Businesses often neglect their working capital management by increasing stock levels to increase revenue and operating profits. When done in conjunction with lenient credit policies, neglecting supplier payment terms and inefficient procurement, it often leads to a creeping accumulation of working capital.
When this happens, the inevitable result is a shortage of cash and an inability to distribute dividends to shareholders.
For many trading companies, an undisciplined working capital environment can result in a business which is over capitalised, with a net asset value greater than its enterprise value. There are a few ways in which undisciplined working capital management affects the equity- and business value.
Increased profits without resulting in increased cash flows will contribute to a low earnings multiple as profits do not translate into cash returns to re-invest or distribute to shareholders. This impacts the ability to grow sustainably or even raise capital in the future. In short, it is not an attractive investment as it yields little returns to investors and stunts potential for growth in the company’s value. Informed investors factor this into company value when doing a business valuation.
Small changes to working capital management could have a large impact on the business value. Changes such as implementing a ‘just-in-time’ stock system, tightening up on the company’s credit policy, improving procurement practices and re-negotiating payment terms with suppliers will all release cash into the system and in turn increase business value.
With the help of scenario analysis one can see how the equity- and business value change with the slightest changes in working capital and once this is known, management will pay much more attention to the working capital cycle.
Worth.Business is the ideal platform for this business valuation scenario analysis!
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