Working Capital Management of Volkswagen
Discuss About The Working Capital Management And Shareholders.
Working capital management is an integral part of any organisation’s success. Efficient management of the working capital of an organisation is a crucial part of its longevity and success. The main aim of ensuring better working capital management of any organisation is the efficient maintenance of the operating system and meeting the short term obligations of the organisation. Thus, it forms the financial heartbeat of any organisation, be it large or small, irrespective of their genre of industries (Banos, 2014). Right from the purchase of raw materials, their assembling, production of the products and their eventual sales and the subsequent collection of cash from the sales. This entire procedure comes into the gambit of working capital management (Kieschnick, Laplante and Moussawi, 2013). The concerned project report deals with the mechanism of working capital management of Volkswagen, a car manufacturing company.
Volkswagen is a leading German automobile maker in the world, headquartered in Wolfsburg, Germany. It is the flagship brand of the entire Volkswagen group and it is the largest automobile maker by worldwide in terms of sales. It is one of the largest car making companies in the world and it has led the German automobile industry for decades (Volkswagen, 2018). Moreover, it has held the largest market share in the automobile sector for close to over two decades.
The company has its operations spread far and wide internationally. Every single action of the company has its repercussions upon the German and the world economy and its competitive environment. It employs more than 270,000 people in Germany alone and is Germany’s largest automobile employer. Moreover, car making is Germany’s most successful export product. If the car sales were to decline, it would have serious repercussion on the German economy. In the competitive field, the company faces stiff competition from mainly two of its competitors; Toyota and General Motors (GM). Ford is closely behind them. In the last couple of years, Volkswagen has rapidly increased its sales. Although, Volkswagen has increased its sales, but recently, in the global profit charts Ford and GM have topped, but Volkswagen have lagged behind them. Despite this, the company has grown by leaps and bounds since its inception in 1937.
Being a car company, Volkswagen has a wide process involved in its working capital procedures. There are six stages which are followed by the German company which completely engages its working capital. They are:
- Stage 1: In the first stage, raw materials are purchased from the suppliers. This stage is the first stage and forms the base of the execution of the subsequent stages. Purchase of the necessary raw materials are done in this stage. Mainly at this stage, oil and iron ore are purchased.
- Stage 2: After the purchase of the initial raw materials, acquisition of refined raw materials becomes a priority for the company’s management. This includes purchase of plastic, rubber, steel and metal. Polytechnic, Saint-Gobain are some of the plastic and rubber suppliers and Arcelor Mittal Steel and Thyssen Krupp are some of the prominent steel providers.
- Stage 3: Complete fabrication and furnishing of the components of the cars are done at this stage. Electronics components which have been brought are assembled into the cars at this stage.
- Stage 4: In this final stage, a thorough assembling of the various parts of the company is done. From headlights to taillights, everything is assembled (Volkswagen, 2018). Doors, hoods and deck lids are all assembled and placed.
- Stage 5: After the final assembly, a thorough inspection is performed by the plant engineers. If any faults are detected, then they are immediately reported to the concerned departments and are immediately removed. After, all these formalities, sales of the cars are initiated.
Importance of Working Capital Management in the Success of Volkswagen
For a car company like Volkswagen, mainly two important working capital management techniques are most suited, which are as follows:
- Economic Order Quantity (EOQ)
- Hedging (Maturity matching) strategy
- Economic Order Quantity: It refers to that optimum quantity of goods, which are to be purchased at a time, for the purpose of minimising the annual cost of ordering and carrying or holding those products in the plant stock. It helps the management to have an estimation of the amount of goods which are required at the correct time in order to reduce costs (Jaber, Zanoni and Zavanella 2014). The most important aspect of EOQ is that it helps the company in reducing the storage and ordering costs of the products. The key technique involved has been explained below:
- EOQ = Square root{ (2 * A * O) / (P * C)}
- A – Annual Sales
- O – Cost per Order
- P – Purchase price per unit
- C – Carrying Cost
This equation mainly emphasises that ordering and carrying costs are interrelated. Personnel and shipping costs are closely depended with ordering costs while warehousing and security costs are connected with carrying costs (Enqvist, Graham and Nikkinen, 2014). All of these must be incorporated in the inventory cost allocation because management’s primary aim is to decrease or minimise both these costs. Less shipments of higher quantity decrease the ordering costs, but increases the carrying costs because greater inventory will be stuck on shelves for a longer period of time. The reverse is true for more carrying costs.
Hedging (Maturity matching) strategy: This is one of the most effective methods of managing working capital of any company. For car companies like Volkswagen, it can work wonders by financing its working capital with a moderate level of risk and profitability (Hill, 2013). Here, each of the assets would be financed by a debt instrument having similar maturity value. This works on the cardinal principle of financing, which is financing long term assets with long term loans and short term assets are financed with the help of short term loans. The basic rationale behind using this approach is the presence of stability. If the company finances a permanent asset with short term funds , then the borrower has to renew the loan repeatedly as long as the asset is to be financed, which would lead to a huge expense for the borrowing company. Similarly, if temporary assets are financed with long term finance, then the borrowing company has to bore the extra cost of the loan interest when the money is not getting utilised due to the short term nature of temporary assets. Thus, hedging is important as it neither affects profitability or survival of the company.
- Economic Order Quantity: In this case, a hypothetical example of Volkswagen has been taken. Volkswagen is primarily engages in sale of cars. Its order cost is $500,000 and the carrying cost unit is $ 100,000 per unit per year. The company faces a huge demand for 20,000 products per annum in its German market. The order size, total numbers of orders needed in a year, total carrying as well as total ordering cost for the given year.
Here in this case, EOQ = SQRT (2 × 20,000 × 500,000/100,000) = 448 units
Yearly demand is 20,000 products, so the company would have to place 44 orders (= annual demand of 20,000 divided by order size of 448). Total ordering cost is therefore $11,363 ($500,000 multiplied by 44).
Average inventory held is 224((0+448)/2) which states total carrying costs of $4480(i.e. 448 × $10)
Hedging: This technique of financing of working capital can be explained through the following equation and diagram. Long term funds will finance= Fixed assets+ Permanent working capital and Short term funds will finance= Temporary working capital. In the diagram, the red vertical line with white spaces represents the type of financing. The bigger line which stretches till permanent working capital is long-term financing and a smaller line is the temporary working capital. The place from where the temporary working capital begins and the line of a hedging strategy is the same. Any kind of strategy below this line will be considered an aggressive strategy and a strategy above it would be a conservative strategy (Bielecki, and Rutkowski, 2013). This technique is more suited to the company because of the stability it provides to the borrowing company. It stresses on financing of fixed assets through long term funds and short term assets through short term loans. It provides a moderate risk and profitability, which is affords more stability to the company.
In this paper, financing of working capital in car companies like Volkswagen was presented and analysed. The report presents a lucid picture of the two important techniques of working capital management. The absence of proper and transparent techniques of working capital techniques in the annual reports of car companies like Volkswagen, would have helped in the adding other important details about these methods mentioned in the report. EOQ and hedging are two of the most important techniques and both of them have been evaluated and presented based on their precision, which would assist in the management of working capital of automakers like Volkswagen. Thus, it could be concluded that the report reflected on the intricacies of working capital and opened new vistas into the management of working capital in auto giants like Volkswagen.
References:
Baños-Caballero, S., García-Teruel, P.J. and Martínez-Solano, P., 2014. Working capital management, corporate performance, and financial constraints. Journal of Business Research, 67(3), pp.332-338.
Bielecki, T.R. and Rutkowski, M., 2013. Credit risk: modeling, valuation and hedging. Springer Science & Business Media.
Ding, S., Guariglia, A. and Knight, J., 2013. Investment and financing constraints in China: does working capital management make a difference?. Journal of Banking & Finance, 37(5), pp.1490-1507.
Enqvist, J., Graham, M. and Nikkinen, J., 2014. The impact of working capital management on firm profitability in different business cycles: Evidence from Finland. Research in International Business and Finance, 32, pp.36-49.
Forbes.com. (2018). Forbes Welcome. [online] Available at: https://www.forbes.com/2005/01/27/cz_0127bbscashcycleimprove.html#4eb0cc8246ec [Accessed 28 Apr. 2018].
Hill, R.A., 2013. Working capital management. Recuperado de https://202.191, 120, p.8020.
Jaber, M.Y., Zanoni, S. and Zavanella, L.E., 2014. Economic order quantity models for imperfect items with buy and repair options. International Journal of Production Economics, 155, pp.126-131.
Kieschnick, R., Laplante, M. and Moussawi, R., 2013. Working capital management and shareholders’ wealth. Review of Finance, 17(5), pp.1827-1852.
Taleizadeh, A.A., Wee, H.M. and Jolai, F., 2013. Revisiting a fuzzy rough economic order quantity model for deteriorating items considering quantity discount and prepayment. Mathematical and Computer Modelling, 57(5-6), pp.1466-1479.
Volkswagenag.com. (2018). [online] Available at: https://www.volkswagenag.com/presence/investorrelation/publications/annual-reports/2018/volkswagen/en/Y_2017_e.pdf [Accessed 28 Apr. 2018].
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