Published June 16, 2009

When 'working capital' doesn't work

By R SIVANITHY

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AFTER the March revamp of its listing rules, the Singapore Exchange (SGX) now requires companies to disclose fuller details when raising funds from the public, either via initial public offers (IPOs) or rights issues; in other words, vagueness is not allowed, presumably based on the reasoning that in order for investors and shareholders to make better-informed investment decisions, companies have to be forthright about why they need to raise funds.

(The corollary, of course, is that if companies can't say why they need the public's money, then maybe they shouldn't be allowed to ask for it in the first place.)

On top of having to give details, companies will also have to disclose in their annual reports whether they actually did use the money for their originally stated purposes, and reasons have to be given for material departures.

This is undoubtedly a step forward in terms of providing the public with useful decision-making information. Yet you'd have to wonder: to circumvent this requirement, will more and more companies simply resort to lumping their main use of funds under 'working capital' (WC) and, if so, what exactly does this magical, catch-all phrase mean?

The question is relevant because in many of the 22 rights exercises since the start of the year, 'working capital' plays a prominent role as one of the uses of the US$5.95 billion raised. Yet it has to be one of the vaguest terms found in the corporate lexicon.

It has to be said that the present rules don't go far enough, because they allow firms to hide behind a vague term that sounds impressive but actually conveys no useful information to the public.

It can't be that firms are referring to the accounting meaning because, as most accounting dictionaries will tell you, 'working capital' is usually taken to mean net current assets (cash, notes receivable, marketable securities and other assets of a quick and liquid nature) less current liabilities (notes payable and other debts payable within one year).

The Encyclopedia of Banking and Finance provides some pointers when it states 'from an operating standpoint, the working capital available to a business is sometimes referred to as gross current assets, the gross in cash, cash items such as marketable securities . . . working capital is useful in determining the ability of a firm to finance current operations and to meet obligations when they mature. Adequate working capital is necessary for a business to operate efficiently and effectively. Liquidity is crucial to survival and success'.

Is this closer in meaning to the 'working capital' that firms are referring to when they ask shareholders for funds? If yes, does the above apply to all firms - that is, is one firm's 'working capital' the same as another's?

Assuming the answers are yes, it leads to the interesting observation that if a large part of recent rights monies is to be set aside for day-to-day liquidity (and to pay daily bills), it must be that the companies concerned are unable to generate sufficient cash for operations, and because bank lending has been severely curtailed by the credit crisis, these firms have had to ask their shareholders to bail them out.

Taking this one step further, this suggests that rights issue firms are struggling financially - in which case you'd have to wonder why the market has regularly sent their share prices up when a rights issue is announced.

The market's puzzling reaction aside (a full discussion of it would warrant a separate column), should companies be more specific in their disclosures?

Yes. Although companies would be loath to admit they need money to survive day-to-day, it has to be said that the present rules don't go far enough, because they allow firms to hide behind a vague term that sounds impressive but actually conveys no useful information to the public.

Moreover, if a firm says it is tapping the public for 'working capital' - and this applies equally to IPOs - how exactly is that firm going to disclose that it did not use the money as intended in its annual report?

Because the number of rights issues can only rise in the months ahead and given that there will very likely be liberal use of 'working capital' as a use of funds, it's time this disclosure loophole was plugged.