Marks & Spencer uses short term finances such as overdrafts and bank loans to fund their working capital. Overdraft may usually be used to cover utility bills, and short term bank loans may be used to pay wages. Also they use trade creditors as a short term finance to purchase goods on credit from their suppliers. The use of short term finance for the day to day running of the business is a better source compared to long term source because resources such as stock will be used soon and there will be no point incurring more charges on it if you were to get a long term loan instead of acquiring it from trade creditors.
In this part of my work, I am going to identify and explain the key ratios, using the information I gathered from M&S annual report.
Ratio is the term applied to a variety of calculations used to compare the results of a business over time or to compare the results of two or more business in the same business sector. Ratios enable changes in important aspects of a business’s performance to be pin pointed and quantified. The calculations of ratios enables trends to be highlighted and also ratios are particularly important to the owners, managers and stake holders of businesses as they will be keen to assess the performance and rivals will be interested too.
I will be using five(5) key ratios namely current ratio, acid test ratio, debtor collection periods, credit payment period and stock turnover to compare the results of M&S business over 2010 and 2011 financial year.
Current ratio: this is also known as the working capital ratio, it is used to compare current assets to current liabilities the formula for working out the current ratio is,
CURRENT ASSETS / CURRENT LIABILITIES. Current ratios are always expressed as ‘something’:1. The ideal current ratio is 2:1 which means that for each £1 owed the business can cover with current assets 2 times. Even though a high current ratio can be a good thing, it is possible for it to be classed as a wasteful of resources, because the business is holding money in that could be put to good use such as expanding the business.
Current ratio
M&S current ratio has increased from 0.5:1 to 0.9:1 this means that liquidity has gone up and for every £1 owed M&S can cover with current assets of 0.9 times. Compared to the ideal ratio which is 2:1, the current 2011 ratio is still not good enough and this may imply that the business will find it difficult its debts since the business is operating with inadequate levels of working capital.
Acid test ratio: this is similar to current ratio because it measures liquid assets in relation to current liabilities and also the amount of liquid assets available to pay the debts of the business. The differences between current ratio and acid ratio is that, current ratio looks at liquidity and cash flow issues further ahead than acid ratio because acid ratio is a more immediate measure of liquidity.
The formula for finding acid test ratio is;
(Current assets – stock)/ Current liabilities
Acid test ratio is also written in the form ‘something’: 1, the ideal acid ratio is 1:1 meaning that for every £1 a business owes it has £1 of current assets less stock to cover this debt. Stock is removed to give an indication of the cash the business has in relation to its liability.
M&S has been able to increase its acid ratio from 0.21:1 in 2010 to 0.54:1 in 2011, yet still this is not close to the ideal ratio and this suggests that the business has nearly twice as many liabilities as it has cash to pay for those liabilities and this might put the firm under pressure.
Stock turnover – this compares the average stock to the total cost of stock sold during a year. Average stock is calculated by adding the two years stock and then dividing it by 2. Stock turnover is very important to M&S since stock is involved in their normal trading activities. The stock turnover will indicates how quickly stocks are being sold. If the rate is increasing, it can mean that the business is selling more stock or perhaps the average stock held is being reduced. However, if the stock is decreasing, this could mean that the business is selling less stock or the business is holding more average stock.
The formula for finding stock turnover is;
(Cost of sales / Average stock) = number of times per year
Average stock= (685.3+613.2)/2 =649.25
Based on the calculation, the resulting stock turnover ratio was equal to a little more than 9 in both years. This means that M&S reduces and replenishes its stock nine times per year to satisfy consumer demand for its products. The goal of any retailer such as M&S is to have a high inventory ratio, since it's always better to sell inventory in the shortest amount of time possible. The longer a company holds on to inventory, the more expenses it incurs to store it, which ultimately reduces profits. Moreover, when there's low stock turnover, it indicates that the company is failing to accurately project what the demand is for the products it sells.
Debtor collection periods -this is the average amount of days for collection period. It is used to measure the business’ efficiency in collecting payment. If the debtors collection period is increasing this tells you that the debtors are taken longer to pay than previously.
Formula for calculating the debtor collection period:
(Trade debtors x 365)/sales turnover = number of days
There has been an increase in of 14 days in the debtors’ collection period from 2010 to 2011 and this could be a weakness to M&S because it could imply that credit control is not being as carefully managed as previously and this could lead to an increase in bad debt, bad debt is when debtors are not able to pay for their amount owed, this is treated as an expense in the business income statement.
Creditor payment period: this measures the number of days taken on an average to pay for credit purchases. Since M&S deals with lots of stock one of their sources of finance form purchasing goods on credit, if the credit payment increases this shows that the business is taking longer to pay creditors than previously. This change can either be a weakness to the business because it could mean that that the business is exceeding the credit period allowed by suppliers and as a result suppliers may discontinue offering credit facilities. On the other hand it can become a strength because it will improve the cash flow of the business.
If the creditors’ collection period is decreasing this means that the company is taking less time to pay creditors. The change in the creditors’ payment period can be interpreted as a strength because the credit control is being more carefully managed and that difficulties with suppliers over exceeding credit limit will no longer occur but it can also be a weakness because the business is now paying suppliers earlier than necessary, resulting in negative impact on cash flow.
Formula for calculating creditor payments period;
(Creditors x 365) / Purchases = number of days
Since these figures are decreasing, it shows that M&S are taken less number of days to repay their suppliers. However, if the credit payment period between M&S and their supplier is 30 days then the business will have to ensure that their debt are repaid more quickly to build up trust between them and the suppliers. In order to maintain the capital structure, the M&S has decided to adjust the number of dividends paid to shareholders, return capital to shareholders, issue new shares or sell assets to reduce debt. But if the credit payment period is more than 71 days, e.g. 100 days instead, then M&S can wait for some more days to repay their debt as this will can help them get a positive cash flow and will attract investors into the business.
Comparing the changes in debtors collecting period and creditors collecting period over the 2 years period shows that M&S take longer time to pay their suppliers but it takes shorter time for them to receive payments from their debtors. The reason behind this could be that, since M&S is not really a wholesale company they don’t give out lots of credit purchases to their customers but they purchase most of their stock on credit which thereby explains the huge difference between the creditors and debtors collecting period.
To be able to manage working capital, there are certain tools in which a business can use. Usually making sure that the business has enough money to pay the bill when they arrive may be good practice however it is important to take into consideration of other tools as it will help you to manage your business more effectively.
The following are ways in which a business can use to manage working capital;
Credit control: these are practices used by businesses that extend credit to customers for the purpose of financing purchases of goods or services offered by the business. The purpose of these practices is to identify whether a customer is a good credit risk, and to monitor existing customer lines of credit for consistent repayment. As M&S don’t give out a huge amount of their stock on credit because they are retailers they still use credit control to assess the few people they sell goods to on credit as this will avoid any bad debt from occurring. From the calculation of the debtors collection period, it is clear that M&S debtors are taken longer days to pay than in the previous years, and this could cause cash to be tied up in debtors and M&S may not be able to pay for their own debt. To be able to decrease the number of debtors, M&S can offer a discount to their credit customers, such as 5% discount if payments are made 14 days earlier rather than the agreed credit collection period. Also M&S should make sure that they are paying a close attention on their debtors and if they spot out any late payments, they should send a reminder to their debtor.
Stock control: is essential in M&S because the more stock it holds the greater the amount of money that is tied up and this can have a significant effect on company profits.
There are different types of costs that occur when stocks are held in a business for so long, these costs are;
Opportunity cost, this is when capital has been tied up in stock, in this situation a business earns a zero financial return, meaning that no money is raised by holding stock in.
Storage and handling, if lots of stocks are held for so long in M&S it will have an impact in the warehousing space, and extra capital will be wasted on the controlling of these stock, lighting heating and labour.
Spoilage, since M&S deals with perishable goods like food, there will be a high risk of these perishable items to get expired.
Usually stock will have to be insured against fire damages or theft, and keeping a higher amount of stock in the business it means that the business will have to pay more money on insurance to cover all the stocks available in the moment.
Theft and shrinkage, when there is lots of stock held in a business it becomes a target for theft by staff and others. Due to this reason M&S has put in a careful strategy called the “Radio Frequency Identification (RFID) technology”. This RFID uses microchips to wirelessly transmit serial numbers to a reading device wirelessly, allowing goods to be tracked electronically along the supply chain from warehouse to point of sale.
Stuart Senior, IT director at M&S, said the company wanted to use the technology to ensure 100% product availability, allowing managers to fill stores with as many different types of merchandise as possible.
"With automatic tracking of stock we can get a perfect picture of the goods we have on the sales floor and in the warehouse," he said. "If we can improve data accuracy, we can replenish accurately."
Another way I would suggest M&S to use to controls its stock is to use “just-in-time approach” on perishable food. The just in time approach is when orders for delivery are made and ready to be sold to the customers straight away, this will help M&S reduce the amount of money wasted on
Debt factoring: this is when a third party usually a bank is given the authority to collect a business’ debts in exchange for a percentage of the original debt. Using debt factoring will be particularly important to M&S as this will help them improve on their cash flow and wouldn’t have to wait till their debtors are ready to settle payments. Currently M&S are not using debt factoring, but I would recommend they use it as this will help them decrease the number of debtors’ collection period and hopefully use the money to obtain new stock or to pay off their creditors.
Cash budgets: cash budget is an estimate of future cash income and cash expenditures. Creating a cash budget helps M&S to ensure that there is always sufficient cash available to allow the normal trading activities of the business to take place. It will also highlight time when M&S have excess cash and this allows the management team in the business to arrange short-term investment of those surplus cash in order to gain maximum return. Lastly cash budgets high light when the business have cash deficits and this allows the management team of M&S to arrange short-term alternative sources of finance which can be bank overdraft, arrangement of extended period of credit, or reducing the agreement on the time limits for existing long term debt collection periods.
Even though creating cash budget helps M&S in the management of its working capital, there is still some limitations, because;
- If the data included in the cash budget is inaccurate then the cash budget will be of little use.
- Budget might become an overriding goal and this could lead to a misuse of resources or incorrect decisions been made.
- If budget are made compulsory instead of negotiated, staff members may become demotivated.
- If budgeted plans are easily achieved this will make the departments appear to be more efficient than they really are and this will lead to underperformance.
In conclusion, the analysis of working capital efficiency of Marks & Spencer is showing instability in the business. Stock holding period is around on the same level in 2011 as it was in 2010. M&S has increased in its debtor collection period in 2011, which is showing their weak position to collect their receivables early. The business can improve its debtors’ collection period by using the credit control ideas I talked about previously.
Since M&S is a retail shop, for the companies working capital to increase we have to look at the main operating activities to be able to solve the issues the company is facing at the moment.
M&S sales have falling from 9,740.3 million in 2010 to 9,536.6 million in 2011 and this reduction in sale will give a bad impact of M&S to all its stake holders. It is important for M&S to increase the number of sales as this will help their working capital to increase too, to do this the business will have to invest in exciting clothing that are in fashion and also look at their marketing strategy to see if they could include discounts sales or give cash discounts to its customers.
Even though M&S is doing quite well in its food department it can look in improving even better by comparing their marketing strategies to their competitors such as Tesco and Sainsbury and incorporate the strategy they find helpful from its competitors into their own business.
From the creditors payment period ratio figure we could tell that M&S takes longer time to repay their creditors, and the reason behind this is that the business has got more than 2000 direct suppliers of finished products. 1500 suppliers are supplying clothing, footwear, beauty and home products and rest 500 provide food products. Keeping the record of 2000 suppliers is not easy and in future complex supplying chain could create problem for M&S. M&S could improve on this issue by probably looking to find suppliers that could offer more than one products at a cheaper price to the company and this will help to reduce the number of suppliers they have and hopefully be able to keep track of their creditors payment period.
In 2011 the acid ratio test which measures the liquidity of the business has fallen below 1 and it is 0.54, this is very unhealthy for M&S because it means that for every £1 liability they owe they have just 0.54p to cover it, for M&S to improve on its liquidity, it needs to reduce its expenses that are incurred through rent, payment of indirect labour and professional fees and also the amount of money spent on advertisement. Also if the business has any assets that are unproductive they could sell it and the money gain would help increase their current assets figure. To add up M&S can improve profitability by looking at stocks that could be charged at a higher a price or they might want to reduce the price of certain stocks as this will attract more customers.
M&S can also improve in its stock turnover by targeting at different age groups, because currently the shop has an image of selling clothes that are targeted to people over their 30’s and in the current market of retail clothing it is known that people below the ages of 30 spend lots of money of clothing. The company could focus on buying and selling products that sell consistently, because there are some products that might sit in the shelf for so long and this will cost cash to be tied up in the stock.
by
mzangie (student)
