt If customers know that they can obtain books
delivery quickly and reliably, they can hold lower levels
of inventory. Many publishers focus on selling
books into rather than out of the bookshops
Formal methods of Bank drafts, Bills of Exchange, Letters of
payment Credit, guarantees. Bonds

Retention of In some countries ownership does not pass to


ownership the customer until the goods have been paid
for.
The accounts Invariably the accounts department will be
department expected to chase customer payments. Private
publishers will give it high priority and owners
will do it personally. It is quite different to most
financial accounting work and is a key priority
for firms. Firm persuasion is needed rather
than accounting skills.
Joint promotions, These may expand the market and cost less
merchandising than bank interest payments

Methods of payment

Banks, suppliers and their customers are forced to find more complex
payment methods in order to gain competitive advantage. These are
needed to expand trade and to give confidence to encourage suppliers
to enter into contracts. In order to stimulate credit trade, banks
created more formal payment methods. These are only as good as the
financial standing and reputation of each bank, supplier and customer.

The aims of these payments methods include the following:

• To protect the supplier


• To encourage the supplier to offer credit and more attractive
prices
• To convince the supplier that he will be paid once the customer
has taken delivery
• To act as collateral to the supplier in particular to obtain bank
overdrafts or lower rates of interests
• To reinforce the legal contract between supplier and customer
• To encourage foreign trade; to obtain governmental credit
insurance

In practice young publishers are more likely to encounter formal


methods of payment when negotiating with foreign printers.

Typical documents include the following:

Method of Explanation
Payment
Bills of Checks drawn on the customer by the supplier for
Exchange payment at a future date. The supplier will hand over
delivery and customs documents once the Bill of
Exchange has been signed by the customer (for new
customers) or perhaps immediately with trusted
customers. The Bill may be deposited with the
supplier’s bank and allow a lower rate of overdraft
interest. Alternatively Bills may be endorsed in order
to pay a supplier.

Bills normally assure prompt payment but do not


guarantee payment

The use of Bills of Exchange must be agreed by both


parties during negotiations
Letters of The customer signs these at contract stage. The
Credit customer undertakes to pay in full provided certain
listed conditions are fulfilled. The conditions must be
capable of clear non-subjective interpretation by
courts.

They are widely used in North America. In other parts


of the world they tend to be used for larger and longer
contracts than Bills of Exchange. They are usually
regarded as more reliable than Bills of Exchange.
Bankers A bank, after debiting the customer’s account, will
checks issue a check to the supplier drawn on the same date.

The situation in young economies is quite different. Many of the items


in the first table concerning the collection of Receivables may not
apply. Banks may not offer financial instruments such as Bills of
Exchange. Cash or deposits may be demanded wherever possible but
distributors survive on supplier credit. Often government departments
will be slow payers. Publishers must therefore take carefully
researched risks and enter into alliances of mutual benefit.

Author royalties

Authors receive advances against future royalty earnings. They serve


also to pay the author while writing. In most cases they are non-
returnable. Thus if sales are low or slow to emerge, the advance may
be in excess of earned royalties and perhaps paid 2 years before the
total sum is earned from sales. In developed countries, trade
publishers and paperback publishers will expect to write-off large
amounts of unearned royalty advances each year. The payment of high
royalty advances, as publishers bid for market share, is cyclical. The
advance will be against earnings over the term of the contract which
will be for several years and several printings and editions.

In many types of publishing, the publisher will find an author who will
be contracted to write to a specification; Artists, photographers and
photo agencies will be contracted to provide illustrations and
photographs. The publisher than provides more added value by the
author. In such cases the level of advances and royalty rates will be
lower. In other fields, e.g. academic publishing, authors may write for
no or minimal advance as the incentive is to increase their academic
reputation.

Publishers should regularly e.g. quarterly or twice a year, review those


titles where advances have not been earned. Reprints may require the
payment of no further royalties in cashflow terms.

In young economies the local Society of Authors may insist on standard


royalty terms and advances regardless of the type of book or print run.
The terms appropriate to approved textbooks (print-run 100,000 plus)
are quite different to those suitable for university publishing (print-run
500-2000) or to authors of original novels. Established authors benefit
hugely but resist competition from new authors. Subject to the laws of
the country and the availability of good authors, most countries will
need to study variations on standard author contracts if authors,
publishers distributors are to benefit from expanded book markets.

Computer programs exist for the monitoring and payment of author


royalties. These are suitable for publishers with large number of titles
with complex contracts. However for most young publishers a
spreadsheet can be used to calculate the royalties earned, and
payments due.

Prepayments to supplier

In developed economies publishers may buy coeditions for the


exclusive licence to publish in a language from foreign publishers or
book “packagers”. Packagers concentrate on creating multi-language
titles but sell the language rights to foreign and local publishers; they
do not involve themselves in the marketing or distribution of books.
Typical contractual terms for packager and coedition contracts involve
stage payments, on signature, on approval for press and on delivery.
Publishers who buy from coeditions or packager products can publish
smaller print runs more economically and without using their own
editors. For rights deals, the publisher will purchase film and pay a
royalty advance.

In FSU countries, many printers still demand payment in advance


whereas in developed countries 60-90 days credit would be given to
publishers. These are also Prepayments.

Payables

In developed countries where printers compete aggressively on an


international basis, credit of 30 - 120 days is used to encourage
publishers. Private publishers will remain loyal to one or more printers
who offer substantial credit. This credit reduces Working Capital levels
and replaces loan capital in many cases. Private publishers will often
negotiate lower printing prices than larger publishers will.

Customer payments in advance

Coeditions have already been discussed under Prepayments. Where


publishers sell coeditions to foreign publishers they will receive
advance payments which will be “owed” to their customers until the
books are delivered and accepted.

Summary

In developed economies, companies are forced to find innovative ways


of reducing Working Capital levels in order to maintain an acceptable
Return on Capital Employed and in order to survive. In most cases
those companies, which are most market, oriented and involved in
market distribution e.g. retail groups will dictate terms to the
producers. Where such compa-nies are successful in expanding the
market, the suppliers may benefit also.

EXAMPLE

In developed countries retailers of high priced items and items with slow stock turn,
may refuse to purchase inventory and will accept only merchandising deals where
the inventory belongs to the supplier until the products are purchased by a
consumer. The retailer is this acting as a commission sales agent only. The supplier is
paid once the goods have been sold.

Investors, banks and suppliers support such companies provided that they are
successful and expanding. In many countries professional retailers are taking an
increasing market share of bookselling proving that bookselling is attractive to
entrepreneurs. Booksellers compete against other successful booksellers, against
supermarkets, bookclubs. Printers, publishers, wholesalers and retailers operate in a
value chain.

However in young economies there is little understanding of the value chain or


teamwork. Printers, publishers, distributors and bookshops operate independently for
survival. In the FSU, printers, publishers and distributors operated like watertight
compartments with no overlap of responsibilities and reporting to different ministries.
Working Capital was not a significant problem for individual enterprises

Printers are accustomed to operating large factories and have to possess


management, commercial and accounting skills. Their long-term assets may be used
as collateral for loans. At the other end of the chain many state distributors have
collapsed, as their vast inventories became unsaleable; many book retailers deserted
bookselling to sell higher margin goods. The publisher is the least experienced
business member of the chain: printers have business skills, distributors have a short
Working Capital cycle and collect cash. Publishers’ Balance Sheets offer little
potential for bank collateral. As a result publishers in young economies may feel
initially at a disadvantage to their printers and distributors.

Working Capital characteristics of different types of publishing


Publisher Developed country Young economy
School Medium. High WIP but for a High WIP; Low Inventory if
textbooks small number of titles; lowbooks are successful;
but seasonal Receivables; Receivables low and
Author advances low; seasonal. Printer
Payables average and advances high as print
seasonal runs are often long.
However printers are
attracted to the long runs
and the guaranteed
market and will start to
offer credit
University Medium. Similar to school High. Publishers will print
textbooks textbooks; larger lists. for several years.
Pricing competitive Receivables low as many
books are sold for cash in
university bookshops.
Professional Low. High WIP but small High WIP and Inventory.
books lists; Receivables low as Professional may pay a
many books are sold direct high price for imported
books but not for local
books
Trade High perhaps 35 – 40% of Medium if books are sold
Publishers turnover. Large inventory to distributors on
due to need to sell to a publication: high WIP as
wide market and due to use many titles; high author
of colour; High author advances. Low
advances and Receivables Receivables.
compensated by high
Payables
Academic Very high. This is making Very high. Similar
publishers the Internet and other characteristics to
electronic medium university textbooks but
attractive to Academic Working Capital levels
publishers and their higher
customers

Factors that reduce Working Capital levels

From the table above we can infer the following checklist of reducing
Working Capital level in developed countries

• Small numbers of titles


• Need to buy rather than want to buy titles with unique
information
• Use of standard formats for paper printing and binding
• Direct marketing
• Closer involvement in market distribution
• Publishing for clearly identifiable markets e.g. schools, doctors,
accountants, lawyers
• Short run printing
• Book packaging
• Titles where printing costs are a low % of the selling price

Whether the same list will apply to young economies will depend on
average wages levels and other economic data such as the percentage
of urban population to rural population. In developed countries
profitability for such publishers is linked to their ability to charge a
premium price for need-to-buy books. Computer books are a typical
example: a typical PC will cost in excess of US$1,000. Thus the selling
price of a book that assists the user to make better use of the
computer and its software is linked to the benefit. In many young
economies that may not yet be the case.

The Value Chain - Supply and Marketing Decisions

This chapter concludes by applying these concepts to the Value Chain


– printers, publishers, distributors and retailers and concludes by
studying in detail the title investment decision.

Most market innovations have arisen through co-operation between


suppliers in the Value Chain, and by the application of Return on
Capital pricing. In general the supplier taking the greater risk will be
relieved of much of the Working Capital burden in order that the risk
taker can invest in selling and promotion costs to enlarge the market.

Company Comment Implications for publisher


Printers Fixed costs are high. Even if a printer adds only a
Profit Contribution % is 10% profit margin, the return
high if labour is regarded on capital may be high. Fast
as a fixed cost. Working jobs are very profitable when
Capital % of turnover measured in terms of return
low. (assumes that on Working Capital. Because
publishers supplies of the large fixed costs,
paper). Printers now printers can vary prices if
compete on an they need to attract more
international basis using work to fill their factories.
similar machinery. Many Book printing is regarded as
reproduction prices have one of the more profitable
fallen by over 1000% in parts of the printing industry
the last 15 years.
Distributor Profit Contribution % Distributors will concentrate
(who stores, low. Working Capital as on selling the more saleable
transports and % of turnover also low. titles into the largest towns.
sells) Payback period short. Therefore many titles are
never seen in many parts of
Distributors will usually the market unless the
have a very low territory is divided up
capitalisation. If they do between distributors.
not sell enough books,
they cannot pay
publishers or buy new
stock
Commission Low profit per 1USD of Only one profit margin is
Sales Agents turnover but almost no added as the publisher sells
Working Capital directly to the retailer rather
involved than to distributors. The
publisher carries the total
Working Capital burden.
Retailers Contribution % quite The prices and profit margin
high, Working Capital % on books are both low.
of turnover medium if
the shop is reasonably
successful.
Bookclubs Low Receivables; high Bookclubs create and
Inventory; Very high maintain a customer base
entry costs before
bookclubs make a profit
and generate cash.
Advertising costs high
Publisher’s Higher fixed costs as Publishers can sell direct to
own sales salary costs have to be the larger shops in large
force paid but faster turnover towns
of inventory follows if
sales turnover increases
Direct Higher fixed and Higher contribution and
marketing variable costs but, if reduced Working Capital
successful, this is amply levels. Higher Break-even
compensated by the point
absence of a discount to
distributors of retailers

Possible Solutions

In financial terms there are three main choices:

• To raise more finance in order to be able to take a longer term


view of publishing
• To develop innovative solutions involving the use of Working
Capital to make books more affordable to more people and
hence expand the market. This has to be linked to a marketing
campaign carried out jointly with distributors, bookshops and
other sales agents.
• To change publishing policy and publish for different more
attractive markets; develop teamwork with partners who have
common needs

It is interesting to note that many publishers in young economies have


chosen to diversify into trade book, often in colour and with long print
runs, in order to pay for overheads. As the table above shows, trade
publishing, based on the developed country model, usually has the
highest level of Working Capital.

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