WORKING CAPITAL MANAGEMENT

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WORKING CAPITAL MANAGEMENT

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AGENDA

• Working Capital, Definition
• Float and Value Dating
• Payment and Collection Instruments
• Short-Term Investing
• Short-Term Borrowing

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Working Capital

• Working Capital All the items in the short term
  part of the balance sheet
• e.g. cash, short term debt, investments,
  inventory, debtors (receivables), payables
  (creditors) etc
• Net Working Capital is the difference between
  Current Assets and Current Liabilities
• Cash Management, Liquidity Management
• Interconnected terms.

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CORPORATE DEFINITION OF CASH MANAGEMENT

• The effective planning, monitoring and management
  of liquid / near liquid resources including
• Day-to-day cash control
• Money at the bank
• Receipts
• Payments
• S-T investments and borrowings

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CASH MANAGEMENT ENVIRONMENT
BANKERS PERSPECTIVE
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BANK DEFINITION OF CASH MANAGEMENT

• The effective planning, monitoring and management
  of liquid / near liquid resources including
• Provision of bank accounts
• Deposit / withdrawal facilities
• Provision of information regarding bank accounts
  and positions
• Money transfers and collection services
• Investment facilities
• Financing facilities
• Pooling and netting

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BENEFITS OF GOOD CASH MANAGEMENT

• Control of financial risk
• Opportunity for profit
• Strengthened balance sheet
• Increased customer, supplier, and shareholder
  confidence

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WORKING CAPITAL
Managing Liquidity
Source Essentials of Managing Corporate Cash
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DEFINITION OF LIQUIDITY

• Having sufficient funds available to meet all
  foreseen and unforeseen obligations
• Liquidity has costs
• Cash is unproductive
• Spread between borrowing and deposit rates and
  between long and short term rates

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NEED FOR LIQUIDITY

• Day to day transactions
• Precautionary balances
• Compensating balances
• Obtaining discounts
• Acid tests
• Favourable opportunities
• Overall avoiding bankruptcy!

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THE CASH GENERATOR / ABSORBER

40
Stock
20
80
Purchases
Sales

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PROFIT?
CASH BALANCE?
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Operating Cycle

• Purchase Resources Pay
  Sell on Credit Receive Cash
• Inventory Conversion
  Receivables Conversion
• Payables Period
  Cash Conversion Cycle
• 
  Operating Cycle
• FromFundamentals of Contemporary Financial
  Management, 2nd ed
• , by Moyer, McGuigan and Rao

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The Various Cycles

• Inventory Conversion
• Inventory x 365
• Cost of Goods Sold
• Payables Conversion
• Payables/Creditors x 365
• Cost of Goods Sold
• Receivables Conversion
• Receivables/Debtors x 365
• Turnover

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Balance SheetShort Term Items

• Current assets
• Inventories
  1,910 1,903
• Trade and other receivables
  1,713 1,625
• Current tax assets
  13 -
• Other financial assets
  43 78
• Cash and short term assets
  733 917
• 
  4,412 4,523
• Current liabilities
• Short term borrowings
  355 555
• Trade and other payables
  1,690 1,735
• Current tax liabilities
  121 44
• Other financial liabilities
  119 13
• Short term provisions
  82 130
• 
  1,367 2,477
• Turnover 9,577
• Cost of goods sold 8,943

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Operating Cycle

• Purchase Resources Pay
  Sell on Credit Receive Cash
• Inventory Conversion 78 days
  Receivables Conversion
• 
  
  65 days
• Payables Period
  Cash Conversion Cycle
• 69 days
  74 days
• 
  Operating Cycle
• 
  143

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Cash Conversion

• We need to consider control in all areas of
  working capital to maximise return, reduce cost.
• Some areas are not controlled by the Finance
  Function Stock/inventory
• Some areas have shared control payables and
  receivables
• Some areas are controlled by the Finance
  Function short term borrowing and investment

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Float

• Any delay in the process of converting materials
  and labour to receipt of payment involves cost,
  float cost.
• Similarly, any delay in making payments will also
  give rise to float but this time to our advantage
• What is float?

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FLOAT

• Definition of bank float
• The time lost between a payor making a payment
  and a beneficiary receiving value
• Cost of Float
• principle amount due x no of days x cost of funds
• 360 or 365

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WHY DOES FLOAT OCCUR?

• Deliberately
• Inefficiency
• Logistical situations
• Compensation mechanism

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STAGES OF FLOAT
1. Order received
Production float
2. Goods dispatched
System float
3. Invoice issued
Credit period
4. Payment due
Customer float
5. Payment made
Postal float
6. Payment received
System float
7. Payment banked
Bank float
8. Funds available
Concentration float
9. Funds to correct account
Information float
10. Advice of availability
 
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Controlling Float

• We need to look at controlling / influencing
  float in three areas
• Ourselves
• Our Customers
• Our Banks

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HOW TO REDUCE/CONTROL FLOAT

• Your Own Actions
• Change own systems
• Educate customers
• Include costs in prices
• Negotiate with bank

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RECEIVABLES AND PAYABLES MANAGEMENT

• Good receivables and payables management aids in
• Cash flow forecasting
• Long-term funding and investment decisions
• Reduced risk of bad debts
• Stronger liquidity
• Stronger balance sheet ratios

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RECEIVABLES IMPACT

• Important because of costs arising from
• Float
• Bad debts
• Management time
• Legal fees
• And
• Impact on analysts and creditors

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RECEIVABLES MANAGEMENT 1

• Clear instructions
• Method of payment
• Documentation
• Account structures
• Terms of Trade

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Controlling Float

• Payment Methods
• Payment methods are important because of
• - Cost
• - Risk
• - Value Dating
• - Finality

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INTERNATIONAL TRADE PAYMENTS

• Terms of trade
• Settlement
• Open account
• Clean collection
• Documentary collection
• Against payment
• Against acceptance
• Revocable documentary letter of credit
• Irrevocable documentary letter of credit
• Unconfirmed
• Confirmed
• Advance payment

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RECEIVABLES MANAGEMENT 2

• Penalties
• Post dated cheques
• Legal process
• Internal process
• Stop supply
• But do not forget Relationship

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VALUE DATING

• Forward Value Dating
• The time between a bank being notified of a
  transaction in favor of a customer and the
  customer receiving future value for the item
• Back Value Dating
• The time between a bank being notified of a
  transaction to the customers account and the
  item being valued on a date prior to the date of
  the transaction

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FINALITY

• The time after which a payment is considered to
  become irrevocable and cannot be returned without
  the permission of beneficiary account holder.

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DOMESTIC PAYMENT INSTRUMENTS

• Paper-based
• Cash
• Cheques
• Bank transfers or giros
• Postal giros
• Bills of exchange
• Promissory notes
• Bankers drafts
• Search for APACS on the internet

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Method of PaymentCheque Clearing, UK
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DOMESTIC PAYMENT INSTRUMENTS

• Electronic
• Funds transfer
• Urgent wires
• Standard EFT
• Automated clearing house payments
• Standing order
• Direct Debit
• Electronic bills of exchange
• Plastic (credit, charge, cheque guarantee, cash
  dispenser, debit)
• Financial EDI
• Look up Voca on the internet, used to be BACS

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CROSS-BORDER PAYMENTS

• Paper-based
• Foreign currency cheques
• Bankers drafts
• Giros (Credit transfer)
• Documentary collections
• Cheque negotiations

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CROSS-BORDER PAYMENTS

• Electronic
• Using correspondent banks
• Using a global or pan-regional bank
• Cross-border systems
• TARGET
• EBA EURO 1
• EBA Step 1
• CHAPS euro (NewCHAPS)
• Credit cards
• Direct debits

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Clearing House Automated Transfer System
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Controlling Float

• Bank Services
• Lockbox
• Intervention accounts
• Remote disbursement
• Controlled disbursement
• Direct collections
• Efficient collections structure

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PAYABLES

• Critical questions
• What is due?
• When is it due?
• Where should the payment be sent?
• How should the payment be sent?
• Are there funds to cover the payment?
• Is the payment properly authorized?

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PAYABLES MANAGEMENT

• The flip side of the coin
• So
• Hang on to it
• Consider float versus control
• Account structures
• Discounts
• But do not forget Relationship

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SHORT-TERM INVESTING

• The Decision Process
• How much do I have to invest per currency?
• How long do I have to invest it?
• Where are the funds located?
• What is my appetite for risk?

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INVESTMENT GUIDELINES

• What are the companys policies regarding
• Currency exposure and hedging
• Banks used and limits
• Investment instruments and limits
• Use of automated sweep accounts
• Bank / investment ratings

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FACTORS IN CHOOSING INVESTMENTS

• The need to make an adequate return
• The need to take into account areas of risk
• Credit risk
• Interest rate risk
• Capital risk
• Market risk
• The need to consider liquidity

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HOW RATES ARE QUOTED

• At a discount Instrument issued at less than
  100
• Coupon Specific interest payments made at
  specific times
• Yield to redemption Interest payments over the
  lifetime of the instrument and principal repaid
  may be greater or less than 100

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SHORT-TERM INVESTMENTS

• Commercial paper (CP)
• Bankers acceptances (BAs)
• Repurchase agreements
• Certificates of deposit (CDs)
• Money market funds
• Treasury instruments (bills, notes, bonds)

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SHORT-TERM BORROWING

• The Decision Process
• How much needs to be financed and in what
  currency?
• How long does the deficit need to be financed?
• Where does it need it be financed?
• What is the maximum level of funding needed?

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FACTORS AFFECTING BORROWING

• These factors affect both amount available and
  cost
• Financial strength of the company
• Key covenants
• Industry
• Available guarantee or security
• Companys ability to repay on time from banks
  perspective

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SHORT-TERM FUNDING INSTRUMENTS

• Internal short-term funding
• Least expensive source of funding
• Cross-border and cross-currency intra-group
  financing can be difficult
• External short-term funding
• Can act as a built-in hedge if sourced in the
  same currency
• Can be inexpensive to borrow local currency in
  the currency center

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FACTORS IN CHOOSING FUNDING INSTRUMENTS

• All-in borrowing cost
• Security required
• Terms conditions
• Tax balance sheet aspects

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INVESTMENT DECISION PROCESS
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THE FINANCING DECISION PROCESS
Monitor cash flow forecasts
annually / quarterly / monthly / weekly / daily
Identify deficits
Determine
Amount / currency
Duration / location
FINANCING DECISION
Financing action
Documentation
Recording / monitoring / reporting
Liquidation
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U.S. SHORT-TERM INVESTMENTS

• Commercial paper (CP)
• Bankers acceptances (BAs)
• Repurchase agreements
• Certificates of deposit (CDs)
• US Treasury instruments (bills, notes, bonds
  STRIPS)

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INTERNATIONAL SHORT-TERM INVESTMENTS

• Bankers Acceptances
• Commercial paper
• Euro
• GBP
• Treasury bills
• Certificates of deposit
• GBP
• Eurodollar

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BILLS OF EXCHANGE

• Foreign currency
• Commercial
• GBP
• Eligible
• Ineligible
• Trade bills

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FACTORS IN CHOOSING FUNDING

• Are all-in borrowing costs being offered?
• Does the bank require security?
• What are the terms and conditions?
• Is interest able to be offset on tax returns?

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OTHER SOURCES OF FUNDING

• Factoring
• Invoice discounting
• Trade bills
• Acceptance credits