WORKING CAPITAL SIMULATION: MANAGING GROWTH
There are five principals of capital investment that one uses in making decisions of how to invest in the growth and cash flow of a business. These principals are Post tax analysis, Timing of, when to inject cash flows, Cash flows dependent on opportunity cost, Cash flows control the results and not accounting revenue, and Projects’ return rate mirrors funding cost.
These are the principals I used as I went about the working capital simulation task and in making decisions. In the first phase which was from 2013-2015, I choose to acquire a new customer who was Atlantic Wellness. This led to the increase in sales during that period but resulted in higher accounts receivable, and inventory balances. I made this decision because bringing in a new customer would add to the cash flow of the business and as this is a key principal of capital investment.
The second decision made was to leverage supplier discount. This translated into meaningful top-line growth, which increased accounts receivable and inventory balances. However the drain on cash flow is partially offset by increased EBIT due to the favourable contract negotiated with Ayurveda Naturals. I made this decision since the contract meant that the supplier would offer a discount.
The third decision in the first phase was to drop poorly selling products which did not go down well.Dropping of the customers had a negative impact on sales volume while on the other hand, the amount of money tied-up in theaccount increased significantly. This decision is arrived at by realising that more cash flow is needed and having customers who were not paying within the stipulated time ended up denying the company that much needed cash flow.
During the first phase, annual cash flow, and cumulative free cash increased while there was a shortfall in the surplus cash flow. By the conclusion of this segment, the overall value created was -$56. In the second phase which was from 2016-2017, there were three options of which I accepted 2 and declined 1. The offers that I accepted were expanding online presence since this would translate to higher earnings for the company. This develops a private-level product which would increase sales significantly. All this led to increasing the cash flow of the company. Here are issues related with limited financingas discussed below.
According to Kerr and Nanda in their working paper titled Financial Constraints and Entrepreneurship, the two discuss the issues under two broad topics which are Financial Market Development and Entrepreneurship, and Personal Wealth and Entrepreneurship.
1. Financial Market Development and Entrepreneurship
Under this topic, they identify a few issues, namely, financial market depth and competition between financial intermediaries.
a. Financial Market Depth
They begin by arguing that the depth of the local market is a starting point to measuring financial market depth and funding capital-intensive businesses. The easiness of receiving a credit from a financial intermediary by an entrepreneur also goes a long way in showing the financial market depth. In an economy where many people are willing to save there will be enough money to be lent out to entrepreneurs to start their businesses. The most affected are start-ups whether is a developed or developing economy. This is because many banks fear that these start-ups may fail and thus they will not be able to recover the loans extended to them. Thus, the growth and depth of a financial market can play an important role in how a starting business can access money to fund its’ venture.
b. Competition Between Financial Intermediaries
Levine (1997) argues that the rivalry between lending institutions can affect how credit is allocated to entrepreneurs, and also determines the degree at which money is lent to those businesses with high quality ventures. Cole (2009) however, argues that this might be captive to political machinations especially in developing countries. Kerr and Nadin (2009) argue that the U.S branch deregulation enhanced competition between them and thus made it easier for entrepreneurs to lend money. The increase in the number of branches showed that competition for customers was getting high, and this gave the consumers greater choice of where to lend money. Entrepreneurs are given a level playing ground where they can pick the best terms. This would spur more to enter into start-ups due to the availability of investment capital
c. Organisation of Financial Intermediaries and their Association with Businesses
Financial lending companies are important in determining which ventures to fund and later they observe them to ensure that the money given is put into what it was intended for and that the start-up can repay the loan. When start-ups want to get a loan, the lending institutions must do a circumstantial check to know if the entrepreneur will be able to repay the loan. This can be difficult because most start-ups do not have the records, as opposed to already established institutions. Established institutions can be able to provide collateral, and their financial records which makes it easier to get loans for businesses. Financial intermediaries use the money to carry out these checks which means they use money, which they cannot transfer as interest. This can be overcome by improving the flow of information between businesses and the financial lenders. Entrepreneurs need to maintain a business understanding with banks so that when it comes to lending, the process will not be prolonged.
2. Personal Wealth and Entrepreneurship
This is the second broad issue that affects access to financing. This is where an individual’s financial might determines if they can start a business. It is general knowledge that those who opt for entrepreneurship, and not employment are better-off. Those who are better-off are also more likely to become entrepreneurs, as opposed to the ones who are not earning. Evans and Jovanovic (1989) are the ones who came up with this model of understanding the relation between entrepreneurship and individual prosperity. According to their model, those with a lot of personal wealth are more likely to face no credit constraints if they approach a financial institution for a loan. The reverse is correct for those who have no wealth since they end up having credit constraints when borrowing. Evans and Jovanovic (1989) model can be summarised into two sub-topics.
a. Endogenous Wealth Creation
According to this model, those individuals who are go-getters tend to have higher returns to their investments, as opposed to those who have an average or low ability to do business. Individuals who get inheritances from their families at an early age are likely to start up personal investments rather than go into full employment. This will mean that they will start earning at a younger age. These inheritances and donations can also boost one’s venture since they inject of more cash that is needed for the business.
b. Wealth Effects, Preferences and, Sorting
A persons’ drive can also determine their entry into a business venture. Rich people tend to be antipathetic towards taking risk and hence will go into any business since they do not fear the risk. One may also choose to be their own boss instead of getting employed and thus will go into individual entrepreneurship hence increasing their personal wealth. Affluent individuals are also able to use loopholes that will enable them to gain access to the needed means to do business with as opposed to those who are employed and are inhibited by their earnings.
Hamilton (2000) argues that people will prefer to be their own bosses due to various inclinations, and tastes. An individual may go into entrepreneurship since they see it as an easier way of them making money, as opposed to being employed which will constraint how much they earn. Financial institutions are also likely to give wealthier individuals loans, as opposed to those who are not wealthy. This is because wealthy individuals have an established financial background, as opposed to those who are just starting a business.
References
Cole S (2000), ‘Fixing Market Failures or Fixing Elections? Elections, Banks and Agricultural Lending in India’, American Economic Journals, Applied Economics.
Evans D. S and B. Jovanovic (1989), ‘An Estimated Model of Entrepreneurial Choice under Liquidity Constraints’, Journal of Political Economy 97.
Hamilton, B (2000), ‘Does Entrepreneurship Pay? An Empirical Analysis of the Returns of Self-employment’, Journal of Political Economy, 108.
Kerr W. and Nanda R. (2009), ‘Financing Constraints and Entrepreneurship’, Working Paper.
Levine R. (1997), ‘Financial Development and Economic Growth: Views and Agenda’, Journal of Economic Literature 35 (2)
