Working Capital Policy of Listed Companies

16 Pages   |   2,719 Words

Working Capital Policy of Listed Companies
Airline Industry Perspective

Table of Contents

Executive summary. 3
Introduction. 4
Factors affecting the working capital requirement 5
Nature and Industry of the business. 5
Scale of operations. 6
Operating Efficiency. 6
Cash Conversion. 7
Business Cycle. 8
Tax and Dividend policies. 8
Working capital estimation approaches. 9
Conclusion. 10
Works Cited. 12
Appendix. 12
Appendix 1. 12
Appendix 2. 12
Appendix 3. 12
Appendix 4. 12

Executive summary

The working capital level maintained by a company plays a very important role in the daily operations of the company.  The report speaks about the factors that affect the policy of the company while taking the decision about the level of working capital to be maintained. Some of the key determinants are business cycle, operating cycle, cash conversion cycle, the dividend and the tax policies, etc. The paper then talks about the working capital level maintained by Easy Jet, a company listed in FTSE 250 and compare it with another company namely British Airways operating in the same industry. The paper analyses the working capital maintained by two of the companies and the reasons for maintaining that level. The policy and the approach adopted by the two companies for their working capital requirements have also been discussed.

Introduction

Working Capital can be defined as the liquidity that is available to the firm to meet the short term planned and unplanned expenses. A positive working capital signifies a good health of the company. It can be obtained by deducting current liabilities from the current assets. The current assets in this case include only those items which can be readily converted into cash.
A positive number implies that the company has sufficient current or cash assets to meet its short term liabilities. If the number so obtained is a negative number then it is known as the working capital deficit. Then the company could land in to trouble while paying its creditors. The negative number could be a result of the company’s less efficient cash management policy, a liberal credit policy, poor inventory management, poor debtors’ management, etc.
 

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Working capital could also be termed as the capital required covering the daily business expenses. In practical terms this is obtained from long term loans, the net income, the long term liabilities, sale of assets and the capital contributed by the promoters. But all these sources have different interest structures applicable to them, so the company while choosing the source for working capital must keep in mind the interest rate applicable to that particular source. There are many such things that the company has to keep in mind while deciding on the working capital needs of the organization.
The company chosen for analyzing the estimation of working capital in the practical life is Easy Jet. Easy Jet is an airways company which has its headquarters located at London. The slogan that the company has is “Come On, Let’s fly”. They work on the concept of no frills and low fares and provide point to point services to the frequent flyers (Easy Jet, n.d.). The other company from London Stock Exchange that was selected for comparative analysis is British Airways. British Airways is the major competitor of Easy Jet in the industry (British Airways, 2011).

Factors affecting the working capital requirement

Generally the factors affecting the working capital policy of the company is the nature of the business, industry in which it operates, scale of operations, business cycle, operating efficiency, profit margin, business cycle, operating cycle, tax and dividend policies, Govt. regulations, the rolling time for cash etc (Doshi, 2009).

Nature and Industry of the business

The working capital requirements depend largely on the nature of the business of the concerned company. Like for a company operating in trading and services area, the working capital requirement may not be very high, but for the manufacturing concerns the working capital requirement is fairly high. As they have to invest in raw materials, inventories, labor etc., the working capital required to meet the daily expenses would be fairly high. The utilities and the engineering companies require the highest average working capital while the telecommunications need the lowest (Stuttgart and Munich, 2009).
As Easy Jet is operating in airlines industry, the working capital that they need to maintain is very high to keep the daily business flow smoothly. The net working capital of the company reported a figure of £420 million in 2009 but improved to £450.3 million in the year 2010. (Kennedy, n.d.)  The fellow company British Airways reported a negative working capital of £1031 million in the year 2009, which speaks highly of the aggressive working capital policy that Easy Jet is following. (British Airways, 2008-2009)

Scale of operations

The scale of operations that the company has also plays an important part in determining the working capital needs of the company. The company with a larger scale of operations would always need a higher amount of working capital to support the needs.
The annual revenue as reported by Easy Jet in the year 2009 was £2666.8 million and in 2010, it was £2973.1 million (Easy Jey, n.d.). For British Airways the revenue reported in 2009 was £8992 million in 2009 and £7992 million in 2010. So, as explained in the table in appendix 1, the working capital margin kept by British Airways is also higher than the working capital margin kept by Easy Jet (British Airways, 2009) . But as the British Airways is reporting operating loss, the working capital is also a negative figure for the British Airways.

Operating Efficiency

The working capital requirement of a company also depends on the operating efficiency of the company. This can be observed from the operating profit margin of the company. Operating profit margin can be determined as the percentage of operating profit to the net sales. Higher the margin, more efficient is the operating process of the company, so lesser would be requirement of the working capital (Gill, Biger and Mathur, 2010).
In Easy Jet the operating profit margin of the company is 2.25% in 2009 and 5.84% in 2010, so we can say that the operating efficiency has improved in 2010 which was evidently the result of more and more utilization of the fleet that the company had (Easyjet Company Financial Information, n.d.). In the year 2010, the operating profit margin has improved substantially when compared with the rival company British Airways. The working capital management in Easy Jet has been very aggressive and up to the mark. They have utilized the available resources to the maximum to have the maximum possible advantage (Easy Jet, n.d.).

Cash Conversion

The cash conversion means the time that is required to convert the sales into real cash. This includes the receivables and debtors management. If the total sales are in cash then the working capital requirement would be very low. But this is usually not the case as the sales are in credit also. So the requirement of working capital is highly dependent on the time period allowed to the debtors of the company. The amount that is to be paid to the creditors of the company and the cycle also determines the requirement of the working capital. If the creditors allow a good time for payment of the purchases then the working capital requirement would be low and if the creditors are to be paid on a very regular basis, then the working capital requirement would be very high. This can be gauzed from the current ratio of the company which is obtained by dividing current assets by the current liabilities. Here the current assets include only the cash, receivables and the inventory and the current liabilities include the short-term debt and the payables (Zariyawati et al., 2010).
Current Ratio – Current Assets/ Current Liabilities
Quick Ratio- (Current Assets-inventories)/ Current Liabilities
For Easy Jet the current assets ratio is 1.42 as compared to 0.71 of British Airways. This implies that Easy Jet is playing safe in the working capital management when compared to the other players in the industry. They are maintaining £1.42 worth of current assets for £1 worth of current liabilities. (Easyjet Company Financial Information, n.d.) Also the quick ratio of Easy Jet is 0.93 when compared to 0.36 of the British Airways. This again suggests that the company has a higher liquid asset when compared to the rival company. (British Airways PLCBAY, 2011)

Business Cycle

There are some businesses in which the revenue generation is high in some months and low in some. The working capital policies also depend on the business cycle of the business. (Filbeck and Krueger, 2010)
Due to the dynamic nature of the underlying business, the company Easy Jet has to maintain a very high liquidity position to meet the requirements. The company is operating in an industry which is highly seasonal in nature. This could be the sole reason for Easy Jet for maintaining a very high current ratio. Also, Easy Jet is operating as a low cost carrier, so they need to maintain even higher working Capital.
British Airways is also operating in the same industry but they have not been maintaining that high level of current ratio, as they operate as a premier air line and the fares are higher than the fares of Easy Jet. So, even after high level of operations, the current ratio is low for British Airways.

Tax and Dividend policies

The tax and dividend policy that is relevant for a firm also plays an important role in determining the working capital needs of the firm. If the firm falls in the high tax paying zone then the company would have less portion of revenues available to them and would have to maintain more amount as working capital. Similarly if the firm has a high dividend payout policy, then the company would be left with fewer amounts from the retained earnings. So, again the working capital requirement is high. This would be similar for all the firms operating in the same industry.
For easy Jet, they have not offered any dividends to their shareholders in the year 2010 and in 2011, so the working capital that they have maintained has also improved in the year 2010. (Kennedy, n.d.)
For British Airways, they have also not offered any dividends to the shareholders in 2010 and also in 2011, nothing has been declared yet. (British Airways Company Financial Information, n.d.) Their working capital maintained has also improved in the financial year 2010.

Working capital estimation approaches

An aggressive working policy means that in expectation of high profitability, the capital is being minimized in the current assets. But in this case the liquidity risk is also very high. A conservative working capital approach means that the firm has high capital and on the liquid assets.
There could be several ways in which the company could decide the working capital policy that it needs to follow. These approaches are
Conventional method, the traditional method of cash flow generation and the expenses are compared to determine the working capital needs but this method ignores the cost of capital and the time value of money techniques.
Next could be Operating cycle method which takes into account the time when the payments would accrue. This method also takes care of the time required to convert the inventories in the finished product while estimating the working capital need of the company.
Another approach could be cash cost technique where the income statement is kept as a guideline for determining the capital needed for the daily operations.
 Last approach is the balance sheet technique where the balance sheet current assets and liabilities are taken as a guide for estimating the working capital requirements.
For Easy Jet as, looking at the working capital it can be said that the company is following the balance sheet and the cash cost technique. They have a debtors’ collection period of 60.29 days which is pretty high. (Easyjet Company Financial Information, n.d.). So they have to maintain a high working capital and are aggressive on their approach towards the working capital management.
For British Airways, the current ratio is lower than the current ratio of Easy Jet. The Debtors Collection period of British Airways is 36.21 days (British Airways Company Financial Information, n.d.) this is much lower than Easy Jet. Due to a better debtor management policy the current ratio maintained by the company is low. They are following a conservative approach to working capital management which means that they are high on capital in the current assets and low on receivables.
The two companies are following the balance sheet technique for the determination of the working capital. The calculation for the working capital for the two companies has been depicted in the appendix 4.

Conclusion

Every business needs cash to run the daily operations smoothly. This amount that is required for daily operations is known as working capital. There are various factors that affect the working capital needs of the company. They are nature of the business, cash conversion cycle, operating efficiency, profit margin, etc. These factors are the determinants of the working capital policy of the firm.
For Easy Jet, a low cost carrier, the profit margin would be very low. They would believe in the quantity. So the working capital that they need to maintain for keeping the quality of services up to date is very high. Moreover they have a higher debtors’ collection period, when compared with the creditors’ collection period.
Whereas for British Airways the debtors collection period is low and they have been maintaining a lower level of current assets when compared with the current liabilities of the company. Their profit margins are also higher when compared Easy Jet as they are the premier airlines in the country. So, the working capital level is low.
The above essay puts a light on the working capital policies that is required to be maintained in a firm. The approach for the working capital to be maintained is highly dependent on the industry in which it operates.

Works Cited

Annual report and accounts 2010, [Online], Available: http://2010annualreport.easyjet.com/files/pdf/Full_Report_easyJet_AR10.pdf [4 Nov 2011].
British Airways (2008-2009) Annual Reports and Accounts, [Online], Available: http://www.britishairways.com/cms/global/microsites/ba_reports0809/overview/cfo7.html [4 Nov 2011].
British Airways (2009) Annual Reports and Accounts, [Online], Available: http://www.britishairways.com/cms/global/microsites/ba_reports0809/overview/cfo7.html [4 Nov 2011].
British Airways (2011) British Airways PLCBAY, 4 Nov, [Online] [http://tools.morningstar.co.uk/uk/stockreport/default.aspx?tab=11&vw=fh&SecurityToken=0P00007O1N]3]0]E0WWE$$ALL&Id=0P00007O1N&ClientFund=0&CurrencyId=GBP].
British Airways Company Financial Information, [Online], Available: http://in.advfn.com/p.php?pid=financials&symbol=LSE%3ABAY [4 Nov 2011].
British Airways PLCBAY (2011), 4 Nov, [Online] [http://tools.morningstar.co.uk/uk/stockreport/default.aspx?tab=11&vw=fh&SecurityToken=0P00007O1N]3]0]E0WWE$$ALL&Id=0P00007O1N&ClientFund=0&CurrencyId=GBP].
Doshi, P.N. (2009) www. Caalley.com, 1 Dec, [Online], Available: http://www.caalley.com/art/WorkingCapitalManagement.pdf [4 Nov 2011].
Easy Jet Notes to Accounts, [Online], Available: http://2010annualreport.easyjet.com/files/pdf/NotestoAccounts_easyJet_AR10-3-8.pdf [4 Nov 2011].
Easy Jet www.easyjet.com, [Online], Available: http://www.easyjet.com/asp/en/book/index.asp?lang=en [4 Nov 2011].
Easy Jey Annual report and accounts 2010, [Online], Available: http://2010annualreport.easyjet.com/files/pdf/Full_Report_easyJet_AR10.pdf [4 Nov 2011].
Easyjet Company Financial Information, [Online], Available: http://in.advfn.com/p.php?pid=financials&symbol=LSE%3AEZJ [4 Nov 2011].
Filbeck, G. and Krueger, T.M. (2010) 'An Analysis of Working Capital Management Results Across Industries', American Journal of Business, vol. 20, no. 2, pp. 11-20.
Gill, A., Biger, N. and Mathur, N. (2010) 'The Relationship Between Working Capital Management And Profitability:Evidence From The United States', Business and Economics Journal, vol. 2010, Jul.
Kennedy, C. Financial Review, [Online], Available: http://2010annualreport.easyjet.com/financial-review.asp [4 Nov 2011].
Stuttgart and Munich (2009) Study on Working Capital Management, [Online], Available: http://www.rolandberger.com/media/press/releases/519-press_archive2009_sc_content/Study_on_working_capital_management.html [4 Nov 2011].
www.easyjet.com, [Online], Available: http://www.easyjet.com/asp/en/book/index.asp?lang=en [4 Nov 2011].
Zariyawati, M.A., Taufiq, H., Annuar, M.N. and A., S. (2010) 'Determinants of working capital management: Evidence from Malaysia', Financial Theory and Engineering (ICFTE), 2010 International conference , Dubai, 190-194.

Appendix

Appendix 1

Easy Jet    
In million £ 2009 2010
Revenue 2666.8 2973.1
Working Capital 420 450.3
     
British Airways    
In million £ 2009 2010
Revenue 8992 7992
Working Capital -1031 -1066
 

Appendix 2

Easy Jet    
In million £ 2009 2010
Revenue 2666.8 2973.1
Operating Profit 60.1 173.6
Operating Profit Margin 2.25 5.84
Working Capital 420 450.3
     
British Airways    
In million £ 2009 2010
Revenue 8992 7992
Operating Profit -231 -222
Operating Profit Margin -2.57 -2.78
Working Capital -1031 -1066
 

Appendix 3

  Easy Jet British Airways
Current ratio 1.42 0.71
Quick ratio 0.93 0.36
(Easyjet Company Financial Information, n.d.)
(British Airways, 2011)

Appendix 4

In million £    
  Easy Jet British Airways
Current Assets 1514.9 2674
Current Liabilities 1064.6 3740
Working capital for Easy Jet- 1514.9-1064.6=450.3 million £
Working Capital for British Airways- 2674-3740=1066 million £

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