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I guess the topic is irrelevant to F9 but Just out of curiosity I would like to request you to let me know the way to figure out the working capital need for a service organisation.
Thank you.i think , service organisations do need working capital like any other organisations.Because for operating, its necessary of have working capital.
Anyways , i dont know my answer is right.
but on the other hand , service organisations dont have the motive of profitability like other organsations.
A service organisation will need working capital for exactly the same reasons as a manufacturing company!
If they allow credit then they will have receivables. They will need to carry a cash balance. They will no doubt buy on credit and therefore have payables.
The only current asset they are less likely to have is inventory.With regard to profitability, working capital does not itself earn profits – it is simply necessary in order to run the business.
Since when did service organisations not have the motive of profitability? Hotels, accountants, lawyers, are all service businesses and most of them want to be profitable!!!!
No – of course not.
Firms of tutors are service organisations, but they are certainly not for profit!!
(They are not all free like OpenTuition!)Hotels are service organisations – they don’t produce anything, they sell a service.
John, but I think in service organisations they do not tie there money in the receivables as they haven’t provided any goods to the clients and their payable is also very low as compared to receivable because they only buy things which are of nominal value as compared to the fees charged for the service…..in other words the working capital (receivables+cash-payable-OD) for service organisation is not actually the money that is tied to run the business and hence don’t have to pay interest……Is it that the time value of money is regarded as the only cost of WC for service organisations?
Thank you.Of course service organisations can have money tied up in receivables!
They might not provide goods, but they supply services.
Firms of accountants have receivables, telephone companies have receivables – any business that supplies goods or services on credit will have receivables.With regard to payables, they are likely to be less that for manufacturing companies because they do not buy raw materials, but they are likely to have plenty of expenses and most of them are likely to be bought on credit!!!
A service company will have to finance its working capital just as a manufacturing company has to, and there is therefore the interest cost in the same way.
(I don’t understand your last sentence – the time value of money refers solely to the interest cost!)In fact, think about this………service organisations are likely to have fewer non-current assets than manufacturing companies – they don’t have machines or factories. It is likely that therefore that most of their long-term capital is there to finance their working capital!!!! It can hardly be called a nominal amount.
Thank you for the prompt response John,
I think an example would make this clear to me…
Lets take an example of a hotel …..the receivables in this case would be the room charge that has been allowed to be paid later….here few of the expenses that incurs are utilities bill(water,phone,electricity etc) and bathroom materials etc which in my opinion is nominal compared to the amount they are charged for the room….most part of the room charge is made up of labour cost which is not the cash being tied up in the receivables for which interest have to be paid…is it that the payment for the staff is made at a current date and the receivables are collected at a later date so the interest cost of the money paid to the staff is regarded as the cost of the working capital?
fewer non-current assets then manufacturing companies which allow them to finance most of their working capital via long term capital definitely make sense.
Thank you.
Cash paid to staff is not itself part of the working capital.
The working capital is the receivables, the inventory (which is likely to be zero or very small for a service organisation), the cash balance, and the payables.
A hotel is likely to have only small receivables, but a firm of accountants (for example) might have very large receivables. The working capital needs financing just as it does for a manufacturing company, and it is the money needed to finance it that creates the interest cost.
I am extremely sorry for being such a Moron….but I still didn’t understand why a firm of accountant needs money to finance its receivables?aren’t they mostly made out of service charge?In my opinion ,for this sorts of organisations the only component of working capital which needs financing is Cash …Please try to explain for the last time…..
Thank you.
Think about a balance sheet!
The long term capital (equity + long term debt) balances against the non-current assets and the working capital (current assets less current liabilities).
If there was no working capital then less long-term capital would be needed – it would only need to be equal to the non-current assets.
Because of the working capital, more long-term capital is needed to finance it, and this costs money (interest). The more receivables, the more working capital, so the more long-term capital is needed and the more interest is payable.
(Alternatively, of course, the working capital could be financed by short term borrowings (i.e. overdraft) but there again – the more receivables etc. the greater the overdraft and therefore the more interest payable.
Have you watched my introductory lecture to F9, which explains why the management of working capital is so important?
Yes I have watched it but I will watch it once again ..let me see if something gets into my head..:(
Anyways thanks a lot for the endeavor John.
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