Working Capital is the money used to make goods and attract sales.

The less Working Capital used to attract sales, the higher is likely to be the return on investment. Working Capital management is about the commercial and financial aspects of Inventory, credit, purchasing, marketing, and royalty and investment policy. The higher the profit margin, the lower is likely to be the level of Working Capital tied up in creating and selling titles. The faster that we create and sell the books the higher is likely to be the return on investment. Thus when we have been using the word investment in the chapter on pricing, we have been discussing Working Capital. In the earlier chapter on Accounting concepts we showed a sample Balance Sheet. The Balance Sheet comprises Long term Assets (real estate, motor vehicles, machinery) and Net Current Assets. The word Working Capital is often used for Net Current Assets. In this chapter we will exclude Cash in Bank from our definition. Thus our Balance Sheet appears as follows:

Long Term Assets Working Capital Cash in Bank Total Capital

6,000 28,000 1,000 35,000

We defined Net Current Assets as Total Current Assets less Total Current Liabilities. In this book we shall subtract current liabilities items from current assets as follows:
Inventory Receivables Prepayments Payables Customer Prepayments Working Capital Young 15,000 17,000 6,000 (9,000) (1,000) 28,000

Using this format we can state than any reduction in the Working Capital figure, other than for provisions for write-offs and write-downs, will generate the same amount of cash. Thus if a customer pays US$ 500 that he owes to the organisation, the Working Capital figure will fall be US$ 500, and the cash figure will be increased by the same figure. This revised format is useful when designing spreadsheet financial planning models for business plans or for internal reporting. The Working Capital cycle, or Cash Conversion cycle as it is also called is usually expressed in terms of the number of days. This figure is the average time that it takes to turn investment in books into cash and profit. We studied Payback in the previous

chapter. Payback expresses the number of days required to recoup the original investment on a single title. In the organisations Balance Sheet there will be the costs of paper, titles still under development, author advances of books already and not yet published. In addition there will be the cost of stocks of unsold books, Accounts Receivable, and Accounts Payable. Example: Osiris publishers In order to illustrate the concept I have adapted slightly the example used in the chapter on Accounting concepts. The Young scenario has the same Income Statement but I have adapted the Prepayments figure within the Balance Sheet in order to illustrate more elements of Working Capital. I have divided the Prepayments figure of 6,000 into Prepayments to authors and Prepayments to printers. The totals are the same.

Income Statement Turnover Cost of Sales Royalties Gross Profit Distribution costs Promotion Write-offs Administration costs Operating Profit Balance Sheet Inventory Receivables Prepayments: authors Prepayments : printers Payables Customer Prepayments Working Capital

Osiris 100,000 (57,000) (18,000) 25,000 (5,000) (2,000) (3,000) (10,000) 5,000 Analysis Osiris 15,000 17,000 3,000 3,000 (9,000) (1,000) 28,000 Working Capital / Sales % Inventory in days Receivables in days Prepayments in days: authors Prepayments in days : printers Payables Customer Prepayments Working Capital Cycle in days 28.00% 96 62 61 19 (36) (4) 198

Explanation of the calculations

Working Capital figure Inventory in days

Accounts receivable in days Prepayments in days authors Prepayments in days printers

Accounts Payable in days

Explanation (Inventory / Cost of Sales) x 365 = 96 days. More correctly the purchases figure, if available should be used, in this case excluding royalties. Thus the publisher holds approximately 2 months of unsold inventory (Receivables / Turnover) x 365 = 62 days. Assuming the turnover is phased evenly throughout the year, this means the on average customers take 62 days to pay (Prepayment: authors / Royalties) x 365 = 61 days. In practice royalties will be earned that reduce this figure while new advances are also paid to other authors. (Prepayment: printers / Cost of sales) x 365 = 19 days. In practice part of the Cost of Sales figure would be new title pre-press costs not carried out at the printer. This item relates to cases where advance payments are made to printers as a deposit or for paper. The purchases figure if available would give a more accurate figure. (Payables /(All purchases) x 365 (9,000 / (57,000 + 18,000 + 5,000 + 2,000 + 10,000) x 365 = 36 days

The purchases (investment) rather than the cost of sales figure should be used if available. I have assumed that this figure includes money owed to authors (see prepayment: authors) Customer Prepayments (Customer Prepayments / Turnover) * 365 = 4 days Working Capital cycle in days 96 + 62 + 61 + 19 - 36 - 4 = 198 Working Capital / Sales % 28,000 / 100,000 = 28%

Explanation of the figures

On average it takes Osiris 198 days to turn an investment into cash and profit. New tiles will use more Working Capital than reprints On average Working Capital equates to 28% of turnover The percentage of Working Capital to turnover varies according to the type of publishing Trade publishing in developed countries may have a figure of between 35- 45 % of turnover. Academic publishing is higher. Professional publishing uses a lower Working Capital % figure Working Capital is also a measure of risk

This figure may include new titles, reprints, foreign language coeditions, licence sales. The figure would be different for each of these. Within the total Balance Sheet, the

Working Capital figure will vary throughout the year according to the phasing of new titles and the sales cycle. Publishers should know the typical Working Capital cycle and the level of Working Capital as a % of turnover for each market or distributor, for each category of book. The relevance of Working Capital to publishing in young economies In the FSU Working Capital levels were controlled at government rather than factory level. Invoices were settled on standard credit terms. Non or slow payment was not a major problem for printers and publishers. Risk was a government problem. Authors were paid standard royalty rates and terms. Inventory levels and print runs were according to a formula: in textbook publishing, 150% of the textbook requirement would be printed in year 1, the remaining 50% would be used for replacement copies in subsequent years. Publishers, printers and distributors would negotiate for annual cash budgets but did not have to concern themselves about Working Capital questions except where budget moneys were delayed. Printing capacity was sufficient to produce local and other agreed requirements. Thus textbook printing would commence in November for the following September. In a competitive open economy printers would have to offer discounts and credit to persuade publishers to take the risk of early ordering. Schools would demand the latest up-to-date editions. Publishers would have to borrow money from the bank or shareholders to pay for the inventory. For young economies, the implications are as follows. 1. In young economies the first industries to develop are those with low or negative Working Capital % to sales. Negative Working Capital is where the organisation uses supplier credit or customer Prepayments to fund their day to day needs. E.G. banks and financial services, retailers, distribution, industries with cash sales or advance payments on signature of contract (e.g. printers). Organisations with negative Working Capital use the money from their customers with which to invest and to pay suppliers. 2. Competition is fiercest among industries with low or negative Working Capital / sales % figures. Financial entry barriers are lower and these industries are easier to expand. However profit margins are often lower because of the competition (but not always!) and the failure rate among such industries among developed countries is usually higher. 3. Banks are attracted to industries with low or negative Working Capital / sales % figures as cash and profits are earned more quickly

4. Entrepreneurs are attracted to industries with low or negative Working Capital % figures 5. Most marketing innovations in book publishing have come about through the application of the above Working Capital concepts to creating additional sales and expanding the market. Most of the innovations introduced at the end of the previous chapter were created by reduced the level of Working Capital and the time schedule of creating and selling books. 6. The customers, suppliers and authors of book publishers also want to operate to a low or negative Working Capital / sales %. Thus printers ask for advance payments e.g. for paper, distributors will try to withhold payment until they have received money from their customers. 7. Printers are loath to change from their dominant position where they could dictate prices and schedules according to price scales formulated at state level. These price scales were geared to maximum production output, not to satisfying publishers and their customers under national or international competition. 4colour printing would cost 4-times the cost of single colour printing, despite the introduction of modern 4-colour sheet-fed presses. Printers will change their attitude to pricing and print-runs only in a crisis. In many young economies printers have not co-operated with publishers (partly the fault of the publishers) and faced near collapse as publishers have purchased printing overseas. 8. In developed countries publishers have sometimes allowed retail groups extra credit (= higher Working Capital for publishers) in order to encourage them to expand into new outlets or sell more books. It is essential to distinguish between genuine expansion cases and opportunistic entrepreneurs. The more a publisher is actively engaged in marketing and distribution, the less likely is the publisher to have to rely on offering credit as an incentive. 9. The concept applies equally to state enterprises and non-profit making organisations. If cash and profits are generated more quickly, new titles can be commissioned sooner, staff and suppliers paid promptly. Bank interest is reduced. 10. Where producers are dominant, their customers will have to accept higher levels of Working Capital. Where customers are dominant, the producers have to accept a greater burden. In some young economies, the government may have a policy of holding key organisations in the state sector or as majority owned state enterprises rather than encouraging a free-for-all enterprise policy. This may affect printers, publishers and distributors. This policy will affect the evolution of the Working Capital cycle and may tilt it more in favour of producers. Working Capital levels in book publishing in developed countries Working Capital is a major problem in book publishing. Most publishers solve the question on a temporary basis by negotiating credit with printers and other suppliers.

Their own customers solve the problem by negotiating credit with publishers or demanding sale or return terms. Sale or return terms make planning and cash forecasting much more difficult. Most publishers rightly prefer to offer a slightly higher discount for a firm sale. Retailers will argue that they would not purchase many new titles without their risk being mitigated by a sale-or-return policy The central issues, which must be solved, are:

Investment decisions rely too heavily on economies of scale e.g. in printing prices, by amortising first edition costs against larger print runs Publishers produce too many titles, which receive too little promotional effort and thus sell slowly or not at all.

These can be solved only through long term changes in publishing strategy and greater attention to the value chain where suppliers, publishers, wholesalers and retailers cooperate to mutual benefit and shared risk. On demand publishing may reduce inventory levels but does not solve the marketing aspects. Many publishers have studied the publishing of music CDs and cassettes, and of greeting cards with a view to finding solutions. While lessons can be learned, there are major differences: CDs, cassettes and greeting cards

Are all high margin projects Carry much heavier promotion budgets and commitment to marketing Are standardised in format Enjoy few economies of scale so short run and on-demand manufacture are the norm Sell to a more wide variety of retailers Sell on a less seasonal basis

Paperback publishers have adopted some of these aspects and have fought successfully to overcome the low price perception of paperbacks. Paperbacks can now sell in many cases at the same price as a hardback edition. The creation of hit-parades or Top 10 listings has been adopted for books of different categories and has attracted significant media attention thus making books more fashionable. As a result books may sell faster, perhaps at higher prices and thus reduce Working Capital levels. Book Packagers

Book packagers create books under contract to publishers, bookclubs or foreign distributors. They evolve as part of the specialisation process especially when publishers become larger and more bureaucratic. Publishers buy the rights for a territory for a period of years or number of printings (provided that the title stays in print). The financial attraction to publishers is that they can buy smaller print runs at economic cost. Most publishers will make advance payments to the packagers but may be able to approve the content and design. Most packagers prefer to sell finished books rather than licence titles on a film and royalty basis. Packagers buy at low prices from printers because they create only a small number of titles but each title will have a large print run. Packagers often stay loyal to printers who reward them with long credit and, in many cases, lower printing prices than those paid by their publisher customers. In the TV world many program companies will create programs for several networks while TV companies concentrate on distributing the programs. The production companies will retain the rights and earn fees for repeat-shown programs. A similar situation exists in the multimedia field. Thus packagers are specialists who are not involved in marketing and distribution. Subsequently a small number of them have decided to become publishers and done so very successfully after re-financing. Most stay as packagers. Compared with publishers, these packagers have little market value in acquisition terms. Thus packagers are very similar to many private publishers in young economies but with important differences as the table below shows:

Book Packagers - Founders are creatively rather than market driven; enjoy freedom - International printers offer them low prices and credit; printers have often offered credit to allow packagers to start up, sometimes with dire results for the printer

Private publishers in young economies - Founders are creatively rather than market driven; enjoy freedom - Printers tend to give better prices to established publishers Some publishers may be closely linked with a printer. The printer may demand advance payment - Publishers will not involve customers in the book content except in special cases e.g. textbooks and Ministry of Education, University Publishing Houses - Are paid after delivery - Will often sell the total print run to a single or

- Packagers usually allow publishers to approve content

- Receive advance payments from publishers - Hold no Inventory but reprints make

high profits - Purchase rights from authors and designers, and sell territorial or other rights to a number of customers

small number of distributors - Sell books with no transfer of rights

The Working Capital cycle in both cases is similar in both cases. The reason is perhaps the same. Neither the book packager nor the young private publisher is adequately financed; both enjoy the creative aspects but do not want to expand if it means losing control. There are few potential buyers for book packagers. The cost of starting such organisations is much lower. Working Capital is lower because they are involved only in creating the books. They influence distributors, retailers and consumers only so long as they generate saleable new ideas. While book packagers can of course sell foreign rights, their potential to sell reprints is lower. Making more efficient use of Working Capital The table below lists items, which influence Working Capital levels favourably and adversely

Items that reduce Working Capital levels for publishers - Increased profit margins - Customers who pay promptly - Advance payments by customers

Items that increase Working Capital levels for publishers - Lower profit margins - Long print runs except where all the books are required on publication e.g. School and university textbooks - Inventory which is sold and paid for quickly - Slow authors who deliver late and whose by customers after publication manuscripts require substantial editing - Lower Inventory levels by reducing print - Holding paper stock unless market quantities and working with printers who will conditions demand and the savings are large deliver quickly and produce low print runs - Slow schedules for the development of economically new titles - Successful promotion that speeds up the rate - Making advance payments to printers of sale - Seasonal sales except where the publishers prints only for the season - Licensing (but problematic in young economies) - Paying suppliers on completion with credit - Authors who deliver manuscripts on disk ready for computer make-up - Incentives to staff , authors , suppliers, customers , sales staff and agents to speed up the rate of sale and of developing new books, delivering manuscripts on schedule

The attention of readers is again drawn to the examples at the end of the previous chapter, which illustrate ways in which publishers have produced affordable books through a marketing initiative. The concepts of this chapter apply in each example. The danger of averaging Working Capital levels Osiris has a Working Capital to Sales figure of 28%. However the figure will be the average of the organisations different activities. Let us assume that there are three divisions that produce different types of books for different markets and use different methods of distribution. The table below shows how each division generates much Net Contribution and also how much Working Capital is used in each division. The cost of sales, royalty, distribution, promotion costs and write-off figures differ in each case as a percentage of sales although not all the costs are necessarily variable. The term Net Contribution is the amount of money that each division generates towards the central administration cost of the company and hence to profit. Items below Net Contribution is not relevant to our analysis unless administration cost vary according to each market. Interest on bank loans could however be usefully charged against each division to give an even more meaningful figure. Although a Balance Sheet item, Working Capital is shown under Net Contribution to highlight the relevance of comparing Net Contribution and Working Capital levels by division.

Income Statement Turnover Cost of Sales Royalties Gross Profit Distribution costs Promotion Write-offs Net Contribution** Working Capital

Division A 60,000 (33,000) (10,800) 16,200 (3,900) (1,100) (1,700) 9,500 19,200

Division B 30,000 (18,000) (6,200) 5,800 (1,000) (900) (1,100) 2,800 7,800

Division C 10,000 (6,000) (1,000) 3,000 (100) 0 (200) 2,700 1,000

Total 100,000 (57,000) (18,000) 25,000 (5,000) (2,000) (3,000) 15,000 28,000

** Gross Profit less distribution, promotion and write-offs. The contribution to administration costs and profit from publishing activities

The analysis of the above sheds useful light on profitability and use of Working Capital by division. This is discussed in detail below.
Analysis of the net contribution

The table below shows each cost item included in the Net Contribution calculation expressed as a percentage of turnover.

Division A Division B Division C Cost of Sales % to Turnover Royalty % to turnover Gross profit margin % Distribution % to turnover Promotion % to turnover Write-off % to turnover Net Contribution % to turnover Working Capital / Turnover % 55.0% 18.0% 27.0% 6.5% 1.8% 2.8% 15.8% 32.0% 60.0% 20.7% 19.3% 3.3% 3.0% 3.7% 9.3% 26.0% 60.0% 10.0% 30.0% 1.0% 0.0% 2.0% 27.0% 10.0%

Average 57.0% 18.0% 25.0% 5.0% 2.0% 3.0% 15.0% 28.0%

Turnover

The turnover figure is the sum of the sales invoices issued during the year by division. Any returns or invoice queries would be shown separately under write-offs in order to highlight to management the extent of returns and invoices queries. The company will invoice either by charging an agreed discount off the recommended retail price, or by using an agreed unit price. If transport is included in the invoice price, the charge for transport will be shown as an expense under distribution. Free samples or extra jackets may also be included in the invoice price.
Cost of sales

The percentage to turnover is influenced by the sales mix, the balance of new and reprint titles, and the length of print runs. A larger print run might increase the gross margin % but also increase Working Capital levels and hence reduce the cash in bank figure. Some organisations will charge new title costs in different percentages to each market. The aim is to demonstrate that certain markets are profitable, but only on a marginal costing basis. If an organisation has to increase prices to local bookshops as a result of charging all new title costs against the home market, the organisation runs the risk of losing market share and profitability in the home bookshop market Other publishers, often the more progressive, may therefore regard new title costs as research and development, and charge e.g. 1/12th each month following publication against the Income Statement. This policy means that inventory is valued at a cost excluding new title costs and reduces the need for write-offs. This policy also gives a better view of trends in gross margins, as the figure is not distorted by changes in the

new title / reprint mix. The Net Income will fall. Countries may have specific policies for writing off first edition costs against profits, as they are similar in concept to research and development expenditure.
Royalty figures

The royalty figures differ because in the case of division A and B, the royalty is charged on the basis of the retail price, while in the case of division C, the royalty payable is based on net receipts, i.e. the unit price charged net of discounts. As markets expand, the need to negotiate royalty terms based on net receipts will grow in order that publishers exploit new markets. Without such author contractual terms, publishers might have to reject otherwise profitable deals. Thus the author might lose also. It is common for net receipts royalty rates to be agreed for deals above a certain discount rate, e.g. bookclub, export deals, coeditions, and licences.
Gross margin

Definition: Turnover minus cost of sales and royalties payable. Gross margin, the percentage of gross profit to turnover is widely used in book publishing as a parameter for book pricing. Where an organisation produces books with a similar cost profile, in similar print runs, and with a constant sales mix, gross profit may be a useful criterion. Here the figures highlight also that the use of gross margin as a criterion is not always useful and can be misleading although the division C, with the highest gross margin, also has the highest net contribution. Use of gross margin ignores distribution, promotion and write-offs, which will usually differ by division or type of book.