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MINISTRY OF FINANCE ACADEMY OF FINANCE -------------------- NGUYEN THI PHUONG THAO CQ54/11.13 GRADUATION THESIS TOPIC: WORKING CAPITAL MANNAGEMENT AT DONG PHONG AUTO LIMITED COMPANY Major : Corporate Finance Code : 11 Supervisor : Dr. Tran Thanh Thu Ha Noi – 2020
Graduation thesis Academy Of Finance DECLARATION I hereby declare that this graduation thesis is my own research, and it was composed by myself. The data and results used in this thesis accurately come from the actual situation of the internship company. I also certify that this thesis has not been submitted to any other organization thus it is the only published version submitted to the thesis’s reviewers. Signature of Author Nguyen Thi Phuong Thao Student: Nguyen Thi Phuong Thao i CQ54/11.13
Graduation thesis Academy Of Finance ACKNOWLEDGEMENT Although I tried my best, my limited level of background knowledge and time does not allow my thesis to be perfect . Sincerely, I want to receive valuable comments from my advisors and the company’s personnel so that it will be successfully completed. I would like to express my great gratitude to all of my teachers, my colleagues, my family and Academy of Finance who all make way for my thesis. Firstly, I want to pay my respect to my supervisor, PhD. Tran Thanh Thu, a lecturer of Academy of Finance. Without her considerate instructions and immeasurably valuable advice, I am not able to finish my graduation thesis. Secondly, I wish to show my gratitude to all my teachers at Academy of Finance, who have provide me with worthy lessons throughout 4 years of study. Moreover, I want to give thank to the personnel of the Department of Finance at Dong Phong Auto Ltd for their valuable support during the internship period. It would be impossible for me to finish this work without their help. Last but not least, I would like to send my deep thank to my parents, my family who generously inspire me with great love and care so that I can complete this thesis. Student: Nguyen Thi Phuong Thao ii CQ54/11.13
Graduation thesis Academy Of Finance Table of Contents DECLARATION............................................................................................................................... i ACKNOWLEDGEMENT.......................................................................................................................ii LIST OF ACRONYMS...................................................................................................................v LIST OF TABLES..........................................................................................................................vi LIST OF CHARTS........................................................................................................................ vii PREFACE........................................................................................................................................8 CHAPTER 1..................................................................................................................................10 OVERVIEW OF WORKING CAPITAL AND WORKING CAPITAL MANAGEMENT....10 1.1 Overview of Working Capital and working capital financing.......................................10 1.1.1 Definition and characteristics of working capital.......................................................10 1.3.2. Objective factors...................................................................................................................31 1. Business cycle : Business cycle means the alternate expansion and contraction in general business activity . The business cycle can be quick or slow depends on the section the firm takes part in . There is a ratio called sector average ratios used to compare with the ratio of the firm to evaluate the level of efficient working capital management............................................................31 CHAPTER 2.......................................................................................................................................33 WORKING CAPITAL MANAGEMENT of DONG PHONG AUTO LIMITED COMPANY..........................33 2.1. Overview of Dong Phong Auto Limited Company:...................................................................33 2.1.1. The establishment and history of Dong Phong Auto LTD......................................................33 2.2.4. Cash management.................................................................................................................56 2.2.4. Accounts Receivable management..................................................................................59 2.2.5. Efficiency and Effectiveness of Working Capital management.................................64 Table 2.13: Indicators to evaluate working capital management of Dong Phong LTD...........64 2.3. Assessment of working capital management of Dong Phong Auto LTD..............................65 2.3.1. The achievements............................................................................................................65 2.3.2. The short-comings and reasons.......................................................................................65 CHAPTER 3.......................................................................................................................................67 SOLUTION TO IMPROVE WORKING CAPITAL MANAGEMENT OF DONG PHONG AUTO LIMITED COMPANY....................................................................................................................................... 67 Student: Nguyen Thi Phuong Thao iii CQ54/11.13
Graduation thesis Academy Of Finance 3.1. Economic context and targeted development of Dong Phong Auto LTD............................67 3.1.1. Economic context of Vietnam in 2019.............................................................................67 3.1.2. Objectives and targeted development of Dong Phong Auto LTD....................................68 3.2. Solutions to improve Dong Phong Auto LTD’s working capital management......................69 3.2.1. Solution for inventories management:.........................................................................69 3.2.2. Enhancing the receivables and payables management...................................................70 3.2.3. Solution for cash and cash equivalent management.......................................................72 3.3. Conditions to implement solutions:....................................................................................73 3.3.1 For the Government...............................................................................................................73 3.3.2. For the Dong Phong Auto Limited Company.........................................................................74 CONCLUSION..............................................................................................................................75 Student: Nguyen Thi Phuong Thao iv CQ54/11.13
Graduation thesis Academy Of Finance PREFACE 1. Introduction Capital is considered one of the most important elements of any company. Business capital is the certain amount of monetary capital in line with the size and condition of business activities. Business capital is important because every enterprise must have the basic elements such as assets, technology, and labor force to carry out businesses. A financial manager is responsible for short-term and long-term financial decisions. Much of this material is devoted to long-term financial decisions such as capital budgeting and the choice of capital structure. Short-term financial decisions generally involve in short-lived assets and liabilities, and usually they are easily reversed. In a sense, short-term decisions are easier than long-term decisions—but they are not less important. A firm can identify extremely valuable capital investment opportunities, find the precise optimal debt ratio, follow the perfect dividend policy, and no one other than the founder is the one who bothers to raise the cash to pay this year’s bills. Hence the need for short-term planning. Short-term, or current, assets and liabilities are collectively known as working capital. Being aware of the importance of working capital in operations of a company, together with a desire of remommending solutions to improve working capital management of Dong Phong Auto LTD., I decided to choose the topic “Working capital management – A case study of Dong Phong Auto LTD.” for my graduation thesis. 2. The objectives of the study The thesis has 3 main objectives, including: To generalize the theory of working capital and working capital management; Student: Nguyen Thi Phuong Thao 8 CQ54/11.13
Graduation thesis Academy Of Finance To examine the situation of working capital management of Dong Phong Auto LTD; indicating the achievements and drawbacks of WC management of Dong Phong Auto LTD; To propose some solutions to improve working capital management of Dong Phong Auto LTD 3. The scope of the study Subject of the study: Working Capital management of a company Space: The study was conducted at Dong Phong Auto LTD Time period: From 2017 to 2019 4. Data & Methodology Data: Both primary data and secondary data were used in this study. Primary data were collected during the internship at Finance Department of Dong Phong Auto LTD. Secondary data were extracted from financial statements and other official sources of information. Methodology: Research method: Based on collected data, start processing and analyze according to the purpose and requirements of the topic. Comparison method: Based on processed data to make comparisons between years, thereby assessing the achieved and unsatisfactory results. At the same time, do comparison with peer firms to make conclusions. 5. The structure of thesis Besides the Contents, Introductions, Conclusion and References, the thesis includes 3 main chapters as follows: Chapter 1: Overview of working capital and working capital management Chapter 2: Working capital management of Dong Phong Auto LTD. Chapter 3: Solutions to improve working capital management of Dong Phong Auto LTD. Student: Nguyen Thi Phuong Thao 9 CQ54/11.13
Graduation thesis Academy Of Finance CHAPTER 1 OVERVIEW OF WORKING CAPITAL AND WORKING CAPITAL MANAGEMENT 1.1 Overview of Working Capital and working capital financing 1.1.1 Definition and characteristics of working capital 1.1.1.1. Definition of working capital Nowadays, to survive and prosper, a company must satisfy its customers. It must also produce and sell products and services for a profit. So as to produce, it needs assets such as plant, equipment, offices, computers, technology, and so on. Some businesses will look to be ‘non-profit’ and aim to reinvest any profit made back into the company or even donated to a good cause. Some businesses will have a huge focus on customer services and make the customer the center of everything they do. There are a lot of things that can become the foundation of a business, and all are valid. Thus, capital is essential to run business activities. To carry out business activities, apart from fixed assets, enterprises need current assets. Current assets could be used in production or in circulation. Current assets in production include raw materials, work-in-progress, half- finished goods. Current assets in circulation include finished goods in stock, receivables, and cash. In the business process, current assets for production and current assets for circulation always move, convert, replace each other, ensure the business running smoothly, continuously. To acquire current assets, enterprises must pay in advance a certain amount of money to purchase those assets. That amount of money is called working capital of a company. Thus, it can be said that “working capital is the total amount of money paid in advance by a company to invest in current assets needed for production and business activities”. Student: Nguyen Thi Phuong Thao 10 CQ54/11.13
Graduation thesis Academy Of Finance Hence, Gross WC = Total current assets The above definition is called gross definition, which defines working capital as the monetary form of total current assets. Financial perspective considers not only the value expression of current assets but also how to finance these assets. That is, net working capital (NWC), which is the difference between current assets and current liabilities. Hence, net working capital is considered as the minimum amount of money that a company needs to maintain smooth and continuous operations. 1.1.1.2. Characteristics of Working Capital Working Capital is used entirely in the business production process. There are four key dates in the production cycle that influence the firm’s investment in working capital. The firm starts the cycle by purchasing raw materials, but it does not pay for them immediately. This delay is the accounts payable period. The firm processes the raw material and then sells the finished goods. The delay between the initial investment in inventories and the sale date is the inventory period. After the firm has sold the goods, its customers pay their bills. The delay between the date of sale and the date at which the firm is paid is the accounts receivable period. The figure below shows this production cycle. FIGURE 1.1. Simple cycle of operations Student: Nguyen Thi Phuong Thao 11 CQ54/11.13
Graduation thesis Academy Of Finance In the business process, the features of Working Capital are as follow: Firstly, the expression form of working capital is always changing through stages of production and business process. Especially for manufacturing enterprises, working capital changes from the form of monetary capital initially to materials reserved in production, then to semi- finished products, finished products and finally, when the product consumption process ends, it returns to its original form, which is capital in money. Secondly, at the end of the operating cycle, working capital value is fully transferred into value of goods and services; and being recovered completely when a company collects sales. Thirdly, the working capital cycle completes after a business operating cycle. The transformation and movement process of working capital takes place regularly, continuously and repeatedly after each business cycle, creates a circulating cycle of working capital. 1.1.2. Classification of Working Capital Working capital can be classified in the ways that fit different purpose of management. 1.1.2.1. By roles in operating cycle. Based on the role of working capital in operating cycle, wc is divided into three stages: Reserve, production, and circulation. Working capital reserve for production (raw materials, sub materials). Working capital in the production (including semi-finished products, unfinished, the upfront cost of capital). Working capital in circulation (including finished products, cash and cash equivalent). This classification shows the role of each type of working capital in the business process. Hence, it helps managers choose the relevant investment strategy. Student: Nguyen Thi Phuong Thao 12 CQ54/11.13
Graduation thesis Academy Of Finance FIGURE 1.2: Classified WC by roles in operating cycle This way of categorizing shows the roles of each type of Working Capital in production process. Hence, the manager can choose the suitable structure of Working Capital, ensure the balance of the production capacity among the stages in the production process of the enterprise. 1.1.2.2. By the forms of Working Capital. Based on the role of working capital in operating cycle, wc is divided into three stages:Inventory, cash and receivable . Working capital in inventory such as: raw materials, work-in-progress, semi-finished products and finished products. Working Capital in cash and receivables includes cash, bank deposits, customer’s receivables, etc. This classifications help for business reviews is the level of inventory reserves, solvency, liquidity of the assets invested in the business. Student: Nguyen Thi Phuong Thao 13 CQ54/11.13
Graduation thesis Academy Of Finance FIGURE 1.3: Classified by its forms This alternative can help the managers examine, control, and evaluate inventory reserve and solvency of an enterprise. It also helps determine the needs for Working Capital. 1.1.3. Working capital financing. To manage working capital efficiently, enterprises need to understand the sources of working capital. Working capital can be funded by a mixture of short- and long-term financing sources. - Permanent financing source for working capital. - Working capital can be financed by permanent sources, which is the total sum of long-term debts and shareholder’s equity. Permanent financing sources creates financial safety for enterprises, allow enterprises to actively meet the needs of investments, ensure production and business processes are conducted regularly and continuously. - Permanent funds for working capital = Total permanent financing sources – Non-current assets. - Different bussineses have different amount tied up in permanent financing sources for working capital. Each enterprise needs to have suitable working capital management strategies in line with business characteristics to ensure the sufficient amount of permanent finance for working capital. Student: Nguyen Thi Phuong Thao 14 CQ54/11.13
Graduation thesis Academy Of Finance - Temporary financing source working capital: During an operating cycle, a firm may need more or less working capital as usual due to the fluctuation of the needs of working capital. For instance, a firm in seasonal or cyclical industry needs more capital during the peak time. Generally, to meet the needs for unexpected working capital, a firm uses temporary financing sources, which includes short-term loans and debts, payables (to suppliers, employees, state, and customers). 1.1. Working Capital management 1.2.1 Definition and objectives of Working Capital management 1.2.1.1. Definition of working capital management Working Capital management is defined as managing cash, inventory, and accounts receivables in order to keep the reproduction progress permanent and uninterrupted. Working Capital management is a set of polices focusing on maintaining efficient levels of both components of Working Capital, current assets, and current liabilities. Working Capital management ensures a company has sufficient cash flow in order to meet its short-term debt obligations and operating expenses. Working capital management can improve a company's earnings and profitability through efficient use of its resources. Management of working capital made the decision about inventory management as well as management of accounts receivables and accounts payables. The objectives of working capital management, in addition to ensuring that the company has enough cash to cover its expenses and debt, are minimizing the cost of money spent on working capital, and maximizing the return on asset investments. 1.2.1.2.Objectives of Working Capital management The goal of Working Capital management is to manage a firm’s current assets and current liabilities in such a way that a satisfactory level of Working Student: Nguyen Thi Phuong Thao 15 CQ54/11.13
Graduation thesis Academy Of Finance Capital is maintained. Each company has their own way to manage Working Capital efficiently but they must achieve the following specific goals: - To maintain the smooth and continous operations for a company; - To enhance operating performance of a company, to improve profitability, and eventually to contribute to the final goal of corporate finance, maximize shareholders’ wealth; ensure To en sure the company has sufficient amount of working assets to cover short-term obligations. 1.2.2 The contents of Working Capital management 1.2.2.1 Determining the needs for Working Capital and Working capital financing: a. Determing the needs for working capital The needs for working capital is is the minimum amount of working capital required to maintain normal course of production and business activities of a company. This amount of money ensure the smooth and continous operations of a company under the assumption of on-going concern. A company can use different approaches to determine the needs for WC. Following is some popular approaches. - The direct approach: *The needs for Working Capital is defined as : NeedsforWC=Estimated Inventory+Estimatedreceivavble−Estimated Payable In which: + Inventory is the minimum necessary capital to reserve raw materials, unfinished products, semi-finished products and finished products. Estimated Inventory = The Average consumption level of each type a day x The number of stock days of each type inventory Student: Nguyen Thi Phuong Thao 16 CQ54/11.13
Graduation thesis Academy Of Finance + Accounts receivable is a legally enforceable claim for payment held by a business for goods supplied and/ or services rendered that customers/ clients have ordered but not paid for. Estimated Accounts Receivable = The Average revenue per day in the period x The Average collection period + Accounts payable is the aggregate amount of an enterprise’s short-term obligations to pay suppliers for products and services which the entity purchased on credit. Estimated Payable = The Average purchase turnover in the planning period x The Average payment period * Remark: +Advantage: reflect WC needs of each component of Working Capital required for business so that it is relatively close to the WC demand of the firms +Disadvantage: complex calculation and time-consuming to determine WC needs. - The indirect approach: This method is based on the analysis of the actual situation of Working Capital use in the reporting year. The changes in business size and rotation speed of Working Capital in the planning year, or the fluctuation of Working Capital needs according to the actual sales in the previous year in order to determine Working Capital demand in the following year .We have the formula: The method adjust the percentage of WC needs compared to the reporting year : V M KH=¿V KH (1+t %)¿ BC x M BC Student: Nguyen Thi Phuong Thao 17 CQ54/11.13
Graduation thesis Academy Of Finance Where: : Working Capital of the planning year : Average Working Capital in the reporting year : Working Capital rotation level in the planning year : Working Capital rotation level in the reporting year : the rate of shortening rotation period of Working Capital in planning year ( rotation period of Working Capital in planning and reporting years ) The method based on the total capital turnover and the rotation speed of the planning year : M V = KH KH L KH In that: : Working Capital of the planning year : Working Capital of the reporting year : the number of Working Capital cycles in the planning year The method base on percentage of revenue: This method bases on the fluctuation of percentage on revenue of elements forming company’s Working Capital in the reporting year to determine Working Capital needs following revenue of planned year. b. Working capital financing management Working Capital is one of the most necessary elements for business smooth operation, so that, every company has to establish clear and reasonable policies relating to each parts. The policies can be classified into the following 3 types; Student: Nguyen Thi Phuong Thao 18 CQ54/11.13
Graduation thesis Academy Of Finance (*) Relaxed policy In this model, each of the assets would be financed by a debt instrument of almost the same maturity. PWC is financed by long-term financing sources and TWC is financed by short-term financing sources. This policy refers to a flexible one that involves in maintaining a large amount of cash, holding a high level of inventory and allowing a generous customer credit terms for a given amount of sale. - Advantages: + Reduce risk in payment + Reduce cost of capital +Working Capital is balanced between the amount of money invested and demand - Disadvantages: + The greater investments in Working Capital can reduce the risk but it also can lead to lower profitability + It has not yet made flexible in using capital and may be risky if demand of Working Capital is not determined reasonably (*) Aggressive policy In this model, fixed assets and a part of PWC are financed by long-term financing sources and the remaining of PWC and the entire TWC are financed by short-term financing sources. This model is associated with low cash, inventory levels and restrictive credit terms for a given amount of sale. With less investment in inventory, reduce money tied up in Working Capital in other word, it may help increase profitability. - Advantage : + Reduce the cost of capital + If the business cycle move smoothly , it is called the most effective Working Capital management Student: Nguyen Thi Phuong Thao 19 CQ54/11.13
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