WORKING CAPITAL & CASH
MANAGEMENT
STRATEGIES TO PROTECT THE FINANCIAL
POSITION OF YOUR BUSINESS
PRESENTATION BY HM Nhende
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)
• 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
Definition of Working Capital (WC)
Explained by other terms used; a) Revolving capital
b) Short-term capital c) Circulating capital Therefore WC is;
“
“……..currentcurrent assetsassets ofof aa companycompany thatthat areare changedchanged inin thethe ordinary
ordinary coursecourse ofof businessbusiness fromfrom oneone formform toto another,another, asas for
for example,example, fromfrom cashcash toto inventories,inventories, inventoriesinventories toto receivables,
receivables, receivablesreceivables toto cash”cash”
……
Components of WC
•
Inventories -
(raw materials, work-in-progress & finished goods)•
Receivables
(e.g. trade debtors)•
Cash & Marketable Securities
•
Cash & Marketable Securities
•
Current Liabilities
(trade payables, short term borrowings).Objectives of WC Management (WCM)
There are two main objectives of WCM;
• Profitability (creation of shareholder value)
• Liquidity (to meet short-term obligations)
• 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
THE WORKING CAPITAL THE WORKING CAPITAL Accounts Payable
Raw
Materials W I P
Value Addition
THE WORKING CAPITAL THE WORKING CAPITAL
CYCLE CYCLE (OPERATING CYCLE) (OPERATING CYCLE) Cash Finished Goods Accounts Receivable Sales
Cash Conversion Cycle (CCC)
A - Inventory conversion period= Avg. inventory Cost of sales/365
B - Receivable conversion period = Accounts receivable
= Accounts receivable
Annual credit sales/365 C - Payables deferral period
= Accounts payable
(Cost of sales )/365
The CCC = Inventory + Receivables Conversion Periods – Accounts Payable deferral period (i.e. A + B – C)
Essentials for Effective WCM
•
IT Systems
•
Credit Rating Bureau
•
Communication Channels
•
Transport and other logistics end
•
Transport and other logistics end
•
Financial & Legal Services Sectors
•
Human Resources / Skills
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 moderate or conservative) or Trade-offs in WC•
Type of products/services
•
Demand patterns
•
Industry/market’s operating cycles
•
Financing options
Trade-offs in WCM
Inventory
High Levels Low Levels
Benefit:
• Satisfied customers
• Few production delays Cost:
• Expensive
• High storage costs
Cost:
• Shortages
• Dissatisfied customers Benefit:
• Low storage costs
• Less risk of obsolescence
• High storage costs
• Risk of obsolescence
• Less risk of obsolescence
Cash
High Levels Low Levels
Benefit:
• Reduces risk Cost:
• Increases financing costs
Benefit:
• Reduces financing costs Cost:
Trade-offs in WCM
Accounts Receivable
High Levels (favourable credit terms) Low Levels (unfavourable terms) Benefit:
• Satisfied customers
• High sales Cost:
• Expensive
• High collection costs
Cost:
• Dissatisfied customers
• Lower Sales Benefit:
• Less expensive
• High collection costs
• Increases financing costs
Accounts Payable
High Levels Low Levels
Benefit:
• Reduces need for external financing source
Cost:
• Unhappy suppliers
• Poor credit rating
Benefit:
• Happy suppliers Cost:
• Suppliers are a cheap source of funding
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
• 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
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
• 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
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
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. • Uphold appropriate products standards.
• Insure (replacement value) adequately at all times.
• Appoint suitably qualified personnel to manage inventory.
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;
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
Receivables Management Strategies
•
Thorough vetting of customers before
extending credit.
•
Credit appropriateness to the customer.
•
Introduce financial services that promote
•
Introduce financial services that promote
early/easier account settlement , such as
electronic payment systems.
•
Employ IT systems that allow effective &
efficient mgt of receivables.
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 • Outsource and discount the debtors book where
possible.
• For Groups, centralise credit mgt but if not practical, the SBUs need to share credit
information.
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, 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.
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. 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.
Cash Management Strategies
REASONS FOR HOLDING CASH;
•
Transaction motive – for normal business
transactions.
•
Precautionary motive – to meet unplanned
•
Precautionary motive – to meet unplanned
emergencies.
•
Speculative motive – to take advantage of
unanticipated business opportunities.
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 • 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.
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).
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.
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 • 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;
