HAPP¥ N€W ¥€AR !
Working Capital Management
Advanced Corporate Finance
Spring 2014 Shanghai- week7
FINC 5880
Look at the past success of Dell
 BTO strategy..
WC Dell
Remember
 WC= current assets used for
operations
 Net WC=current assets-current
liabilities
 Net Operating WC=Cash + AR+
Inventory-AP-Accruals
 Current ratio
 Acid test ratio
 WC policy; target levels and
finance
 WC Management: setting targets,
organize, lead, monitor…day to
day…
Reduced WC creates value
 FCF will increase since delta WC
decreases over time
 EVA increases since the total
operating capital decreases and
thus WACC*TOC
 Remember EVA=NOPATWACC*TOC
 Also ROE increases since total
assets reduces
 Remember ROE=ROS*Sales/Total
Assets*Total Assets/Equity
Cash conversion cycle
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
Cash
Purchase inventory
Process goods
Sell goods on credit
Collect AR
Cash
Conversion calculated
 Inventory Conversion:
Inventory/Sales per day (say 72
days)
 Receivables Conversion: (also
DSO) Receivables/Sales per day
(say 24 days)
 Payables Conversion:
Payables/Purchases per day
(note at COGS) (say 30 days)
 Conversion cycle=72+24-30=66
days
 Shorter conversion cycles create
value!
Companies that pursue WCM
actively
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Boeing
Guess
PepsiCo
Cisco
Johnson Controls
Mac Donald’s
Eastman Kodak
WC score cards
 CFO magazine
calculates WC
performance for
main industries
 Check their website
at www.cfo.com
Barely Working: The 2003 Working
Capital Survey
 Maybe they were preoccupied with governance issues.
But whatever the reason, U.S. companies blew some
good chances last year to generate extra cash via
working capital improvements. That's the primary
conclusion of CFO's annual CFO's annual working
capital survey, conducted by REL Consultancy Group.
 The survey, which examines the 1,000 largest U.S.
companies, showed the average company improved
its days working capital (DWC) by a meager 2.1
percent. That's a poor showing compared with
previous years — for 2001 the improvement was 9
percent. It's also just a fraction of the 7.6 percent
improvement recorded by European companies
WC Performance…
 U.S. Versus Europe
A comparison of the top 1,000 companies
(by sales, in $billions, for all figures) here
and in Europe show European firms
narrowing the gap.
 Despite deterioration in DPO, they
improved their average DWC by 7.6
percent. Their U.S. counterparts displayed
an unimpressive 2.1 percent improvement
in DWC in 2002.
Zero WC

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
General Electric..
Inventory should be
financed by suppliers
So force payables to this
level
WC=AR+ Inventory-AP
these three elements are
intensively managed
Companies carry on
average 20 cts per USD in
WC
The WC is turned over 5
times per year!
Cash management
 Reasons for holding cash:
 Transaction balances for
day to day payments
 Compensating balances
allowing banks to provide
for costs of loans
 Precaution
 Speculation
Advantage of holding cash
 Benefit the discounts for
paying promptly
 Maintain good credit ratings
 Take advantage of special
offers/discounts on
opportunity buys
 Meet emergencies as strikes,
fires, marketing campaigns
of competition, and cyclical
downturns
The cash budget
 Forecast of Cash in
versus cash out
 Per month, week,
day
 Based on past
experience and
updated with new
knowledge
 Focusing on a Cash
target level
Inventory

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

Supplies
Raw materials
WIP
Finished goods
 Inventories should be available at the right
time
 Ordering and carrying costs of all inventory
should be minimized
Inventory control
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The red line method
Two bin method
Computerized inventory control
JIT
Outsourcing
Accounts Receivable
 Quantity: DSO
 Quality: aging schedule
 Credit policy:
 Credit period
 Discounts for early payment
 Credit standards (credit worthiness of
customers)
 Collection policy (how to approach slow
payers)
EOQ (Economic Order Quantity)
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Order Cost= D/Q*Co
Holding Cost= 1/2Q*Ch
Total Cost= D/Q*Co+1/2Q*Ch
d(Tc/Q)=0
Then Q= (2DCo/Ch)0.5
Assignment: Working Capital
 Analyze the WC of your company
 Determine the cash cycle time and compare it
to it’s main competitors
 If you were in charge in this company what
would you do to better manage WC
 What is the implied value impact of your
actions on the company’s value?