WORKING CAPITAL & CASH MANAGEMENT

Transcription

1 WORKING CAPITAL & CASH MANAGEMENT STRATEGIES TO PROTECT THE FINANCIAL POSITION OF YOUR BUSINESS PRESENTATION BY HM Nhende 1

2 Overview of the Presentation Definition of Working Capital Components of Working Capital (WC) Objectives of WC Operating Cycle Cash conversion cycle Essentials of Effective WC Management (WCM) Determinants of WCM Strategies Trade-offs in WCM Inventory Management Strategies Receivables Management Strategies Accounts Payable Management Strategies Cash Management Strategies Conclusion. 2

3 Definition of Working Capital (WC) Explained by other terms used; a) Revolving capital b) Short-term capital c) Circulating capital Therefore WC is;.current assets of a company that are changed in the ordinary course of business from one form to another, as for example, from cash to inventories, inventories to receivables, receivables to cash Genestenbreg 3

4 Components of WC Inventories - (raw materials, work-in-progress & finished goods) Receivables (e.g. trade debtors) Cash & Marketable Securities Current Liabilities (trade payables, short term borrowings). 4

5 Objectives of WC Management (WCM) There are two main objectives of WCM; Profitability (creation of shareholder value) Liquidity (to meet short-term obligations) As such WC is the life-blood and engine of any business. The management of this life-blood focuses on the Operating & Cash Conversion Cycles of the business. 5

6 Accounts Payable Value Addition Raw Materials W I P Cash THE WORKING CAPITAL CYCLE (OPERATING CYCLE) Finished Goods Accounts Receivable Sales 6

7 Cash Conversion Cycle (CCC) A- Inventory conversion period = Avg. inventory Cost of sales/365 B- Receivable conversion period = Accounts receivable Annual credit sales/365 C- Payables deferral period = Accounts payable (Cost of sales)/365 The CCC = Inventory + Receivables Conversion Periods AccountsPayable deferralperiod(i.e.a+b C) 7

8 Essentials for Effective WCM IT Systems Credit Rating Bureau Communication Channels Transport and other logistics end Financial & Legal Services Sectors Human Resources / Skills 8

9 Determinants of WCM Strategies WCM strategies are driven by a number of factors including; Risk appetite of the Company (aggressive, moderate or conservative) or Trade-offs in WC Type of products/services Demand patterns Industry/market s operating cycles Financing options 9

10 Trade-offs in WCM Inventory High Levels Benefit: Satisfied customers Few production delays Cost: Expensive High storage costs Risk of obsolescence Low Levels Cost: Shortages Dissatisfied customers Benefit: Low storage costs Less risk of obsolescence Cash High Levels Benefit: Reduces risk Cost: Increases financing costs Low Levels Benefit: Reduces financing costs Cost: Increases risk 10

11 Trade-offs in WCM Accounts Receivable High Levels (favourable credit terms) Benefit: Satisfied customers High sales Cost: Expensive High collection costs Increases financing costs Low Levels (unfavourable terms) Cost: Dissatisfied customers Lower Sales Benefit: Less expensive Accounts Payable Benefit: High Levels Reduces need for external financing source Cost: Unhappy suppliers Poor credit rating Benefit: Happy suppliers Cost: Low Levels Suppliers are a cheap source of funding 11

12 Inventory Management Strategies Reduce procurement & manufacturing lead times Focus on key product lines to eliminate or reduce stock-outs increase profitability. Replenishment should be demand driven (knowledge of market & technology is key). Apply EOQ, to reduce procurement costs consider economies of scale as per next slide. Establish optimal stock holdings to reduce carrying costs. Manage stock ageing IT driven. Slow moving stocks should be disposed at reduced prices / on cost recovery basis (avoid sentimental or speculative holding) see example next slides 12

13 Economic Order Quantity (EOQ) EOQ = (2FS/CP) Assuming Musiyemwa(Pvt) Ltd is in the business of selling Mackarel fish. Fish sold per year: 240,000kg at $2/kg Inventory carrying costs: 20% of average inventory level Fixed cost of ordering: $30 per order EOQ = (2)($30)(240,000)/(0.20)($2) = 6000 kg per order 13

14 Slow Moving Stocks Costs Cost of Inventory $ 1,000 Mark-up 15% Effective borrowing costs p.a. 18% Carrying costs per month 1% Gross Profit $ 150 Borrowing costs over 6 months $ 90 Carrying costs over 6 months $ 60 Total cost over 6 months $

15 Inventory Management Strategies (CONTINUED) Where applicable consider consignment stocks arrangements. In this country JIT may not be an option. Reduce or eliminate pilferage. Uphold appropriate products standards. Insure (replacement value) adequately at all times. Appoint suitably qualified personnel to manage inventory. 15

16 Receivables Management Strategies Extending credit to customers is effectively giving loans to customers. Establish robust credit mgt policy & application forms. Before extending credit consider the 5 Cs in credit mgt; 1. Character: moral integrity, legal standing and reputation of credit applicant. 2. Capacity: financial capacity to meet required account payments credit limits 3. Capital: general financial condition of firm as judged by analysis of financial statements 4. Collateral: existence of assets. 5. Conditions: operating and financial conditions 16

17 Receivables Management Strategies Thorough vetting of customers before extending credit. Credit appropriateness to the customer. Introduce financial services that promote early/easier account settlement, such as electronic payment systems. Employ IT systems that allow effective & efficient mgt of receivables. 17

18 Receivables Management Strategies (continued) Appoint an effective & qualified credit controller. Establish effective communication & distribution systems (orders, invoicing & stmts, delivery) Early settlement incentives & push for cash sales. Outsource and discount the debtors book where possible. For Groups, centralise credit mgt but if not practical, the SBUs need to share credit information. Infuse marketing aspects in credit mgt. 18

19 Receivables Management Strategies Debtors ageing reviews should be done regularly. Where a customer appears to be struggling promptly cut /minimise losses; take action - stop supplies, if product is still on hand get some back, final demand, acknowledgment of debt & take legal action. Litigation has its shortcomings. Where possible insure certain aspects of debtors book, particularly for export customers. 19

20 Accounts Payable Strategies Aim to extend the credit terms offered by suppliers, ideally the terms should dovetail your operating cycle. Have more than 1 supplier per product. Where possible seek for consignment arrangements. Avail production and/or inventory replenishment plans covering well beyond the lead period. Request suppliers to guarantee supplies & product quality. Actions should provide assurance to suppliers that the business is credit worth. 20

21 Cash Management Strategies REASONS FOR HOLDING CASH; Transaction motive for normal business transactions. Precautionary motive to meet unplanned emergencies. Speculative motive to take advantage of unanticipated business opportunities. 21

22 Cash Management Strategies Diligently perform cash budgets/forecasts daily, weekly, monthly and annually. Allocate cash resources first to key business drivers & most profitable lines. Utilise cash balances to achieve lower cost of inventory economies of scale, cash discounts etc. Invest (short-term deposits) excess cash to maximise interest income. Keep a number of standby borrowing / overdraft facilities with a number of financial institutions. 22

23 WCM Strategies Conclusion Liquidity ratio analyses are critical but should not be taken at face value. Benchmark with reputable local and international businesses (mediocrity is not enough). When the indications are negative, move swiftly to downsize to ensure there is no overtrading. Overhead costs are the greatest threat to eating into WC thus should be at consistent level with business activity. 23

24 WCM Strategies Conclusion Indications of overtrading; rapid growth in sales over short period; rapid growth in current and perhaps non-current assets; deteriorating inventory and trade receivables days ratios; increasing use of trade credit to finance current asset growth (increasing trade payables days); declining liquidity, indicated perhaps by falling quick ratio; declining profitability, perhaps due to using discounts to increase sales; decreasing amounts of cash and liquid investments, or a rapidly increasing overdraft. 24

25 WCM Strategies are not Stagnant "Success is a lousy teacher. It seduces smart people into thinking they can't lose. Bill Gates 25

26 Q & A 26