Working Capital Simulation: Managing Growth - Assignment Example

The use of simulations as a learning tool is a new educational trend that has gain popularity with the rise of the internet. Universities with onlineprograms such as the University of Phoenix are using simulations to teach students valuable lessons. A simulation provides a student with different scenarios in which students have to make decisions. Simulations are great learning tools because they allow students to be exposed to scenarios that imitate the real world. Some of the benefits of the use of learning simulations are: Cheaper to create than real life counterparts Easy to construct Remove element of danger Simulations can be paused (Creativeteachingsite, 2011). The simulation from the course that I am going to be discussing in this paper is called Working Capital Simulation: Managing Growth Assignment. The company showcased in the simulation is called Nutraceuticals (SNC). The company is an internet based distributor and retailer of dietary supplements. Some of the products that the company sells are vitamins, minerals, and herbs. Despite the fact that the company is generating $10 million in sales the firm is close to breaking even. A firm that is breaking even is neither generating profits or assuming losses. The firm has very thin margins and its operations are very capital intensive. During the last year the company several times has struggled to finance payroll due to its constraint cash position. The company keeps a minimal amount of cash for operation expenses of $300,000. The organization has a credit limit of $1.2 million spread over one year based on the Libor rate. The current interest rate of the credit line is 8% and the cost of capital the firm uses to evaluate investments is 12%. The nutraceutical industry currently generates $128.6 billion worldwide with the industry growing at a 4.9% annual rate. The simulation requires that I make decisions for three phases each covering a three year period. In the simulation I act as the chief executive officer of the organization. I have to apply principles of capital budgeting to invest in growth and cash flow improvement opportunities in three phases over 10 simulated years. Some of the potential decisions that I must make to analyze the effect on working capital are taking on new customers, capitalizing on supplier discounts, and reducing inventory. As I started the first phase of the simulation I took a look at the financial results of the company. The firms sales have been stagnant at $10 million during the past three years. Since the company is currently breaking even it is of the utmost importance for the company to increase its total yearly sales. In 2012 the firm had EBIT of $650,000 and net income of $236,000. Both results are an improvement over the previous year. The total firm value at the end of 2012 was $3,248,000. The firm generated cash flow from operations in 2012 of $356,350. The first phase of the simulation provided me with four alternative solutions which were acquire a new customer, leverage supplier discount, tighten account receivables, and drop poorly selling products. The option of adding a new customer provided me with an opportunity of landing a major client. The new customer is Atlantic Wellness. This new client will generate for the company $4 million of revenue and it will increase EBIT by $260,000. I decided to accept the option of adding a new client. The second option of leveraging supplier discount was accepted as well because working with Nutrilife on a new herbal nutraceutical product line will increment sales by $2 million per year. Sales expansion is a goal that is achieved through this option. I decided to decline the third option because it could hurt the customer relations the company has with its customer base. The fourth option was dropping poorly selling products lines. I decided not to drop poorly selling products because the company is not in a position to lose over a million in sales at the present time. As a result of my decisions sales in 2015 reached $16 million, $1.07 billion in EBIT, and $503 million net profit. The equity value of the firm is $509 million and total value of $3,043,000. The DSI and DSO of the firm were 90 days and 109 days. The DPO of the firm was 39 days, while the cash conversion cycle was 160 days. In the second phase the three options are pursue big-box distribution, expand online presence, and develop a private label product. I decided to establish a partnership with a major retailers. This partnership provided the unique opportunity of being able to expand massively. Sales would increment by $4 million, $6 million, and $7.1 million the following three years. Another benefit of accepting this option is a lower DSO. A negative aspect of this transaction was that it will drop margins from 6.5% to 6%. The partnership will bring a lot of cash into the company, this should offset the lower margins. The second option of increase online presence was also accepted. The EBIT of the organization increase in 2016, 2017, 2018 by $108 million, $167 million, $204 million respectively. Sales increase by 10%, 5%, and 3% in the next three years. Another benefit is that DSO would decrease by 12 days after three years. The third option was to develop a private label product. Fountain of Youth Spas wants the firm to develop for them a new high end organic, age-defying nutraceutical line that the spa beauticians could offer to well-heeled clientele. Despite the fact that the alternative offers sales increment for the company I decided to go against it because it reduced both DSO and DSI. In phase two my decisions helped the company achieve sales of $26,134,000, EBIT of $1,644,000 and net income of $833,000. The equity value of the company was $338,000 and the total value was $2,881,000. DSI was 89 days and DSO was 96. Both metrics were lowered in phase II than in phase I. DPO was 39 days and the cash conversion cycle was 147 days. The cash conversion cycle was reduced by 13 days. The third phase provided three alternative solutions. The three solutions were acquire a high risk customer, renegotiate supplier credit terms, and adopt a global expansion strategy. The first option is doing business with Midwest Miracles. This a high risk client that if it works out could increase the sales of the company in 2018 by 30%. One of the risk associated with client is that there is a 20% probability that the company will declare bankruptcy. A con of choosing this alternative is that the company pays extremely late which would increase DSO to 190 days. I decided not to choose this alternative. The second alternative was renegotiate supplier credit terms. Dynasty Enterprises offered advantageous credit payments which could reduce SNCs cost of sales by an incremental $200,000 and accounts payable by an incremental $812,000. The alternative was accepted by me because it provide benefits with little risk involved in the implementation. The third option was to adopt a global expansion strategy. Adding Viva Familia to its client list is a smart move for the company. Latin America is a virgin market for the types of products the firm offers. The population of South America is 389.86 million (Worldpopulationstatistics, 2015). DSO decreases by 2 days, but DSI increase by two days. My decision was to accept the option. Upon completion of phase III the final metrics of the firm were: Sales = $27,995,000 EBIT = $2,284,000 Net Income = $1,217,000 Free Cash Flow = $1,370,000 Equity Value = $744,000 Total Firm Value = $3,288,000 The simulation was a tremendous learning experience. As the acting CEO of SNC I faced many tough decisions. Decisions making is extremely important in the field of management (Businessballs, 2014). The total sales of SNC during my nine year tenure as CEO of the firm increased from $10 million to $27.99 million. The company undertook new projects that helped it become more profitable. The future of the firm is bright. Global expansion already started and should continue in the future. Globalization has become important for a number of reasons, including the overall need for businesses to compete (Kokemuller, 2015). Upon completion of this simulation my decision making and analytic abilities have improved. The simulation was very challenging, but it was a lot of fun to complete. I look forward to doing more simulations in future courses. References Businessballs.com (2014). Problem-solving and decision-making. Retrieved January 9, 2015 from http://www.businessballs.com/problemsolving.htm Creativeteachingsite.com (2011). Use Simulations To Help Students Learn. Retrieved January 9, 2015 from http://www.creativeteachingsite.com/edusims.html Kokemuller, N. (2015). Why has Globalization Become so Important? Retrieved January 9, 2015 from http://smallbusiness.chron.com/globalization-become-important-77671.html Worldpopulationstatistics.com (2015). Population of South America (2014). Retrieved January 9, 2015 from http://www.worldpopulationstatistics.com/population-of-south-america-2014/ . Read More