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Current asset management in the enterprise
The crisis of 2008 still affects business-to-business companies. Many of them have problems with current assets in general and with accounts receivable in particular. In a given paper a field research is conducted on the example of a telecommunication equipment producer. The goal of the research is to develop recommendations to improve the efficiency of current assets for the specific example of Russian business-to-business company.
The first part is devoted to theoretical background of current assets management and represents the findings of desk research conducted.
The second part represents field research or analysis of the company’s financial performance. There were used such methods as horizontal and vertical analysis of financial statements, methods, techniques and tools of mathematical statistics: collection and grouping of statistical data analysis and comparison of time series. In the practical part of the research there were used computational and analytical methods, the methods of structural and dynamic analysis, grouping and comparison of modeling techniques.
The third part is mainly devoted to recommendations on how to improve the management of current assets at the enterprise. In order to get a competent opinion an interview with a specialist concerning the research and recommendations was conducted.
Property of business entity consists of fixed and current assets, representing its actual assets, due to which the company carries out its economic activities and by which it has the ability to grow and expand. The state and effectiveness of fixed and current assets are one of the main conditions of success of the enterprise. The development of market relations in our country defines new terms of their organization. High competition, the need to quickly and effectively adapt to rapidly changing market conditions are forcing companies to change its policies toward working capital, search for additional reserves of their efficiency, increase turnover, forcing the company to optimize the structure and volume of current assets.
The problem of lack of current assets becomes the primary concern of financial services and enterprise management. Now it depends on them, how properly and efficiently current assets of the enterprise are organized, how effective are the methods used when working with suppliers, customers, how well planned and supported are reserves, controlled by the collection of receivables, and so on.
The aim of this work is to develop recommendations to improve the efficiency of working capital for the specific example of the Russian company.
To achieve the aim the following has been done:
Theoretical background of organization and management of current assets have been studied;
Various options of working capital formation and current assets financing have been explored;
Analysis of current assets management in the specific entity has been performed
Recommendations to improve the efficiency of working capital according to peculiarities of firm activity and its current assets condition have been developed.
Theoretical and methodological basis for the study consists of classical and contemporary works of Russian and foreign economists in the field of working capital management, legislation and regulatory materials.
Methodological basis of graduate research consists of methods of financial analysis: the horizontal and vertical analysis of financial statements, methods, techniques and tools of mathematical statistics: collection and grouping of statistical data analysis and comparison of time series. In the practical part of the research there were used computational and analytical methods, the methods of structural and dynamic analysis, grouping and comparison of modeling techniques.
Information base for research are data of financial and management reporting, information from periodicals, monographs and textbooks of domestic and foreign experts in the field of financial management.
SPETSSTROY-SVYAZ is the leading company of the Taganrog-based Proton-SSS Science Production Enterprise Holding, Russia's largest developer and producer of digital telecommunication equipment. The company was founded in the city of Taganrog on October 1, 1996, and has been the exclusive exporter of the Proton-SSS telecommunication platform for more than 14 years.
The main product of the company is a telecommunication platform Proton-SSS. The telecommunication platform Proton-SSS is self-developed hardware-software complex with using electronic components that are produced by the leaders of telecommunication and computer market.
Like all business-to-business companies, SPETSSTROY-SVYAZ faces problems concerning accounts receivable. The findings obtained in the course of the research provide evidence that in order to increase its liquidity SPETSSTROY-SVYAZ should implement the components associated with cash and accounts receivable to the management system of its current assets.
Chapter 1. Theoretical background of current assets organization and management
Current assets are assets that serve the process of current economic activity, while participating in the production process and in the process of product selling. The main purpose of current assets is in ensuring the continuity and rhythm of the production and turnover.
The economic essence of current assets is determined by their role in ensuring the continuity of the reproduction process, during which current assets pass through all stages of production and turnover, changing its form and completely transferring its value to the goods produced.
In literature, along with the term "current assets" it is also used the term "working capital". It is believed that under the working capital it should be understood the monetary value of current assets, current assets themselves have a natural form of expression1. Within this framework, it is considered possible to ignore this distinction, because it there will be discussed assets in kind and their value, and both terms will be used in the paper without regard to this distinction. Under the working capital within this work will be understood cash advances for working capital, they refer to the liabilities of the balance sheet and are a source of financing of current assets.
Current assets perform a continuous circulation in the process of current economic activities of an enterprise. By functions, i.e. by their role in the process of production and turnover current assets are divided to current operating funds and funds of turnover. Current operating funds service the sphere of production, they materialize in the objects of work (raw materials, etc.) and partly in the means of work (inventory of little value, etc.), goods in progress, semi-finished products of own manufacture. Circulating productive assets also include prepaid expenses of non-natural forms, such as reserves for future production of goods.
Another element of working capital, turnover funds are not directly involved in the production process. Their purpose is to provide the resources of the reproduction process and to maintenance circulation of funds. Funds of turnover include finished goods and cash.
Circuit of funds of enterprises begin with advance payments in cash for the purchase of raw materials, fuel and other means of production - the first stage of circulation. As a result, the money takes the form of industrial stocks, expressing the transition from the sphere of circulation in the sphere of production. The cost is not spent, and is advanced, as after the completion of circulation, it is returned. The second stage of the circulation occurs during the manufacturing process, where labor is productive consumption provides the means of production, creating a new product that carries a deferred and re-created value. The advanced value again changes its form - from the productive, it becomes the commodity. The third stage is to implement the circulation produced finished goods (services) and cash is received. At this stage, working capital once again passes from the sphere of production into the sphere of circulation. Interrupted commodity circulation is resumed, and the cost of the commodity-form moves into the money. The difference between the amount of money spent on the production and sale of goods (works, services), and received from the sale of manufactured goods (works, services), is the accumulation of cash businesses.
Thus, current assets are advances in the form of money for the systematic formation and use of production assets and current operational funds and funds of turnover in the minimum required amount to ensure the implementation by an enterprise of the production program and the timeliness of payments. Since current assets include both tangible and monetary resources on their organization and efficiency depends not only on the process of material production but also the financial stability of the enterprise.
By the nature of the financial sources current assets are divided for gross, net and own ones.
Gross current assets characterize their overall volume formed from both own and borrowed capital.
Net current assets (or net working capital) characterize the portion of their volume, which is formed due to own and long-term debt capital.
Amount of net current assets (net working capital) is calculated as follows:
NWC = CA – CL, (1.1.1)
where NWC - net working capital, CA – total current assets, CL – current liabilities.
Own current assets that characterize their part, which is formed with equity capital of the enterprise.
Amount of own current assets of the business is calculated by the formula:
OCA=CA – LD – CL, (1.1.2)
where OCA – own current assets, CA – total current assets, LD – long-term debt, CL – current liabilities.
Consider now types of current assets. On this basis they are classified in the practice of financial management as follows:
Inventories of raw materials and intermediate products. This type circulating assets characterizes the volume of input material flows in the form of stocks, providing productive activities of the enterprise.
Stocks of finished products. This form of circulating assets is usually added to the volume of work in progress (with an assessment of the coefficient of its completeness for particular products in general).
Often in the literature on financial management stocks of raw materials and finished product inventories are combined into a group of "inventories". Effective inventory management makes it possible to reduce the duration of the production and the entire operating cycle, reduce the level of current costs of storage, reduce transaction costs for their purchase, free from the current economic turnover part of funds, reinvesting them in other assets.
In the process of inventory control there should be already included measures to accelerate their integration into direct operational process (manufacture or sale). This ensures release of part of financial resources, as well as reduction of the size of losses of inventory in the process of their store.
Current receivables. Under the current accounts receivable are understood debts of businesses and individuals of certain amounts of cash and cash equivalents to an enterprise, which occurs during the normal operating cycle or provided to maturity in a period of one year. It characterizes the amount of debt in favor of the company, estimated for the goods, works, services, issued advances, etc.
The largest volume of current receivables of enterprises falls on receivables for goods, works and services. Effective management of current accounts receivable is connected first of all with the optimization of size and provision of customers debt collection for goods and services.
Cash assets and their equivalents. These include not only cash balances in national currency (in all its forms) but also short-term highly liquid investments, freely convertible into cash and characterized by insignificant risk of changes in value.
Management of cash assets or the balance of cash and cash equivalents, being constantly at the disposal of an enterprise, is an integral part of the functions of general management of current assets. The size of the balance cash assets, which the company operates in the process of economic activity determines the level of its absolute ability to pay (readiness to pay the company immediately to all its immediate financial obligations), affects the amount of capital invested in current assets, as well as characterizes to a certain extent its investment opportunities (enterprise’s investment potential of short-term financial investments).
The main purpose of financial management in the management of cash assets is to ensure permanent solvency.
Along with this main goal an important task of financial management in the management of cash assets is to ensure the effective use of temporarily free funds, as well as to form their investment balance.
Operational (or transactional) cash balance of assets is formed to provide current payments related to operating activities of an enterprise: the purchase of raw materials and semi-manufactures; earnings; taxes; payment to third-party organizations, etc. This type of cash balance is the core part of the total cash assets of an enterprise.
Insurance (or reserve) cash balance of assets is formed for insurance against the risk of delayed receipt of funds from operations due to worsening market conditions for finished products, slow payments and to other reasons. The necessity of forming this kind of balance is due to the requirements of maintaining a constant solvency. Investment (or speculative) cash balance of assets is formed to carry out effective short-term financial investments in the favorable situation in selected segments of money market.
Requirements to ensure continuing solvency of the enterprise determine the need for a high amount of cash assets, i.e. pursue the goal of maximizing their average balance in the financial capabilities of the enterprise. On the other hand, the cash assets of the company during their storage are vulnerable to loss of real value by inflation; in addition, cash assets lose their value over time, which determines the need to minimize their average balance. These conflicting requirements must be taken into account in the management of cash assets, which therefore becomes an optimization in nature.
By the nature of participation the operational process current assets are differentiated as follows:
Current assets, serving the production cycle of the company (they are a set of current assets of the enterprise in a form of stocks of raw materials and semi finished products, the volume of unfinished goods and finished goods inventories);
Current assets, serving the financial (money) business cycle (they are a collection of all inventory and the amount of current receivables net of payables).
By period of operation of current assets there are distinguished following types:
Constant part of current assets. It is a unwavering part of their size, which is not dependent on seasonal and other fluctuations of the company. In other words, it is regarded as irreducible minimum of liquid assets required for the implementation of enterprise operations.
Variable part of current assets. It represents a varying portion, which is associated with the seasonal increase in production volume and sales. As part of this kind of current assets there are usually distinguished maximum and average parts of them.
Thus, the current assets of the enterprise are assets that characterize set of property assets of the enterprise, serving the current industrial and commercial activity, the value of which is determined by its scale and the nature and depends on the duration and specifics of production and sales cycle, the state of the fixed assets of the enterprise, its relationship with contractors.
A qualitative analysis of internal and external factors affecting the value and condition of the working capital allows to timely detect hidden reserves in the management process of working capital, to take measures on their use and, finally, to detail through the budgeting process the impact of each factor in a specific financial performance .
Management of financing of current assets of an enterprise is subordinated to the goals of the necessary requirements for their respective financial resources and optimization of sources of formation structure of these resources. With this goal financial management of current assets of the enterprise is based.
Movement of current assets during cycle goes through four basic stages consistently changing its forms.
Management of current assets of an enterprise is due to the specific design of its operating cycle. Operating cycle is a period of total turnover of entire amount of current assets in which there is a change of their individual species. He characterizes the period between the acquisition of inventory and receiving cash from sales generated from these products.
The most important characteristic of an operational cycle, significantly influencing the volume, structure and utilization of current assets is its duration. It includes the period time from the moment of spending money to purchase input inventories of assets to the receipt of money from the debtors for products sold to them.
Duration of operating cycle is calculated as follows:
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