Page 23 - DCOM505_WORKING_CAPITAL_MANAGEMENT

Working Capital Management

Notes
Did u know? The suppliers of debt capital usually receive a contractually fixed annual
percentage return on their loan, and this is known as the coupon rate.
Think of interest expense as the cost of “renting” the capital to expand your business; it is often
known as the cost of capital. For many young businesses, debt can be the easiest way to expand
because it is relatively easy to access. The profits for the owners is the difference between the
return on capital and the cost of capital.

Example: If you borrow ` 1,00,000 and pay 10% interest yet earn 15% after taxes, the
profit of 5%, or ` 5,000, would not have existed without the debt capital infused into the business.

Specialty Capital

This is the gold standard. There are a few sources of capital that have almost no economic cost
and can take the limits off of growth. They include things such as a negative cash conversion
cycle (vendor financing), insurance float, etc.

Negative Cash Conversion Cycle (Vendor Financing)

Imagine you own a retail store. To expand your business, you need ` 1 crore in capital to open
a new location. Most of this is the result of needing to go out, buy your inventory, and stock your
shelves with merchandise. You wait and hope that one day customers come in and pay you. In
the meantime, you have capital (either debt or equity capital) tied up in the business in the form
of inventory.
Now, imagine if you could get your customers to pay you before you had to pay for your
merchandise. This would allow you to carry far more merchandise than your capitalization
structure would otherwise allow.
Typically, vendor financing can be measured in part by looking at the percentage of inventories
to accounts payable (the higher the percentage, the better), and analyzing the cash conversion
cycle; the more days “negative”, the better. Dell Computer was famous for its nearly two or
three week negative cash conversion cycle which allowed it to grow from a college dorm room
to the largest computer company in the world with little or no debt in less than a single generation.

Case Study Vendor Financing at AutoZone

utoZone Inc. is the largest U.S. retailer of automotive parts and accessories to do-
it-yourself (DIY) customers by number of stores. The company began operations
Ain 1979 and at August 30, 2008, operated 4,092 stores in the United States and
Puerto Rico, and 148 in Mexico. Each of its stores carries an extensive product line for cars,
sport utility vehicles, vans and light trucks, including new and remanufactured automotive
hard parts, maintenance items, accessories and non-automotive products. In many of our
stores we also have a commercial sales program that provides commercial credit and
prompt delivery of parts and other products to local, regional and national repair garages,
dealers and service stations.
Contd...

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