The financial director of a company makes the following comments: “The company performed remarkably well this year. You be the judge – our depreciation policy enabled us to generate 50% more EBITDA than last year. Our working capital has increased sharply, due to a more generous customer credit policy (three months instead of two) and to a significant increase in our inventories.” What is your response? What advice would you give?

Answer:

The Financial director's comments seem rather critical of the organization. He points out that the EBITDA growth in the financial statements is only due to a liberal Depreciation policy, that the company is selling out more on credit and that the length of this credit facility has gone up by a month, implying a higher risk of non-recovery and higher collection costs to keep track of these debts. He further mentions that there's a significant increase in inventories which goes to show that despite a more liberal credit policy, the organization is unable to sell its goods. The organization seems to be showing signs of deteriorating financial health.

The organization should concentrate on all 3 fronts equally. The first comment on depreciation policy shows the management is intentionally portraying a rosier picture of the business affairs and trying to conceal weaknesses in its balance sheet. No business is immune to losses and such efforts to fudge financials should be strongly discouraged. For the long term remedies, the reasons for inventory accumulation should be stayed and necessary steps, even of coming up with new products should be considered. Credit policy should also be reviewed, and if thought fit, the previous 2 months' policy should be reinstated.