_______________ Retail Paper by Jens-Peter Labus, December 1st, 2008
This paper looks at the theory and practise of Working Capital in the retail industry and finally seeks to answer the question presented above.
The Definition of Working Capital
There are several definitions of working capital. They all circle around the idea that working capital is the money bound or incurred on the ‘Money-Go-Round’ (Teji, 2006), thus making working capital a time-money equation. Definition 1: Cash available for day to day operations of a firm (Business Dictionary). Definition 2: Current assets minus current liabilities (Investorwords). An empirical study from Switzerland suggests that for a manufacturer, the level of working capital corresponds to a quarter of its revenues (Wagner, 2008). Prof. Dr. Wagner uses a more sophisticated definition based on the same principals laid out above. Retailers commonly do not have liquid assets, defined as assets which are traded in standard units at high volume, thus allowing an asset to be liquidated speedily. An example would be government bonds. The standard assets of retailers can be liquidified only at substantial losses; by selling off stock in a store closure, for example. A good part of available liquidity is usually locked-up in assets, such as:
Current assets, namely inventory and cash. Non-current or fixed assets, such as shelves, lorries, IT infrastructure, etc.
This locked-up money can be named working capital (Teji, 2006). The most widely accepted accounting definition of assets is the one used by the International Accounting Standards Board (IFRS). The IFRS Framework states: "An asset is a resource controlled by the enterprise as a result of past events and from which future economic benefits are expected to flow to the enterprise."
Negative Working Capital
Negative Working Capital in General By definition this occurs when current liabilities exceed current assets, which can lead to bankruptcy (financial terms). Here, working capital is diminishing or declining. Negative Working Capital in Retailing Tesco's head of treasury, Mr. Nick Mourant, has stated that retail is traditionally run with negative working capital (Treasurytoday, 2007). In the same article, Mr. Mourant states that Tesco has raised funds through a bond deal at a size of £1.2bn, locking away funding for some 42 years. This might serve as an example of the use of negative working capital for short term financing and the congruent financing of long term assets. Cash Flow In a classic definition, cash flow is the movement of money in and out of a business (LSE 2008). Such cash flow might encompass: Cash flow from operations: o Sales o Less cost Divestments/Selling an asset
Debentures/Loans Current assets + / Noncurrent (fixed) assets + / Collecting faster, even faster than zero days (e.g. by selling gift cards) Paying slower
The formula cash flow (cf) over assets would be a useful calculation for that purpose.
Calculating Working Capital
Store A: In this example the author imagines a retailer (running store A) that is able to turn its stock every 8 weeks (which is 6.5 times per year) while having negotiated paying its suppliers after 12 weeks. Being a retailer, no credit terms are offered to customers. Store B: In a comparative example, the assumptions are altered only slightly. In this case the competing retailer (running store B) turns its stock every 20 weeks (which is 2.5 times per year) while having negotiated payment terms of 8 weeks.
In terms of working capital, store B would need £3,326,923 more working capital than store A to fund essentially an identical operation (£10.000.000 sales at 5% net profit margin). If both stores had to compete in the same marketplace then the outcome would be quite clear. Store...