Working capital

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Domestic credit to private sector in 2005

Working capital (abbreviated WC) is a financial metric which represents operating liquidity
available to a business, organization, or other entity, including governmental entity. Along with
fixed assets such as plant and equipment, working capital is considered a part of operating
capital. Net working capital is calculated as current assets minus current liabilities. It is a
derivation of working capital, that is commonly used in valuation techniques such as DCFs
(Discounted cash flows). If current assets are less than current liabilities, an entity has a working
capital deficiency, also called a working capital deficit.

Working Capital = Current Assets

Net Working Capital = Current Assets − Current Liabilities
Equity Working Capital = Current Assets − Current Liabilities − Long-
term Debt
A company can be endowed with assets and profitability but short of liquidity if its assets cannot
readily be converted into cash. Positive working capital is required to ensure that a firm is able to
continue its operations and that it has sufficient funds to satisfy both maturing short-term debt
and upcoming operational expenses. The management of working capital involves managing
inventories, accounts receivable and payable and cash.

Contents
[hide]

 1 Calculation
 2 Working capital management
o 2.1 Decision criteria
o 2.2 Management of working capital
 3 See also

[edit] Calculation
Current assets and current liabilities include three accounts which are of special importance.
These accounts represent the areas of the business where managers have the most direct impact:

 accounts receivable (current asset)

  inventory (current assets), and
 accounts payable (current liability)

The current portion of debt (payable within 12 months) is critical, because it represents a short-
term claim to current assets and is often secured by long term assets. Common types of short-
term debt are bank loans and lines of credit.

An increase in working capital indicates that the business has either increased current assets (that
is has increased its receivables, or other current assets) or has decreased current liabilities, for
example has paid off some short-term creditors.

Implications on M&A: The common commercial definition of working capital for the purpose
of a working capital adjustment in an M&A transaction (i.e. for a working capital adjustment
mechanism in a sale and purchase agreement) is equal to:

Current Assets – Current Liabilities excluding deferred tax assets/liabilities, excess cash,
surplus assets and/or deposit balances.

Cash balance items often attract a one-for-one purchase price adjustment.

[edit] Working capital management

Corporate finance

Working capital

Cash conversion cycle

Return on capital
Economic value added
Just in time
Economic order quantity
Discounts and allowances
Factoring (finance)

Capital budgeting

Capital investment decisions

The investment decision
 The financing decision

Sections

Managerial finance
Financial accounting
Management accounting
Mergers and acquisitions
Balance sheet analysis
Business plan
Corporate action

Societal components

Financial market
Financial market participants
Corporate finance
Personal finance
Public finance
Banks and Banking
Financial regulation
Clawback

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'Bold text' Decisions relating to working capital and short term financing are referred to as
working capital management. These involve managing the relationship between a firm's short-
term assets and its short-term liabilities. The goal of working capital management is to ensure
that the firm is able to continue its operations and that it has sufficient cash flow to satisfy both
maturing short-term debt and upcoming operational expenses.

[edit] Decision criteria

By definition, working capital management entails short term decisions - generally, relating to
the next one year period - which are "reversible". These decisions are therefore not taken on the
same basis as Capital Investment Decisions (NPV or related, as above) rather they will be based
on cash flows and / or profitability.

 One measure of cash flow is provided by the cash conversion cycle - the net number of
days from the outlay of cash for raw material to receiving payment from the customer. As
a management tool, this metric makes explicit the inter-relatedness of decisions relating
to inventories, accounts receivable and payable, and cash. Because this number
 effectively corresponds to the time that the firm's cash is tied up in operations and
unavailable for other activities, management generally aims at a low net count.

 In this context, the most useful measure of profitability is Return on capital (ROC). The
result is shown as a percentage, determined by dividing relevant income for the 12
months by capital employed; Return on equity (ROE) shows this result for the firm's
shareholders. Firm value is enhanced when, and if, the return on capital, which results
from working capital management, exceeds the cost of capital, which results from capital
investment decisions as above. ROC measures are therefore useful as a management tool,
in that they link short-term policy with long-term decision making. See Economic value
added (EVA).

[edit] Management of working capital

Guided by the above criteria, management will use a combination of policies and techniques for
the management of working capital. These policies aim at managing the current assets (generally
cash and cash equivalents, inventories and debtors) and the short term financing, such that cash
flows and returns are acceptable.

 Cash management. Identify the cash balance which allows for the business to meet day
to day expenses, but reduces cash holding costs.
 Inventory management. Identify the level of inventory which allows for uninterrupted
production but reduces the investment in raw materials - and minimizes reordering costs -
and hence increases cash flow. Besides this, the lead times in production should be
lowered to reduce Work in Progress (WIP) and similarly, the Finished Goods should be
kept on as low level as possible to avoid over production - see Supply chain management;
Just In Time (JIT); Economic order quantity (EOQ); Economic quantity
 Debtors management. Identify the appropriate credit policy, i.e. credit terms which will
attract customers, such that any impact on cash flows and the cash conversion cycle will
be offset by increased revenue and hence Return on Capital (or vice versa); see Discounts
and allowances.
 Short term financing. Identify the appropriate source of financing, given the cash
conversion cycle: the inventory is ideally financed by credit granted by the supplier;
however, it may be necessary to utilize a bank loan (or overdraft), or to "convert debtors
to cash" through "factoring

Management of working capital

Guided by the above criteria, management will use a combination of policies and techniques for
the management of working capital[16]. These policies aim at managing the current assets
(generally cash and cash equivalents, inventories and debtors) and the short term financing, such
that cash flows and returns are acceptable.

 Cash management. Identify the cash balance which allows for the business to meet day
to day expenses, but reduces cash holding costs.
 Inventory management. Identify the level of inventory which allows for uninterrupted
production but reduces the investment in raw materials - and minimizes reordering costs -
and hence increases cash flow; see Supply chain management; Just In Time (JIT);
Economic order quantity (EOQ); Economic production quantity (EPQ).

 Debtors management. Identify the appropriate credit policy, i.e. credit terms which will
attract customers, such that any impact on cash flows and the cash conversion cycle will
be offset by increased revenue and hence Return on Capital (or vice versa); see Discounts
and allowances.

 Short term financing. Identify the appropriate source of financing, given the cash
conversion cycle: the inventory is ideally financed by credit granted by the supplier;
however, it may be necessary to utilize a bank loan (or overdraft), or to "convert debtors
to cash" through "factoring".

Chapter 6: Working Capital Management

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:

6,000 
Long Term Assets 
Working Capital  28,000 
Cash in Bank  1,000 
Total Capital  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:
 Young 

Inventory  15,000 
Receivables  17,000 
Prepayments  6,000 
Payables  (9,000) 
Customer Prepayments  (1,000) 
Working Capital  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
organisation’s 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.

Osiris 
Income Statement 
Turnover  100,000 

Cost of Sales  (57,000) 

 Royalties  (18,000) 

Gross Profit  25,000 

Distribution costs  (5,000) 

Promotion  (2,000) 

Write-offs  (3,000) 

Administration costs  (10,000) 

Operating Profit  5,000 

Analysis 

Balance Sheet  Osiris  Working Capital / Sales 28.00% 

% 
Inventory  15,000  Inventory in days  96 

Receivables  17,000  Receivables in days  62 

Prepayments: authors  3,000  Prepayments in days: 61 

authors 
Prepayments : printers  3,000  Prepayments in days : 19 
printers 
Payables  (9,000)  Payables  (36) 

Customer Prepayments  (1,000)  Customer Prepayments  (4) 

Working Capital  28,000  Working Capital Cycle in 198 

days 
Explanation of the calculations

Explanation 
Working Capital figure
Inventory in days  (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
Accounts receivable in days  (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
Prepayments in days – (Prepayment: authors / Royalties) x 365 = 61 days. In
authors  practice royalties will be earned that reduce this figure
while new advances are also paid to other authors.
 Prepayments in days – (Prepayment: printers / Cost of sales) x 365 = 19 days. In
printers  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.
Accounts Payable in days  (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 96 + 62 + 61 + 19 - 36 - 4 = 198
days 
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. 4-colour 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 co-operate 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 CD’s and cassettes,
and of greeting cards with a view to finding solutions. While lessons can be
learned, there are major differences:

CD’s, 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:
 

Private publishers in young economies 

Book Packagers
- Founders are creatively rather than - Founders are creatively rather than market
market driven; enjoy “freedom”  driven; enjoy “freedom” 
- International printers offer them low - Printers tend to give better prices to
prices and credit; printers have often established publishers
offered credit to allow packagers to -
start up, sometimes with dire results for
the printer Some publishers may be closely linked with a
printer. The printer may demand advance
payment 
- Packagers usually allow publishers to - Publishers will not involve customers in the
approve content  book content except in special cases e.g.
textbooks and Ministry of Education, University
Publishing Houses
- Receive advance payments from - Are paid after delivery
publishers 
- Hold no Inventory but reprints make - Will often sell the total print run to a single or
high profits  small number of distributors
- Purchase rights from authors and - Sell books with no transfer of rights 
designers, and sell territorial or other
rights to a number of customers 
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 increase Working Capital

Items that reduce Working Capital levels levels for publishers 
for publishers
 - Increased profit margins - Lower profit margins 
- Customers who pay promptly - Long print runs except where all the
- Advance payments by customers  books are required on publication e.g.
School and university textbooks
- Inventory which is sold and paid for - Slow authors who deliver late and whose
quickly 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 conditions demand and the savings are
will deliver quickly and produce low print large
runs economically - Slow schedules for the development of
new titles 
- Successful promotion that speeds up the - Making advance payments to printers
rate 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.

Division A  Division B  Division C  Total 

Income Statement 
Turnover  60,000  30,000  10,000  100,000 
Cost of Sales  (33,000)  (18,000)  (6,000)  (57,000) 
Royalties  (10,800)  (6,200)  (1,000)  (18,000) 
Gross Profit  16,200  5,800  3,000  25,000 
Distribution costs  (3,900)  (1,000)  (100)  (5,000) 
Promotion  (1,100)  (900)  0  (2,000) 
Write-offs  (1,700)  (1,100)  (200)  (3,000) 
Net Contribution**  9,500  2,800  2,700  15,000 
Working Capital  19,200  7,800  1,000  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  Average 

Cost of Sales % to Turnover  55.0%  60.0%  60.0%  57.0% 

Royalty % to turnover  18.0%  20.7%  10.0%  18.0% 
Gross profit margin %  27.0%  19.3%  30.0%  25.0% 
Distribution % to turnover  6.5%  3.3%  1.0%  5.0% 
Promotion % to turnover  1.8%  3.0%  0.0%  2.0% 
Write-off % to turnover  2.8%  3.7%  2.0%  3.0% 
Net Contribution % to turnover  15.8%  9.3%  27.0%  15.0% 
Working Capital / Turnover %  32.0%  26.0%  10.0%  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.

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