Chapter 23: Exercises Related to Cash Flow Management

Transcription

1 Management for Engineers, Scientists and Technologists by John V. Chelsom, Andrew C. Payne and Lawrence R. P. Reavill 2005 John Wiley & Sons, Ltd Chapter 23: Exercises Related to Cash Flow Management Introduction What happens when new technology is developed by a small team of scientists at a university, or on a new science park, and they wish to turn their research output into a commercial product? There may be only half a dozen people in the team, they may have been in business for less than two years, yet they have an idea that may have huge commercial potential for some global organization. When they approach the buyer in an appropriate industrial giant they hear that they can t be taken on as a direct supplier, because that conflicts with the policy of reducing supplier numbers, and there is a rule that the giant only does business with financially sound companies with ISO 9000 quality certification. The best that can be offered is a role as subcontractor to an established first-tier supplier dealing in somewhat similar technology. This is typical of conflicts of objectives in large companies, and typical of the gap between grand corporate concept and nitty-gritty implementation at ground level. It has serious implications for the survival of the small innovator, as may be discovered from the two exercises. Also, the global company may not retain access to the new technology if it fails to establish a good relationship with the SME. Some general business background has been provided to put the exercises into context. These are real-world examples. See what you make of them they may help any of you who have plans to start your own business. The arithmetic is easy. Management s job is to see the implications of the numbers and decide what to do about any problems that they pose. Background to exercises In the late 1990s Ourco, the small start-up company featured in Chapter 23, had the opportunity of assisting Ford Motor Company with the task of preparing service literature for its products, that were increasingly being made and sold on a global basis. The situation created relationship problems similar to those found in several industries where companies were learning to operate on a global scale andatthesametimetakeadvantageofnew technologies, which sometimes originated in small organizations in obscure corners of the world. A description of some of Ford s data management requirements, and a reminder of other major

2 20 CHAPTER 23: EXERCISES RELATED TO CASH FLOW MANAGEMENT international IT concerns at the time, will serve to illustrate the context of Ourco s cash flow management tasks that form the basis of the exercises. At Ford identical or very similar vehicles were planned that would be assembled in North America, South America, Europe and the Far East. Major systems, such as engines and transmissions, were also to be manufactured in plants on different continents and fitted to more than one range of vehicles. For example, a fourcylinder petrol engine was manufactured in Lima, Ohio (USA), Chihuaha (Mexico), Cologne (Germany) and Bridgend (Wales) and fitted in three car ranges Fiesta, Focus and Mondeo. Publications had to be prepared to describe the repair and servicing tasks for all these vehicles, and databases listing all serviceable components had to be prepared and maintained for use in all locations where the vehicles might operate. Printed and electronic publications were required. Another aspect of Ford s globalization was that it was seeking to establish a global supplier base. To simplify its interaction with component suppliers, Ford, like most western automotive companies, sought to change from a broad, flat supply base involving contact with thousands of suppliers, to a tiered structure, with only a few hundred suppliers dealing direct with the vehicle maker. First-tier suppliers, those shipping direct to Ford, would provide assemblies (systems) and be responsible for coordinating all activities of subassembly suppliers in the lower tiers. Similar thinking was applied to non-production suppliers the providers of materials, equipment, lubricants, stationery, tools, services etc. based on the realization that when dealing in small quantities with small suppliers, the procurement process often cost more than the price of the item purchased. The objective was to reduce the number of non-production suppliers by 90%. However, globalization of processes and the incorporation of new technologies might require the addition of suppliers who had rare new skills. This applied particularly to the information technologies required to manage data on a global scale the World Wide Web depends on esoteric programming languages that relatively few people have mastered, and the design of global systems requires analysts of unusual vision and experience. Implementation of global systems requires special project management skills. All three of these sets of rare abilities were needed for many of Ford s global programs engineering data from the various centres of product development in the USA and Europe was the input to support systems for the newly designed vehicles in many different countries. Every vehicle has an owner s manual, a spare parts list, dealer servicing instructions, sales literature etc., and a design change has to be reflected in all the databases supporting these publications, some of which are in up to 15 languages. Outside the automotive industry at that time (the late 1990s), other companies were also involved in global projects. Financial institutions operating international banking and investment systems were all concerned about the effects of Y2K and the Millennium Bug. In Europe, most EU members were also preparing for launch of the euro. These two events themselves generated increased demand for computer programmers and systems analysts, and the fact that they were one-off events meant that clients were prepared to pay double or treble the normal rate for short-term help. Ourco, based in Oxford, with only 20 employees, could see many opportunities to sell its services and had to select those that offered the best long-term growth potential. Assuming some degree of success, it had to build up its workforce to

3 CHAPTER 23: EXERCISES RELATED TO CASH FLOW MANAGEMENT 21 deliver the increased level of sales and be prepared to cooperate with clients far away from Oxford. The first exercise relates to taking on new employees and the effect on Ourco s finances. The second is based on a situation where Ourco had the opportunity to supply a multinational company (MNC) that was going through a process similar to that described above for Ford. The MNC wanted the rare skills that Ourco could provide, but did not wish to engage directly with an additional supplier particularly a small, untried one. Its solution was to procure Ourco s services through one of its existing first-tier suppliers (T1co). The services were provided direct to the MNC, but administration, including payment, was handled between the MNC and T1co. This led to cash flow problems at Ourco. EXERCISES Exercise 1: The cash flow effect of taking on one employee The company has to keep hiring to meet growing demand for its services. It costs 6000 to equip each newcomer, and their employment and other costs are 3000 per month. After one month s training and assimilation the new employee can be charged out at 600 per day plus VAT at 17.5%. Chargeable days are invoiced in the first week of the month following completion of the work. Customers make payment runs at the end of each month, and their banks transfer funds to suppliers in the first week of the next month. (Students may find it helpful to draw a bar chart showing these events.) (a) What is the effect on cash flow, for each new employee, for the following pattern of work? Month 1 Month 2 Month 3 Month 4 Month 5 Month 6 etc. Induction/ 8 chargeable 12 chargeable 15 chargeable 15 chargeable 15 chargeable Training days worked days worked days worked days worked days worked (b) What can the company do to improve this aspect of cash flow? Exercise 2: Expanding as a subcontractor The start-up company, now an SME, is taken on as a subcontractor to a UK-based first-tier supplier (T1co), which holds a blanket purchase order from the German subsidiary of a multinational client (MNC). (See Chapter 21 for a description of blanket orders.) Consultancy services are to be provided in the UK at 800 per day plus 200 per day expenses plus VAT at 17.5%. Chargeable days are invoiced to T1co in the first week of the following month. T1co marks up SME invoices by 10%, and includes them with other work in a month-end invoice to MNC. MNC issues cheques at month end for all invoices cleared OK to pay by the 10 th working day, and T1co pays its subcontractors at the end of the month in which it is paid by MNC. (Again, a bar chart of invoice/payment events may be found helpful.)

4 Chapter 23: The Debtors Dilemma Customer Relationship Issues for Discussion Background Many public authorities operate annual budgets with use it or lose it rules. Organizational components are allocated sums of money, to be spent on specified activities within the financial year. If the money has not been spent by the end of one year, it cannot be carried over to the next. In some cases, an under-run will actually result in a lower allocation for the following period. One symptom of this practice is the flurry of repair and improvement activity on Britain s streets in February and March, when borough engineers see that they still have money to spend before the budget period ends on March 31. A less obvious effect is the practice of asking suppliers to invoice before the end of the financial year for work not fully completed, or services not yet rendered, possibly linked to an understanding that the supplier will not press for payment within its normal terms but will wait until the job is done. This puts the supplier in an awkward situation. It wants to be cooperative and to build a relationship with the user area in the client company (the people who actually use the product or service) that will lead to ongoing business. However, it does not wish to do anything illegal and it will be wary of breaking any of the client company s internal rules in a way that may damage the overall relationship, or make it difficult to deal with the client s support activities such as purchasing and accounts payable. Should it receive an invitation (proposition?) to cooperate with the client user area in this way, the supplier needs to do a risk assessment covering at least the following issues: 1. Is what we are being asked to do legal? 2. Do we really need this assignment, or are there other, more straightforward, applications for our resources available at this time? 3. Do we have the capacity to deliver over the deferred period proposed? 4. What is the likely long-term effect on our level of business with this client of (a) refusing (b) accepting the invitation? 5. If we accede to the request, is there a risk that payment for our goods and services may be delayed (for example by queries from the client s accounts payable activity)?

5 24 CHAPTER 23: THE DEBTORS DILEMMA CUSTOMER RELATIONSHIP ISSUES FOR DISCUSSION 6. What is the risk that we may not be paid at all? If the answer to question 1 is No, that should be the end of the matter don t do it. Similarly, if question 3 or 6 indicates any significant risk, a carefully worded refusal would be appropriate. EXERCISES Exercise 3 An SME supplier who has been in business for only three years has reached a turnover level of about 1 million p.a., with a portfolio of about 20 clients, including five who account for more than 60% of sales. The company sells office equipment with lead times from order to delivery of between 30 and 60 days, with prices ranging from to It also provides after-sales services such as installation, training and maintenance. A public-sector client, one of the big five customers with whom the supplier has been doing steady business, finds that it is approaching the end of its financial year with of its budget unspent, which it will have to surrender to the regional authority if it is not used. It issues an enquiry to the SME for of equipment and of after-sales services. The SME responds with a delivery date two weeks into the new financial year. The client suggests that it issue an order without a specified delivery date, and that the SME issues an invoice for in the last week of the financial year three weeks before the equipment can be delivered. What should the SME do? Exercise 4 Faced with the situation described in Exercise 3, the supplier decides to go along with the client s proposal and awaits the purchase order (PO) against which to invoice. Shortly before the end of the client s financial year, about the time that the supplier had agreed to issue the invoice, the supplier calls to give the number of the PO, which has been raised and approved by local management. However, it adds, there has been a delay in processing the order through the regional office. It asks the supplier to issue the invoice as previously agreed, and the supplier complies. Three weeks later, when the equipment is ready for delivery, the PO still has not been received. The client user area assures the supplier that approval is imminent and asks the supplier to ship and install the product, which the supplier does. After the equipment has been installed, the supplier is asked to provide the training specified in the order, but declines to do so until the PO is received. Anxious about the of the invoice now due for payment, the supplier contacts the client s accounts payable department, which say that nothing can be paid because it does not have a copy of the approved PO. Three weeks later, with no PO or payment received, the supplier s finance director contacts the client s regional finance director to ask for the to be paid. She replies

6 CHAPTER 23: THE DEBTORS DILEMMA CUSTOMER RELATIONSHIP ISSUES FOR DISCUSSION 25 that it will not be paid, since the region has a budget deficit and she has called in each district s unspent balances from the prior year. She claims that there is no obligation to pay because the supplier has no approved PO. What should the supplier do? Exercise 5 While the situation at the end of Exercise 4 is unresolved, the client issues an enquiry for one year s general maintenance of all office equipment in the district where the supplier has installed, but has not been paid for, the equipment invoiced at Contacts in the client user area tell the supplier that the budget for the contract is , and suggest that its chances of winning the order would be improved if its does not press its outstanding claim for What should the supplier do? Answers: There are no right answers to the questions posed in Exercises 3, 4 and 5. Some possible courses of action are provided in the solutions section.