“How the Company manage their Working Capital and at the same time manage their Liquidity?”
LONDON SCHOOL
OF
COMMERCE
Course Title: MBA Finance
Muhammad Yasir
Student ID Number: 0670-KRKR-0609
Report Title
How the Company manages their Working Capital
and at the same time manages their Liquidity?”
“
A Case Study based on Royal Dutch Shell Plc
“How the Company manage their Working Capital and at the same time manage their Liquidity?”
PREFACE
In the Name of Almighty God who has enabled me to
successfully complete this Analysis Report.
All Praise is to Him and All Thanks is to Him.
I also thank my Personal Project Tutor who has mentored and
assisted me in completing this task.
I would also like to dedicate this Report to my Parents who
gave me the chance, ability and support to undertake the
course which entailed the Report Research and successful
completion.
“How the Company manage their Working Capital and at the same time manage their Liquidity?”
Table of Contents:
1.0
REPORT INTRODUTCION
1.1
Reason for choice
1.2
Purpose
1.3
Objectives
1
1
2
3
2.0
COMPANY INTRODUCTION
2.1
Company history
2.2
Geographical presence
2.3
Business lines
4
4
7
8
3.0
METHODOLOGY USED TO CONDUCT STUDY
3.1
Project planning
3.2
Project organization
3.3
Project analysis
3.4
Project documentation
3.5
Quality assurance
11
12
12
13
13
13
4.0
LITERATURE REVIEW
4.1
Working capital
4.2
Working capital management
4.2.1
Reducing inventories
4.2.2
Managing Receivables
4.2.3
Managing suppliers
4.2.4
Days sales outstanding
4.2.5
Days inventory outstanding
4.2.6
Days payable outstanding
4.3
Working Capital Management during the recession (credit crunch)
4.3.1
Ernst & Young’s ‘All tied up – Working Capital Management
Report 2009’
4.3.2
Key findings of the report
4.4
Importance of cash management during the crisis
4.5
Suggestions for the future regarding Working Capital Management
4.6
REL’s Research report: ‘Blue Print for cash culture’ released in
January 2010
4.7
Relevance of these two reports and their findings to my research
4.8
Cash Management and its importance for organizations today
15
15
16
18
19
19
21
21
22
22
23
24
26
27
29
31
31
“How the Company manage their Working Capital and at the same time manage their Liquidity?”
4.9
4.8.1
Effective cash management
4.8.2
Ways to achieve more effective cash management
The six pillars to increasing profitability in a business
31
32
33
5.0
PROJECT REPORT RESEARCH & METHODOLOGY
5.1
Sources Used and Reasons
5.2
Methods Used in gathering information
36
36
37
6.0
DATA ANALYSIS
6.1
Interpretation
6.1.1
Profitability Ratios
6.1.2
Management Efficiency ratios
6.1.3
Liquidity Ratios
6.1.4
Stability Ratios
6.1.5
Investor Ratios
6.2
Explanation of Analysis
6.2.1
LIQUIDITY
6.2.2
MANAGEMENT EFFICIENCY RATIOS
6.2.3
FINANCIAL EFFICIENCY RATIOS
39
39
39
39
40
40
40
42
42
43
44
7.0
SWOT ANALYSIS
46
8.0
REFINING INDUSTRY OUTLOOK 2010
49
9.0
CONCLUSION
53
BIBLIOGRAPHY
57
APPENDIX I
59
APPENDIX II
62
“How the Company manage their Working Capital and at the same time manage their Liquidity?”
1.0
REPORT INTRODUCTION
This Research and Analysis aims to report the financial health and situation of Royal Dutch Shell
Plc (the expression ‘Shell’ and “Company” will be used subsequently). It is majorly based on the
available audited financial statements for the year ended 31st December 2008 with the last five
years acting as comparatives. Additionally it includes some interpretations by some of the well
known financial experts and advisors as well as Organisations. There are many readily available
techniques of financial and working capital management, however for the basis of this project
the author has utilised Kaplan’s ACCA study literature (outlined in detail in the methodology
section). The analysis has been carried from a shareholders’ point of view where the author will
endeavour to determine the prospect of future growth of the Company. The author will utilize
some of the key ratios, important aspects of the business and the general economic environment
to obtain a clear picture about the future financial health of the company. Furthermore, by
evaluating Shell Plc’s performance in respect of the general economic environment and also
making comparisons with British Petroleum Plc (the expression ‘BP’ will be use subsequently),
the Company’s closest rival in the UK, the analysis will be complete from an investor’s point of
view.
1.1
Reason for choice
This particular topic was chosen by the author because the author has read many interesting
articles about Shell Plc via the press (newspapers and business magazines) and the refining
industry in general. Despite the fact that there has been recession in the overall capital markets
forcing companies into either administration or contracting their operations, Shell Plc on the
other hand has been looking to expand its product line and innovate constantly. The company’s
strategy has been of resilience and expansion throughout whilst maintaining their core principles
of innovation. Shell Plc’s commendable performance through the financial turmoil is shown by
their exceptional credit ratings ‘A-1+’ and ‘AA by Moody’s in the short term and long term
respectively. Their outlook has remained positive and stable (rated by both Moody’s and S&P)
throughout the financial turmoil. The aforementioned facts were a vital factor in choosing to
analyze the financial structure and thereby the health of Shell Plc, as it seemed like a story of
success for a company which is strong enough to maintain an efficient working capital
management system through one of the toughest economic conditions observed since World War
II. Additionally another article that caught the author’s attention was the dividend announcement
for the fourth quarter in the year 2008, despite the fact that there was an overall recession in the
capital market. Prices have increased due to inflation which significantly impacts the demand for
products and on the other hand industry is facing problems due to the volatility in the oil
markets. Additionally, the geographical tension in the Middle East and limited OPEC spare
production capacity caused further problems for the refining industry. Despite this Shell Plc has
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“How the Company manage their Working Capital and at the same time manage their Liquidity?”
managed to defy the odds and remained profitable and attractive to the investor(s). Other articles
of similar interest:
“Royal Dutch Shell on Thursday beat analysts' expectations with an 18 per cent rise in quarterly
earnings to $8.67bn. On a current cost of supplies basis, stripping out the effect of changes in
prices on inventories, Shell's earnings were 20 per cent higher at $7.56bn in the second
quarter.” (Financial Time)
“BP’s top executives, including Tony Hayward, chief executive, lose out on share bonuses last
year after the company performed worse than its peers in terms of shareholders returns. In the
three years to 2007, BP’s performance was the worst in that group, as a result of operational
problems, including project delays, shutdowns at its US refineries and an oil spill in Alaska that
led to a cut in production and company’s performance was fourth or fifth among its peers.”
(Financial Time)
“Royal Dutch Shell (RDS.A 50.36, +0.03, +0.06%)(RDS.B 48.81, +0.03, +0.06%) was
upgraded to overweight from neutral on Monday at J.P. Morgan, which said investor concerns
on exploration over the Macondo well incident in the Gulf of Mexico are "masking long-term
commodity positives." The investment bank is raising its 2010 estimates on oil prices to $80 a
barrel, owing to such factors as higher marginal supply premium risk from Macondo.” (The
Wall Street Journal)
Shell Plc’s net profit is $26,476 million compared to B.P Plc’s net profit which is $21,666
million which denotes that Shell Plc’s profits are 18.1 % higher than that of major rivals B.P. It
clearly shows that Shell Plc’s performance was far greater than BP in the use of the available
resources in the market (refer to appendix 1). The many other reasons include the reality that
Shell Plc constitutes the world’s largest retail fuel network with more than 46,000 service
stations. On the other hand BP is gradually deteriorating italic service stations, which has led the
author to enquire more about the company and its working capital structure. After having a
preliminary glance at the accounts and reading about the effective use of available resource(s)
and the situation of the company, the task of analysing the financial standing of Shell Plc seemed
much more interesting and challenging. (Source: The Shell Global)
1.2
Purpose
The basic purpose of this research is to determine how Royal Dutch Shell Plc manages their
working capital and profitability in order to maximize their profits and maintain their adequate
capital structure. This research and analysis report will present an attentive assessment of the
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“How the Company manage their Working Capital and at the same time manage their Liquidity?”
current financial status and the future growth opportunities of Shell Plc from an investor and
shareholder’s point of view. The present stakeholders are majorly interested in the level of risk,
liquidity, assets utilisation (activity), level of debt and return (profitability).
1.3
Objectives
The main objective of this study is to analyse the effect of working capital management on firm
profitability. Furthering this aim will be to consider statistically significant relationships between
firm profitability and the main constituents of the cash conversion cycle at length. According to
McDaniel and Gates (2006), “The research objective is a clear, targeted statement that
delineates the exact information needed to solve a research problem.” Therefore it is a necessary
requirement to define the objective of the research clearly before conducting the project.
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“How the Company manage their Working Capital and at the same time manage their Liquidity?”
2.0 COMPANY INTRODUCTION
Shell Plc is a global group of energy and petrochemical companies. Shell is a multinational oil
company (‘oil Major’) of Anglo Dutch background and is amongst the largest of oil producers
and refiners in the world. It has its second major functions in the United States where it operates
under the subsidiary ‘Shell Oil Company’. The headquarters are in The Hague, the Netherlands,
and the Chief Executive Officer is Peter Voser. The parent company of the Shell group is Royal
Dutch Shell plc, which is incorporated in England and Wales
Quick Facts: Shell by numbers
+ 90 countries where they operate
~101,000 number of employees
2% amount of world’s oil they produce
3% amount of world’s gas they produce
3.1 million barrels of gas and oil they produce every day
44,000 Shell service stations worldwide
145 billion litres of fuel sold
>35 refineries and chemical plants they run (figures for 2009)
1 ranking by Fortune 500 in 2009
(Source: The Shell Global)
2.1
Company History
In 1833, shopkeeper Marcus Samuel decided to expand
his London business. He sold antiques, but now added
oriental shells. His aim was to capitalise on a fashion for
using them in interior design. Demand was such that
Samuel quickly began importing shells from the Far East,
laying the foundations for his import and export business.
Until the year 1886, the market for oil remained confined
to lighting and lubricants. With the upcoming of the
internal combustion engine and with Karl Benz and the first Mercedes the demand for gasoline
arrived. At this time the Samuel business had passed to Marcus Samuel junior (pictured above)
and his brother Sam. They were involved in the export of British machinery, textiles and tools to
newly industrialising Japan and the Far East and on return imported rice, silk, china and
copperware to the Middle East and Europe. In London, they traded in commodities such as
sugar, flour and wheat worldwide. Whilst in Japan Marcus became interested in the oil exporting
business which was at the time based in Baku, Russia. Transport facilities were weak at this time
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“How the Company manage their Working Capital and at the same time manage their Liquidity?”
to ship oil overseas from the landlocked region of Baku. The route taken by major suppliers
(Rothschild & Bnito) to bring oil to the Black Sea and then the overseas markets at this point is
pictured below:
Figure 1.0 (Source: The Shell Global)
The red line (currently known as the “Baku-Supsa” oil pipeline) was the route taken by major oil
suppliers to transport oil from Baku, Russia to the Black Sea and then overseas. However,
shipping oil still posed a major problem as oil was carried in barrels that could leak and took up
much space in the ship’s hold causing it to be inefficient.
The business was revolutionized when Marcus commissioned a fleet of steamers to carry oil
using the Suez Canal for the first time, this coupled with the establishment of oil storage ports in
the Far East, the Samuels managed to cut the cost of oil by substantially increasing the volume
that could be carried. This marked the beginning of the company renamed in 1897 from ‘The
Tank Syndicate’ to the ‘Shell Transport & Trading Company’.
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“How the Company manage their Working Capital and at the same time manage their Liquidity?”
Figure 1.1 (Source: The Shell Global)
The Successful Voyage of Marcus Samuel's ship, the Murex. It carried Rothschild kerosene
through the Suez Canal to the Far East. The canal shaved thousands of miles off the trip around
the horn of Africa. Rothschild kerosene could be sold cheaper than Rockefellers.
Marcus then decided to expand the oil business and cut his dependence on the Russian suppliers.
This led him into the Far-East region, where he encountered ‘Royal Dutch’ as the biggest
competitor. To overcome the might of Standard Oil, the two companies joined hands in a venture
and became fully merged in the year 1907. Two separate holding companies were setup with
Royal Dutch taking 60% of the earnings and Shell Transport left with 40%. The group has since
then rapidly expanded across the world and taken full advantage of the increasing demand of
gasoline in the markets of United States, Europe and in many parts of Asia (including the
emerging markets).
Shell is amongst the largest oil companies majorly in the US where approximately 22,000
employees are based. Shell leads the US oil market through approximately 25,000 self-branded
gas stations. This also serves as the most substantial consumer presence. Shell also is a 50%
stake holding partnership with the Saudi-Arabian state-owned oil company Saudi Aramco in
Motiva Enterprises. Motiva Enterprises is a refining and marketing joint venture owning three oil
refineries on the gulf coast of the United States. Shell also holds 80% of exploration firm Pecten
which specialises in exploring and drilling on various offshore locations including oil basins near
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“How the Company manage their Working Capital and at the same time manage their Liquidity?”
Douala, Cameroon in partnership with the French state-owned Elf Aquitaine (now Total). Shell
also has an agreement with Chevron in the US to supply each other with base stocks of gasoline
in areas where one company has refinery capacity while the other doesn’t. Since 1997 Shell and
Texaco have been jointly running two refining/marketing ventures. One of them merged the
Midwestern and western US operations forming Equilon. The other is Motiva, which mixed the
eastern and gulf coast operations of Shell Oil and Star Enterprise; Star Enterprise itself is a joint
holding of Saudi Aramco and Texaco. In 2001 Texaco merged with Chevron 2001, Shell then
purchased Texaco’s interests in the joint ventures in 2002 and began converting these Texaco
stations into the Shell Brand, which completed by 2004. This was termed ‘the largest retail rebranding initiative in American Business history’.
2.2
Geographical Presence
The company is a truly global provider of energy and petrochemicals with a presence in 90
countries and about 101,000 employees. The map below outlines the presence of Shell across the
world including the locations of its current major projects:
Figure 1.2 (Source: The Shell Global)
The following data has been extracted from the annual accounts of Royal Dutch Shell plc. The
figures (in $ Millions) give us an overview of the geographical split of Shell’s global business.
The chart below signifies this in a diagrammatic fashion. It can be seen that shell’s major
business is driven by the Europe, Africa and Asia regions while Australia / Oceania, USA and
Other Americas are contributing with decreasing contribution as listed.
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“How the Company manage their Working Capital and at the same time manage their Liquidity?”
200000
150000
Europe, Africa,
Asia
100000
Australia /
Ocenia
USA
50000
0
2009
2008
2007
Other Americas
Figure 1.3 Revenue split by Geographical Area (in $ Million) (Source: The Shell Global)
2.3
Business Lines
The shell company majorly deals with the production and sale of petrochemicals and associated
products. It is widely divided into three major business streams. This is explained by shell in the
following diagrammatic depiction:
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“How the Company manage their Working Capital and at the same time manage their Liquidity?”
Figure 1.4 (Source: The Shell Global Annual Accounts (2009))
1. Upstream Business: The Upstream businesses explore for and extract crude oil and
natural gas, often in joint ventures with international and national oil companies. Here
Shell also liquefies natural gas by cooling and transports it to customers across the world.
The Upstream businesses are grouped into two organizational units: Upstream Americas,
covering the Americas, and Upstream International, covering the rest of the world with
major interests in Europe, Asia/Middle East/Russia, Australia/Oceania and Africa.
2. Downstream Business: Downstream organization is made up of a number of businesses.
Collectively these turn crude oil into a range of refined Products, which are moved and
marketed around the world for domestic, industrial and transport use. These include fuels,
lubricants and bitumen. The manufacturing business includes Refining, Supply and
Distribution. Marketing includes our Retail, Business to Business (B2B), Lubricants and
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“How the Company manage their Working Capital and at the same time manage their Liquidity?”
Alternative Energies and CO2. The Chemicals business has dedicated Manufacturing and
Marketing units of its own. The global network of Shell Trading companies encompasses
Shell’s trading activities in every major energy market around the world. Shell also
manages one of the world's largest fleets of liquefied natural gas (LNG) carriers and oil
tankers.
3. Product & Technology: The Projects and Technology business stream provides technical
services and technology capability in upstream and downstream activities. It manages the
delivery of major projects and helps to improve performance across the company.
The following information depicts the cross business segment distribution of shell’s business. As
the data suggests, Downstream business provides the bulk of shell’s revenues.
450000
400000
350000
300000
250000
200000
150000
100000
50000
0
Upstream
Down Stream
Corporate
2009
2008
2007
Figure 1.5 Revenue By Business Segment (in $ Million) (Source: The Shell Global)
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“How the Company manage their Working Capital and at the same time manage their Liquidity?”
3.0
METHODOLOGY USED TO CONDUCT STUDY
The topic under discussion is based on “How the Company manage their Working Capital and at
the same time manage their Liquidity?”. The topic in question requires a methodology to be
adopted which will enable a smooth transition in tasks conducted, processes and with set
controls.
The methodology chosen which best suits the project methodology approach is that of PRINCE
II.
PRINCE II is the backbone of a structured approach to accomplishing project tasks. PRINCE II
(PRojects IN Controlled Environments) is a process-based method for effective project
management. PRINCE II is a de facto standard used extensively and widely recognised both in
the UK and internationally.
It has assisted as a complete set of rules, standards and guidelines in achieving key project
deliverables and within timelines for the completion of this study.
The reason for choice is that it has enabled the author to make use of the project methodology
contents such as:

Project Planning

Project Organisation

Project Analysis

Project Documentation

Project Risks

Project Control

Quality Assurance
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“How the Company manage their Working Capital and at the same time manage their Liquidity?”
When taking each of the contents into consideration, we can discuss how each stage has been
achievable. From inception of the report, through to analysis, documentation and closure, each
stage of the chosen methodology has been adopted to incorporate these practices.
3.1
Project Planning
In order to reach the report targets of formulating a detailed but concise report, Project Planning
is an essential platform which lays down the foundation of what needs to be achieved to produce
project deliverables within a set timescale.
This stage has been implemented where the author has created a detailed Project Plan
highlighting the various tasks to be completed (Please see Project Plan for further details,
Appendix 11).
The project plan is a detailed account of the events that have taken place throughout the lifecycle of producing this report. This entails actions such as Project Organisation, Analysis and
Documentation. Each task has been broken down using a Work Breakdown Structure (WBS) and
the actions to be completed have detailed in the plan to ensure that these are met by following up
on tasks and ensuring complete closure before embarking on the next.
This has provisioned as a guideline and determined a control procedure mechanism by
continually reviewing this document.
3.2
Project Organisation
This particular aspect in the Project Methodology has been exploited to detail the key personnel
directly involved in the development of this key deliverable being the complete Project Report.
This also includes a Communication Plan to address the particulars that are the main points of
contact being are approachable, to attain information, hold discussions and meetings as well
provide Project Status Reports (Please see Appendix 11 for a detailed Communication Plan).
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“How the Company manage their Working Capital and at the same time manage their Liquidity?”
The importance of Project Organisation is that it can lead to direction and purpose of the
intended and relevant portions of information to be appended and encompassed in the final
Report.
3.3
Project Analysis
This section of the report constructs the core literature of the intended report.
The measures which will be applied to attain pertinent data for analysis completion are as
follows;

Research on Annual Shell Plc Accounts and Quarterly Presentation Reports

General reading of material such as Newspapers, journals and topic related Books

Studying facts from CD-ROMs available from Libraries

Probing and investigating the internet from appropriate websites
This investigation and research method will provide a viable approach in understanding and
documenting the concepts described in the report. By utilising these measures, it will be possible
to extract and provide a complete explanatory report underlining aspects such as Data Analysis,
the risks involved during report findings and structuring the material in accordance to the
guidelines defined for successful completion.
3.4
Project Documentation
This entails everything from the analysis report itself comprising of the Project Plan, Project
Objectives, Communication Plan, Risk Analysis, Project Methodology used, Project Control
Procedures and the Report Analysis and Investigative Report.
3.5
Quality Assurance
This is a process by which the quality of the project can be tracked throughout the various stages
of the Report compilation. This is an essential tool and a control procedure to ensure that the
project does not deviate from its original scope.
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“How the Company manage their Working Capital and at the same time manage their Liquidity?”
Measures taken will be to monitor tasks achieved against listed tasks. Tools such as Project
Plan’s can be used to monitor progress and as check points to certify that tasks are being
achieved accordingly.
Furthermore, Project Status meetings with key stakeholders, such as with the Project Board
Members will also enable focus, direction, explore new avenues and follow guidelines as well as
address key issues and clarify current chores.
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“How the Company manage their Working Capital and at the same time manage their Liquidity?”
4.0
LITERATURE REVIEW
4.1
Working Capital
Introduction
The term ‘working capital’ relates to the current assets of the company that are left after
deducting current liabilities. These assets show the short term financial strength and stability of
the company and also reflect the company’s ability to raise further finances. Therefore, it can be
said that working capital essentially measures the Company’s liquid assets that are available to
further enhance, support and expand the business. The working capital figure itself can be either
positive or negative depending upon the company’s current assets or current liabilities. If the
company’s current assets exceed the current liabilities of the company then the figure will be
positive. On the contrary if the company is carrying more liabilities than its assets, then working
capital will be negative.
For example, in the consolidated balance sheet of Shell Plc for the year ended 31 December
2009, the company’s current assets are more than company’s current liabilities. Shell Plc current
assets are $96,457m and its liabilities are 84,789m (refer to appendix 1). The difference of the
two figures will give us a positive working capital of 11,668m. Therefore the working capital of
a company can be calculated by using the following formula:
Working Capital = Current Assets – Current Liabilities
Therefore it can be said that the working capital is the lifeline of the company and in order to
progress, it is imperative for any Company to maintain a healthy and positive working capital. A
high and positive value of working capital reflects high liquidity. Thus the companies that
possess surplus working capital are more successful since they can further expand and enhance
the efficiency of the business. These companies can excel without resorting to raising capital or
borrowing. But the companies that carry a negative figure for working capital on their balance
sheets struggle and terribly lack the funds necessary to grow and gradually sink in quick sand.
Other terms used for working capital are net current assets, net working assets or operating
assets. The corresponding ratios to further evaluate a company’s working capital current ratio
and quick ratio.
While gauging the enormity of consequences of negative working capital, it can be undeniably
stated that these consequences are catastrophic. A negative working capital signals the risk of
insolvency or bankruptcy. When the year on year negative working capital figures are revealed
in company’s balance sheets, both the shareholders and creditors grow wary of the financial
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“How the Company manage their Working Capital and at the same time manage their Liquidity?”
health of the company and their relevant stake in the company thus causing further problems for
the company. At the same time low working capital can also be translated in reduction in future
cash flows. Thus it is very important for a Company to maintain its working capital in order to
progress or grow.
However, it is worth mentioning here that the use and importance of working capital varies from
Company to Company depending upon its nature and type of business. Although generally it can
be stated that a positive working capital reflects strength of the company but if we go in further
depth, for some of the companies that is not necessarily the case. For instance a positive figure of
working capital also means that the company’s money is mostly in the form of stocks. This
would mean that the business is unable to sell its stock or is not liquid enough to pay its
immediate debts. Furthermore, a positive working capital can also mean that the debtors of the
company are not paying their debts in a timely fashion. This would mean that in an even where
the company is under a situation where they have to immediately pay its creditors, it would not
have enough liquidity as the money will be tied up due to late payments from trade debtors. This
issue can also raise concerns for bad debts or provisions related to trade receivables. Similarly, it
is not always necessary for all businesses; a negative working reflects a sign of warning or
caution. For example for the business that have high inventory turnover or are performing their
day to day transactions on a cash basis, they need very little working capital. For example a
grocery shop would want its stock to turn on a daily basis so that it can quickly generate cash.
For a grocery store if the stock is just sitting in the shop, it would be immensely problematic
despite working capital being high and positive since stocks form part of current assets.
Therefore for such businesses, if a financial crisis arises, the situation can be averted by simply
accumulating the cash generated from daily proceeds to pay off the debts. Thus businesses where
cash is generated on a daily basis, there is no need for a positive or high working capital.
(Source: QFinance)
4.2
Working Capital Management
Working capital management refers to a practice whereby management of the Company ensures
the maintenance of working capital by ensuring all the efficient levels of all the components of
working capital. These components of working capital are inventory, cash, accounts receivables
and accounts payables. By the virtue of working capital management, the efficiency of all these
components is ensured and thus working capital is maintained. The responsibility for managing
the working capital lies with senior management. The senior management ensures that the
efficient working capital management practices are followed in all the areas of the business that
make up the value chain.
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“How the Company manage their Working Capital and at the same time manage their Liquidity?”
The way working capital is managed has a great impact on company’s profitability. Working
capital management has both the long term and short term impacts. In the short term, if the
company’s working capital is managed improperly such that its value is low, the company can
pile up debts and can come under liquidity crisis. In the long term if working capital
management causes the working capital levels to stay high, this may lead to decreasing returns
on investments and will reflect poor use of cash and cash equivalents and poor investment
decisions on management’s part. Thus in long term, a reduction in working capital can help the
company to settle in debts and use the surplus cash to either pay dividends or reinvest in the
company.
The importance of working capital management can never be ignored in any form of the
business. According to one study on Nordic Countries, 64% of the Chief Financial Officers of
various companies put working capital management in the top three priorities for the Company.
The companies that efficiently manage their working capital can release or free up their cash
quickly in the face of adversity and can significantly reduce the need or dependence on external
finance and funding. A well managed working capital can provide cash for growth and also can
significantly reduce costs especially the ones linked to interest payable for raising short term
debt.
The efficiency of working capital management can be checked by calculating working capital
ratios. For example a high working capital ratio will indicate that cash of the company is tied up
with the debtors of the company and the inventories. The immediate solution to decrease the high
working capital ratio will be to significantly reduce the number of days in which debtors pay and
increasing the creditor days with the suppliers. However this will only be an interim and a short
term solution. The long term and more efficient solution will be to fix and to strengthen the
foundation of the business and organize the procedures of the business in a manner that each
component of the value chain is optimized and works efficiently. This long term solution might
cause delays in immediate release of the cash but would give a company significant cost
reductions.
A good measure of working capital for effective working capital management is:
‘Net working capital = Receivables + Inventories – Payables – Advances received + Advances
made

Receivables relate to Trade Debtors

Inventories is raw materials along with work in progress (WIP) and finished goods

Payables are trade creditors
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“How the Company manage their Working Capital and at the same time manage their Liquidity?”

Advances received are the payments already made from customers

Advances made are the payments made to the suppliers
By ensuring that each component in the above mentioned formula is working effectively and all
the processes within the value chain are functioning efficiently, the company can manage its
working capital impeccably. For instance, a company can reduce the volume of its inventories;
ensure quick payments from debtors, and increase the period of payment to suppliers, a company
can improve its working capital. A company’s working capital is affected by both the
endogenous and exogenous factors. Even the components that make up the working capital are
intertwined and interdependent causing impediments in enhancing working capital management.
Therefore the management has to ensure that they address all the factors that impact working
capital to ensure quality working capital management.
In the following paragraphs, it is discussed that how management address the three operational
components of net working capital during the process of working capital management.
4.2.1
Reducing Inventories
One of the major areas that can improve the working capital management is ensuring the smooth
flow of inventories. It is very important to manage the inventory levels of the business for
efficient working management. By arranging the contracts and deals with the suppliers and
customers in a manner that can minimize and reduce the inventory levels in the value chain, a
company can improve its working capital in a long term.
A company can make its forecast more accurate and can plan its demand properly to ensure that
they do not buy unnecessary supplies and respond to customer demand properly. This way the
business will not pile up stocks that cannot be sold to customers and thus will significantly
reduce inefficiencies associated with working capital by reducing inventories. The companies
that have good working capital management environment make sure that the terms with their
suppliers are such that they are driven by demand at any point in time. For efficient working
capital management, management should optimize their production processes. They should
ensure that their work in progress stock is quickly converted to finished product and all the
processes that do not add value to the good are eliminated from the value chain. Furthermore, the
work in progress should be proportional to the demand instead of a target or benchmark. This
way all the factors would be considered while producing and buying inventory and no
unnecessary accumulation of inventory will take place. A company should maintain an efficient
mix between high quality low volume and low quality high volume products. This would
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guarantee that nothing is produced that is not demanded and everything is delivered to satisfy the
demand. It is always a good practice to make the processes within the value chain as
standardized as possible and keep customization for the very end. For example, companies that
specialize in laptop production advertise a standardized product that has all the features of a
basic laptop and leave it on the customer to customize it according to his or her own needs. Thus
by following this simple example a company can significantly reduce its costs by eliminating
unnecessary processing in the value chain; giving customers products that completely match
their needs and ensuring an advance payment from the customer.
4.2.2
Managing Receivables
The other area of focus for efficient working capital management is an efficient receivable
collection process. There are many companies that are caught up in a cycle where they quickly
pay their suppliers but receive late payments from their debtors. Such practice has a very
negative impact on the working capital. This approach of settlements with debtors and creditors
leave the company in significant cash flow problems due to mismatch in timings between the
payments from the customers and the actual costs incurred. Thus a company should ensure that
all the necessary areas revolving around efficient maintenance and collection of receivables are
properly addressed.
A company should invoice its customers as quickly as possible. It should remove any
unnecessary delays in invoicing and ensure that invoices are promptly dispatched after providing
the service. It is often the case that most customers delay their payments to a point where they
receive the first reminder for the payment. If that is the norm, then it should be ensured that early
reminders are sent to the customers. The customers can also be incentivized to pay early by
offering discounts. For instance British Gas offers ‘prompt payment discounts’ to its customers
to ensure that customers pay quickly. Also, where the services provided extend over a period of
time, it is a good practice to secure prepayments and advances from customers. These practices
can significantly improve the liquidity levels and working capital of the company.
4.2.3
Managing Suppliers
A company should always discuss the terms of payments with its suppliers. A company does not
gain anything by paying its suppliers before the due date. Thus any payments that are made
before the due dates should be avoided and should fully use the period given to delay the
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“How the Company manage their Working Capital and at the same time manage their Liquidity?”
payment. This will increase the payables and in turn improve the working capital and liquidity of
the business. A company can also use its bargaining power while agreeing the payment terms
with suppliers. For example a company like Shell plc that is very global and is technologically
very strong, can influence its payment terms with the relevant suppliers. The payment terms can
be extended and trade creditor days can be increased. Another method of extending the
payments, a clause can be added in payment terms whereby the payment can be made
conditional upon the fulfilment of obligations on supplier’s part. These practices ensure that
payments to the suppliers are legally extended and thus the working capital stays healthy.
Furthermore, if the senior management ensures that the efficiency of working capital
management is enhanced by incorporating the goals and performance based remuneration within
the management and employee packages, the supply chain and all the processes in the business
can further be improved. This concept was further ascertained by the study carried out by Ernst
& Young where they concluded a positive correlation for optimization of working capital when
included in the company’s targets and financial goals and strategies.
(Source: Ernst & Young LLP (2009) and Danskebank.com (2009))
In one study by Oliver Wyman they summarized what actions can be taken to ensure a good
working capital and optimize working capital management.
Actions
Methods
Reduction in Accounts Receivables Reduce the number of bad debts by accelerated collection
Decrease labour costs once the debtor days are reduced
Once cashflow increases, reduce the interest expense by
decreasing funding or external financing
Optimizing the inventory
Reduce the warehouse space & keep it at its full use
Increase in Accounts Payables
Get rid of obsolete inventory by either selling it at low price or
disposing it.
Reduce the number of unnecessary staff related to inventory
management
Decrease the interest expense and associated depreciation
Decrease in interest expense by re assessing the payment terms
Optimize the process by assessing discounts, payment terms and
price of supplies
In addition to the above mentioned components of working capital, there are various working
capital management key figures that show the level and quality of working capital of a company.
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These are known as Days of Sales Outstanding (DSO), Days of Payables Outstanding (DPO),
Days of Stock Outstanding (DIO) and Cash-to-Cash cycle (C2C).
4.2.4
Days Sales Outstanding (DSO)
DSO = AR / (net sales / 365)
AR refers to the value of Trade Debtors at the year end after deducting the provisions for
doubtful debts. The denominator in the above equation will give us the net sales per day. When
trade debtors (net of provision of doubtful debts) are divided by net sales per day, we get days
sales outstanding.
When there is a negative change in DSO it reflects an improvement. If this ratio is poor, it will
signal problems in customer to cash procedures also abbreviated as C2C. These processes are the
ones related to sales, how the sales orders are made and processed, how much time is given to
customers to pay and how the payment collection is managed. However there are other factors
that can affect DSO as well. For instance if the sales are made internationally, the payment terms
will be long and due to high debtor days DSO will perform poorly.
4.2.5
Days Inventory Outstanding (DIO)
DIO = Inventory / (net sales / 365)
This ratio divides the year end inventory with net sales per day. If the change in DIO is negative,
this would mean that there is an improvement in working capital management. The poor
performance of this ratio will raise concerns for forecast to fulfilment abbreviated as F2F
procedures. These procedures encompass manufacturing procedures, supply chain and the
outbound supply chain procedures. There are a lot of factors that affect DIO. For instance, if a
company produces its products efficiently but only has one outlet or distribution hub would
suffer from delays in the delivery. On the other hand if a company has several distribution
centres then it would have to hold inventory at each centre causing the numerator of the ratio to
increase. Similarly companies that have factories overseas or companies whose production units
are installed offshore might face significant working capital issues due to long shipping times.
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Thus both the exogenous and endogenous factors have to be incorporated to ensure an optimized
working capital management.
4.2.6
Days Payable Outstanding (DPO)
DPO = AP / (net sales / 365)
The ratio divides the year end trade creditors by net sales per day. If this ratio is positive, it
means that the business has arranged long payment terms with its creditors. This is better for the
working capital management since it allows the business to delay its payments to its creditors
thus keeping the cash in the business and taking advantage of it for both the long term and short
term ventures. However care must be taken while making such long payment terms. If the
suppliers offer good or advantageous discounts that can surpass the advantages of increase in
DPO, then it is worth considering making early payments. The poor performance in this ratio
portrays weaknesses in procure to pay (P2P) processes. The P2P relates to how a business
manages its suppliers, creditors and payment terms with suppliers and other creditors.
It is imperative upon senior management to keep a close eye on these management key figures.
By comparing these ratios from period to period, management can spot the areas of weaknesses
in working capital management and then can adopt remedial measures for the optimization of
working capital.
In the light of above discussion, it is portrayed that if the company adequately addresses the three
basic components of working capital, they can ensure efficient working capital management.
And by ensuring efficient working capital, the company can strengthen its liquidity position and
can further progress and develop its business without resorting to external funding or finances.
The long term adoption of such practices will improve all the processes within the value chain of
a company and make the company more efficient and cost effective in long term.
(Source: Oliver Wyman)
4.3
Working Capital Management during the Recession (Credit Crunch)
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This part of my research focuses and closely bases the arguments, mainly on two research
reports, released by big four Accounting based organisations ‘Ernst & Young LLP’ titled ‘All
tied up – working capital management report 2009’ and research by working capital management
research company REL which is a part of Hackett Group of Companies titled ‘Blue Print for a
cash culture’ released in January 2010. The main report among these is the Ernst & Young LLP
report which gives a detailed and more intuitive and empirically supportive argument to the
effects, causes, trends and future insights on working capital management in the credit crisis.
These reports analyse and discuss the issues relating to working capital. The surveys have
closely monitored leading companies in the European and the US market stating key findings.
They have also concluded with the methodology for effective working capital management with
trends and future looking analysis to go forward. I will list the key findings of these reports and
discuss and analyse in the light of this literature to contribute to my arguments on Working
Capital Management.
4.3.1 Ernst & Young’s ‘All tied up – Working Capital Management Report 2009’
This report was published following a stringent and testing global recession in the recent
memory of the economic markets. The report has provided background comments which indicate
that there are signs of economic recovery in the corporate environment but there still are ‘large
corporate rescues’ taking effect across the USA and Europe (especially UK) with a ‘generally
increasing level of concern’. Government bailout packages have annihilated the credit squeeze in
the capital markets and have paved way to capital raisings by corporations through bonds and
rights issues. These trends are all proof of the uncertain and troubled environment which has
carried onto the economic atmosphere of 2009 from the crisis. The report has thus studied on the
effects of this climate in the economy and concluded that:
‘In this context, cash protection and management have risen to the top of the agenda for diligent
corporate seeking to strengthen their balance sheets and maximize their flexibility and strategic
options. It is no coincidence that in our most recent opportunities in adversity survey, 73% of Clevel executives mentioned conducting top-down reviews of cash management and cash flows.’
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“How the Company manage their Working Capital and at the same time manage their Liquidity?”
This clearly indicates the squeeze that the companies have put on their balance sheets to free up
cash to support operational and capital cash flows. Under this pretence, companies may find that
working capital management cam be the cheap and reliable option of freeing up cash resources.
The report focused on companies and their accounts, analysing the 2008 year end reports of
companies which suggested increasing importance being laid on working capital management.
The report discusses an improvement in working capital of more than 5% of annual sales in most
businesses with a structured ‘root and branch’ approach to improvement in cash management.
4.3.2
Key findings of the report
Although in the wake of current economic environment has made companies focus on effective
working capital management, and newer and more creative methodology is being adopted in this
regard, Ernst & Young’s (EY) report has proven that there are numerous opportunities for a
majority of companies to improve their working capital situations and release cash in the
process. The report indicates that there is potential to free up to a total sum of around ‘US$1
trillion for the leading 2,000 corporations in the US and Europe’. The key findings of the report
can be summarised as below:
 The report’s analysis reveals unanticipated changes in working capital results on a yearly
comparison.
o Companies managed to lower their working capital in 2008 compared to 2007 which
was largely due to less purchases in anticipation of slower sales owing to the
economic climate. The radical picture has been portrayed by comparing the last
quarter results of 2008 to 2007 to the full year-on-year analysis
o There were other drivers to these changes which included: the capacities of supply
chains to adapt to decreasing demand, changing and usually contradicting plans of
payment implemented among the various constituents in the working capital
contributors and greater uncertainty in currency exchange rates and commodity
purchase and sale prices
 There were significant differences when working capital efficiencies were analysed on a
cross-company, inter-industry and international level
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“How the Company manage their Working Capital and at the same time manage their Liquidity?”
o Of the research set of companies, lower working capital was reported for 2008
(compared to 2007) in 63% of American and 50% of European companies. In stark
difference, if we take the last quarter year-on-year analysis from the report, this is a
relatively minor 43% drop for each region
o There were wide spread differences of efficiencies among corporations due to key
differences in strategies of dealing with working capital reduction during the credit
crunch.
o The credit crunch hasn’t affected companies other than the financial industry as
much as it has impacted the financial sector
o There have been stark differences of conclusive indication in the study’s
performance measures of working capital when the researchers compared last quarter
results year-on-year and when they compared the yearly results.
o Across Europe, there was a significant difference in working capital performance
due to fluctuations in the currency exchange market, volatility in oil prices and
differences in economic policy and economic outlook and specific industry
importance for individual economies.
 The short term impact of this continuing adverse economic influence will further tighten the
screws on the working capital requirements of companies. There will be widespread risk of
bad-debts, loan write-offs and the possibility of discontinuity in supply operations which
might result in varying reactions and tensions between the participants of these processes.
Although this remains as a major threat, recent data found by the author of this report had
suggested that stocks might lessen and decrease the burden from working capital. This hints to
an imminent return to normality of things in the corporate working capital management arena.
 This economic crisis will induce a discrepancy among the working capital efficiencies on an
inter-company level. Companies which have historically managed to curb their working
capital requirements are thus likely to suffer much less than those which are lax in this
respect. This varying impact raises the question of ‘Whether companies will use working
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“How the Company manage their Working Capital and at the same time manage their Liquidity?”
capital as a lever to win business, reduce operating costs, enhance customer service and/or
improve risk management’.
4.4
Importance of cash management during the crisis
This argument in the study is based on Ernst & Young’s 2009 survey entitled ‘Opportunities in
adversity’. The survey had participants spanning over 300 global C-level (CFO, CEO etc) and
Board-level executives. The study generally concluded that cash and cash management issues are
at the core of the issues that these companies have started to focus on. It clearly is indicated from
the fact that out of the participants of the study 82% were concerned about cash in their
organisations. In addition to this fact, there is also the observation that there are wide spread
discrepancies between the companies when the working capital management policies are
compared between them. The key results from this study which contribute to the argument of
working capital management taking more and more importance as the credit crisis intensified
and now is abating.
 More than 50% of the study’s participants had already put measures in place to check their
working capital performances
 46% of the companies had started focussing on its supply chain and had started to tighten
their supplier base to achieve price efficiency. 42% of the respondents expanded their supply
base to hedge the risk of suppliers going bust
 55% of the surveys participant companies reported greater time delay between the order and
cash payment while 53% saw credit ratings of their customers drop. In this manner 31% of
companies terminated their agreements with customers which pose higher risks
Further development is mentioned on top of this report where after six months the researchers
met with executives and ran additional polls on the market to release new results. Their major
finding was in line with the argument above that the focus on freeing up cash by effective
working capital management has taken the primary concern of companies. Of the members in the
survey, number of companies reporting cash to be a minor issue decreased from 26% to 18%.
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“How the Company manage their Working Capital and at the same time manage their Liquidity?”
73% of the original members of study were now reviewing their cash handling processes and the
flows of cash to and from their businesses. This was up from 68% in the January survey.
4.5
Suggestions for the future regarding Working Capital Management
The short term view of the report is such whish suggests that the economic situation will further
press the companies in terms of cash flow and force them to look into Working Capital
Management. This might be explained with scenarios of late and non-paying business and
household users of the companies’ products. There is also the risk of higher bad debts and writeoffs where the consumers of goods and services may default due to the tightening of economic
resources in households, businesses and government spending. There will be pressure from the
customers to relax the payment procedures while the companies might want to delay their
payments to suppliers to the supply chain. The economic downturn points to a decrease in
revenue growth, which might prompt companies to cut their spending. This indicates that the
creditor’s performance will be adversely affected. The research report has found out that there is
a steep decrease in demand in the final months of 2008. This will induce an effect on companies
which will decrease their stock levels in anticipation of this market tightening. This will further
result in further differences in working capital management among companies: those good at
managing working capital will be less affected while those poor in managing their working
capital will suffer. The report further suggests that this discrepancy in responding to the
economic changes raise a question on whether companies will use working capital performance
enhancement to create more business (i.e. by lax payment terms and keeping lower inventories
etc).
The research concludes that there still are a lot of companies by proportion which do not see the
importance of working capital management in freeing up cash and creating more business.
Although these companies are aware of the tightening in cash movement, they still are resisting a
change in their organisations view on this issue. This might be because changing their strategies
might take complex changes in their corporate structures especially in the supply chain
management.
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“How the Company manage their Working Capital and at the same time manage their Liquidity?”
In view of these findings, the report has thus effectively suggested that effective working capital
handling will allow businesses to improve their cash status, cut costs and allow them to be more
adaptable in the highly volatile economic conditions.
I thus quote the ten steps the Ernst & Young report has suggested towards effective working
capital management strategy, they are as under: (Quoted from page 13 of the report)
“10 steps towards an effective working capital management strategy:
1. Appropriately incentivize management to improve cash performance
2. Effectively manage payment terms for customers and suppliers (with terms and
conditions appropriate to the current environment)
3. Improve speed and accuracy of billing and cash collections and deal with disputes
effectively
4. Use data captured for disputes to eradicate the root cause
5. Increase billing frequency (noting, however, the extra costs associated with this) and use
of e-billing
6. Develop an agile supply chain that can be more responsive to changing market conditions
7. Build greater linkage and closer collaboration among the various participants of the
working capital value chain internally and externally, focused around sharing of demand
signals and planned response down the chain
8. Maintain metrics that monitor the financial health of customers and suppliers
9. Identify the key drivers of working capital consumption and focus on improving them
(forecasting error, lead-times, minimum lot sizes, supply variability, capacity constraints
and accuracy of billing, customer segmentation and appropriate collection strategies)
10. Identify, understand and quantify the trade-offs that need to be made (e.g., order fill rates
or inventory levels, early payment discounts or longer payment for payables
optimization, larger batch sizes or inventory levels)”
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“How the Company manage their Working Capital and at the same time manage their Liquidity?”
4.6
REL’s research report: ‘Blue Print for a cash culture’ released in January 2010
This report was slightly less intensive as compared to the report summarised and discussed
above, yet had some insights which are useful for this section of my research. The survey
majorly hinted that the companies have looked into managing their working capital more
intensely in the wake of the credit crunch. The survey included participants ranging across 53
companies. These companies had average revenues of around $24 Billion. The survey concluded
in the end that 94% of these participant companies have started considering working capital
management key terming cash management as ‘important’ or ‘very important’ in their replies to
the questions. The report is based on information found in 2008 which states that cash on the
balance sheets of companies fell by more than 10% year on year from the previous year in a
majority of the industries (57 out of the 59 industries grouped in the research). This gave a strong
indication of the fact that freeing up cash in operations was a minor initiative before which has
increased in importance with the developments of the credit crisis.
The latest survey has found out that most of the respondents have now put complex methods to
improve their business’ cash management which form the greater working capital management
procedures. These are widely classified into four important areas namely creditor management,
debtor management, cash flow and cash spend management and stock management. The survey
found that the proportion of companies which did reveal that they have various initiatives to
manage these working capital management areas, 51% targeted all four of these broadly
classified areas, 32% looked into three of these four areas, 14% focussed on two out of four
while only 3% touched only one of these working capital management area. The survey found
significant evidence of the fact that a ‘steering committee’ which overlooked these initiatives
was an important part of the whole process. More than half of the companies which were part of
the survey agreed to the fact that they had steering committees in place to over look their
working capital management chain. This is further broken down in respect of the four broad
areas mentioned above where 53% have committees in creditor management, 52% have
committees over seeing cash flow and spend management while 64% have committees working
to optimise stock management. There was confirmation from a majority of the study’s
respondents that the committees were an efficient way of obtaining performance enhancement in
these areas.
The survey identifies another key element in judging the quality of the success of companies
using these initiatives. This is mentioned as the ‘degree of senior-level engagement’. Where the
C-level executives (CEOs, CFOs etc) were actively involved in working capital management, the
survey found that 88% of the companies graded their efforts to be ‘effective’ or ‘very effective’
where the cash flow position of the company had seen betterment. The companies which
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reported that the C-level executives did not mingle with these initiatives, only 55% reported this
level of improvement.
Another finding of the survey suggests that companies who use more of the working capital tools
are more efficient. The survey questioned the use of ‘working capital metrics and score cards,
cash target setting or employee compensations used by CFO to improve cash allocations’. The
survey revealed that companies using four or more of these tools showed greater efficiency in
working capital management which was measured by lowering of ‘working capital-to-sales
ratio’.
Another important tool mentioned in the report is that of using a Weighted Average Cost of
Capital (WACC) being used to achieve lower levels of ‘working capital to sales ratios’ which
were the study’s main indicator of working capital efficiency measurement. Although there were
only 32% of the participants of the study which applied this method, there is significant proof
within this subset to suggest that it worked. The results of the survey have shown that out of this
minor group of companies from the total set of respondents, 73% achieved reduction of 15% in
working capital to sales ratio. This is significant when compared to the companies which didn’t
use this methodology. Their results show that only 46% of those companies achieved these
results.
Finally the survey focuses on using incentives on employees to drive improvement in working
capital management. More than 2/3rd of the companies surveyed include targets relating to
working capital and cash management while compensating employees. In these companies 58%
have working capital needs of less than 15%while otherwise there is a 48% need by companies
which do not compensate employees as such.
All in all the survey has thus managed to lay a strong case in favour of empowering employees
and incentivising them to run effective working capital management procedures and has detailed
findings by questioning companies which have used or failed to use many of these methods. In
effect showing that working capital management is highly important in the wake of current
events and is suggestive of the many ways these targets regarding working capital and cash
management could be reached.
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“How the Company manage their Working Capital and at the same time manage their Liquidity?”
4.7
Relevance of these two reports and their findings to my research
In conclusion by discussing the above literature, I have tried to give a view on the working
capital environment with the view of the current economic crisis. The first report has identified
key statistics which prove that working capital management has become of all the more
importance in the current corporate financial control environment. The literature has provided
with various studies and research findings to prove these points and given perspectives on the
many things affecting these corporate decisions. Concluding with some key suggestions to those
directly involved in working capital management. The second bit of literature has been reviewed
and summarized to provide insight into the many ways working capital management is being
utilized effectively to fight the threat of recession. In similar study like methodology this second
bit of literature has reinforced the major points made by the Ernst & Young report. This all adds
to my arguments to the importance of Working Capital Management and the ever more
increasing need to put effective controls in this regard in the corporate financial control structure.
4.8
Cash Management and its importance for organizations today
Due to current financial turmoil, cash- or more adequately the lack of it- has increased in
importance for many businesses and organization; specifically those will a huge global presence
like Royal Dutch Shell plc.
In the refining industry, a consumer driven cycle persists which in turn places a huge strain on
cash resources for many businesses.
4.8.1
Effective cash management
In simple words, it means being better at getting cash into the organization (collecting from
debtors as soon as possible), making it (cash) work harder while the organization is in possession
and being smarter about paying it out (to creditors).
Alongside the general focus on areas such as credit control, more examples of poor cash
management practices in the refining industry include:
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
Significant balances on overnight deposits, while paying bank charges and overdraft
interest in the organization

Poor or indeed no, forecasting of cash flow resulting in very significant cash floats sitting
idle while general trading and operational activities of the business could be producing
returns

No appropriate enforcement of service level agreements with creditors, debtors and other
agents
Taking a generalist approach, it can be seen that the refining industry has been traditionally weak
at managing their cash effectively and efficiently in comparison to other sectors of the economy.
This lack of cash management focus can be linked to the management nature of the refining
industry- where funds for projects (exploration and development) are received upfront, which
means having to deal with a scenario of cash shortage becomes rare. In addition to this the
widespread use of net accounting with creditors and other agents has contributed significantly to
a weak cash culture. Overall it can be claimed that due to an abundance in cash in the refining
industry the use of effective cash management strategies has been limited, which in the current
economic environment of financial turmoil can be considered a vicious trap for organizations of
Shell’s competence.
4.8.2 Ways to achieve more effective cash management
For firms in the industry concerned, to improve efficiency of cash management, the focus should
lie on three major areas:
Primary focus should be laid onto understanding the cycle of cash within the business, ensuring
that it is properly and fully documented. This is important as it certainly paints a better picture
for the manager to highlight opportunities where additional cash maybe generated.
The secondary focus should lie in the comprehensive implementation of robust cash forecasting
procedures. This is important for giving a detailed overview of the most lucrative areas for
improving efficiency and cash generation opportunities within the business.
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“How the Company manage their Working Capital and at the same time manage their Liquidity?”
Finally, the main key to more effective cash management is to embed a cash culture within the
firm. Through backing of senior management there are usually a number of quick wins which
can be utilized to demonstrate the positive side of more effective cash procedures and their
prospective benefits to the firm’s strategic priorities. A simple example of a way to improve cash
management efficiency would be to setup a cash committee with membership across the
business; this can demonstrate the commitment to an improved cash management process.
Ultimately, it is true that money talks, it improves cash management processes which can in turn
lead to higher levels of investment income and lower finance charges without any significant
increase in costs. In the current uncertain economic environment, the prospects that such a source
of increased profitability provides is very likely to attract attention in the boardrooms of firms
involved in the refining, production, exploration and development of energy products.
Managing cash effectively is a challenging task at any given period of time, however as the
industry comes back to a firmer footing, it remains a crucial aspect for a successful business.
Spanning the operational, financial and strategic departments of the business a sound cash
management culture and framework can help numerous firms (including B.P, Shell, PetroChina
and other major players) to improve and maintain their performance.
4.9
The six pillars to increasing profitability in a business
There are a number of perspectives out there which detail on how to survive the recent credit
crisis which can be easily attributed as one of the turbulent times the industry has faced.
However, through effective government intervention in the form of economic stimulus packages
it is true that the most dangerous period has passed, nevertheless the full impact of the recession
in the refining industry has yet to be felt. As the refining companies struggle back to recover
losses they should consider the six main strategic pillars which underline a successful profitable
business model. The six pillars are outlined below in more detail:
a) Managing the cost base: When survival is the priority, cost control becomes an overriding imperative in the energy industry. Often, valuable long-term initiatives or
secondary support activities need to be forgone, for better control costs to be present. As
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the firm gets back to a satisfactory footing this task can become more subtle.
Undoubtedly there is still a need for effective cost control as the economy moves forward
but its position in comparison to other business needs becomes more balanced.
Competition in the industry as a whole becomes more intensive. Due to stringent
regulation in some countries the capital requirements are driven higher and margins get
squeezed. Customers tend to demand cheaper and better quality products. The objective
is to sustain a competitive cost base which would not affect the high standard of products
and service, the development of a strong brand and diversification into new products and
markets to meet the ever growing needs of the consumers. For organisations in the energy
industry the return to ‘level flight’ depends on getting an appropriate balance of this.
b) Optimizing the business model: Business models need to be re-evaluated and adjusted to
the new realities of the economic marketplace. In most scenarios, this means cheaper,
higher quality products and services. Companies deciding to reposition themselves in
response to the emerging ‘narrow product range’ model require re-evaluating marginal
activities for possibility of closure. However, even companies that decide to maintain a
broader range of products need to ensure that their business model is functional and
adaptable in the increasingly competitive environment. As with all segments of trading
activities, understanding and implementing a ‘good’ risk management framework into the
firm will deem to be essential.
c) Ensuring robust capital and liquidity: Optimizing the balance sheet and making sure it is
able to support the needs of the business in the most cost effective way while at the same
time remaining flexible will require more active management. Companies in this day and
age therefore need to be more alert to the risks that face them and thus re-design their
business models and operational costs in accordance.
d) Retaining and recruiting talent: Hiring and retaining the right labour force is perhaps the
core element to building a sustainable business. This however, seems simple to say but is
by far a very challenging task especially due to economic environment changing. During
the peak of the financial turmoil very few organisations kept recruitment at a normal
level, Shell itself axed about 3200 jobs. Additionally, in the developed companies such as
the UK, demographic changes mean the labour force has significantly reduced especially
in the age group 20-30. Overall because of the aforementioned facts the battle for top
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“How the Company manage their Working Capital and at the same time manage their Liquidity?”
talent will become more intense. It is therefore clear that attracting and retaining the best
labour will depend highly upon building the best brand and reputation of the organization
e) Rebuilding reputation, trust and enhancing the brand: In the highly competitive
environment of today, successful businesses need to develop relationships of trust with
customers and stakeholders. For companies in the refining industry selling energy
products, this is possibly more important than other sectors. In this environment, it is
highly important to regain trust and reinforce brand values. The effects of this can be felt
across all business operations, and therefore it is a key factor for a successful company to
get this correct.
f) Developing new products and markets: The energy sector remains a dynamic
marketplace. Economic and demographic change has opened up new opportunities in
different parts of the world (emerging markets). New perceptions about products and
services have made innovation much more significant. Effective consumer and market
segmentation is essential for a robust product strategy.
(Source: KPMG frontiers in finance journal(September 2009)).
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“How the Company manage their Working Capital and at the same time manage their Liquidity?”
5.0
PROJECT REPORT RESEARCH & METHODOLOGY
5.1
Sources Used and Reasons
1. Annual accounts of Shell (audited) – Provide a detailed overview of Shell’s current
financial standing in the current economic environment. It contains the results on which
the key financial ratios are based, which are crucial in analysing the financial health of
the company. By utilizing reports from the year 2003 to 2008 has facilitated trendanalysis that illustrates the progress of the company over a period of time, again an
important tool in analysing the financial position of any company.
2. BP Global – are also important to this report. The key ratios calculated using BP’s annual
accounts assist in making a financial comparison with Shell and develop an outlook on
the refining industry in general. It mainly enables one to paint an accurate picture of
Shell’s performance on an annual basis in respect to a major competitor in the business
environment it operates in.
3. Quarterly presentation reports – Provide an abundance of useful information related to
each quarter and shed light on the seasonal changes of the company’s business. They
provide a concise yet detailed insight into the company’s operating environment and are
easy to understand due their brief nature and point form structure.
4. Newspapers (compromising of the Financial Times, Times Magazine, The Economist and
City A.M) – commentaries tend to have significant impact on the share price of a
company. Newspaper articles provide up-to-date information about a company regarding
its reputation in the market. They detail the effects both seasonal and annual on a
company related to the financial market it operates in and the commodities it trades in (in
this case this has mainly focussed on the energy market and products related to energy
such as oil, gas and coal). Such articles have contributed vital information to my project.
5. Books (Library Research- more detail in method used below): The main sources of
information regarding the analysis techniques used in the project have come from the
following books:
a) Madura, J. (2009): This book has provided me with the basic knowledge base on cash
management and efficient financial management techniques. It has also provided me
with a detailed insight into international financial markets which assisted me in
understanding the newspaper articles mentioned earlier.
b) Kaplan Publishing, ACCA Paper 2.4: This book has provided me the basic
information on working capital management techniques. It clearly explains the role of
cash in the working capital cycle as well as detailing the calculation and interpretation
of cash ratios. It has assisted me in calculating and analysing the annual reports of
Shell and B.P from a cash management perspective and has proved a vital asset in
writing the Data Analysis section of my project.
c) Kaplan Publishing, ACA (ICAEW): This book gave me an insight into the sceptical
approach used by auditors while checking financial statements and writing the audit
opinion. The audit opinion is a crucial aspect of the annual accounts that enables
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“How the Company manage their Working Capital and at the same time manage their Liquidity?”
investors and shareholders to make vital decisions regarding the company’s
management which later on affect the share price of the company involved. The
literature in this book helped me in understanding the audit opinion and draw up
conclusions on the financial health of the company.
d) Brealey, R. A. & Myers, S. C. (2002): This text contained information regarding cost
benefit analysis and provided in depth knowledge with regards to how companies
make investment decisions and justify them financially. It contains a good description
of the many factors of risk facing modern organisations such as Shell in the current
competitive economic environment. It assisted me in utilizing SWOT Analysis as an
effective tool to analyse the position of Shell in the refining industry.
e) SWOT Analysis Using your strengths to overcome weaknesses and opportunities to
overcome threats by Lawrence G. Fine: This literature provided me with a good
understanding of the SWOT matrix and how it can be used to analyse Companies
from an investor’s point of view. The information gathered enabled me to evaluate the
SWOT matrix for Shell.
6. Analysts’ reports – provide an overview about the health and future prospects of a
company in relation to the external factors affecting the business world. These reports
are prepared by skilled professionals who critically analyse decisions made by the
company and draw up conclusions, which can be a great source of information for the
shareholders and external investors.
7. Un-audited, Interim reports – show the trends and seasonality in the business and its
operations. They can also be compared with previous reports to demonstrate the
company’s performance and give a detailed insight into the company’s major projects.
8. Student Accountant magazine - and Kaplan’s’ Manuals for Advance Financial
Management are also part of my background reading and they provide me with a lot of
useful ideas and ideologies in efficient capital management. They have been important to
the form and content of my analysis, presentation and conclusions about Shell.
5.2
Methods Used in gathering information
Library Research:

General reading: This was mainly around the topic and involved reading different books,
newspapers, magazines, journals to understand the company and its operating
environment.

Specific Reading (1): This involved gaining background information in regards to the
topic using the books listed above.

Specific Reading (2): This involved going through different CD ROMs to get information
about Shell and BP. Some of the CD ROMs used are as follows:
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“How the Company manage their Working Capital and at the same time manage their Liquidity?”
o Investext plus – this database provides an unparallel breath and quality of
business data that cannot be obtained with ease elsewhere. It delivers instant, fulltext reports in the original published formats, complete with charts, photographs,
and graphics.
o European Intelligence Wire (Formerly McCarthy) – is a compilation of company,
industry and market news and information from over 170 international
newspapers and business magazines. This method of gathering information in
regards to the current situation in the energy market and refining industry made
things easy as it provided relevant articles at the click of a button.
o Libraries used for general reading and use of CD ROMs includes: City Business
Library, British Library and London School of Economics & Political Science
library.

Shell’s investors’ website www.Shell.com was another technique of gathering
information; it includes the press releases and financial reports of the company. Other
websites
like
www.BP.com,
www.economist.com,
www.ft.com
and
www.londonstockexchange.com are really useful to take the information. Although these
sites provided significant information but most of the information was exaggerated in
nature and therefore this took a lot of time to extract relevant information.
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“How the Company manage their Working Capital and at the same time manage their Liquidity?”
6.0
DATA ANALYSIS
6.1
Interpretation
This data analysis report presents an assessment of the current financial standing and the
future prospects of Shell from an investor and shareholder’s point of view.
Main shareholders interests lie in the current level of risk, liquidity, assets utilisation (activity),
level of debt and return (profitability). Thus the main content of this analysis will constitute on
the calculation of the ratios listed below:
6.1.1
Profitability Ratios
These ratios illustrate whether a business is making profits - and if so whether they are at an acceptable
rate or not. The key ratios are:
Ratio
Comments
Gross Profit
Margin
This ratio tells us about the business's ability to control its production costs or
to manage the margins its makes on products its buys and sells. Whilst sales
value and volumes may move up and down significantly, the gross profit
margin should remain quite stable (in percentage terms).
Operating
Profit Margin
Given a constant gross profit margin, the operating profit margin tells us about
a company's ability to control its other operating costs or overheads.
Return on
capital
employed
("ROCE")
ROCE is sometimes referred to as the "primary ratio"; it tells us what returns
management has made on the resources made available to them before making
any distribution of those returns.
6.1.2
Management Efficiency ratios
These ratios give us an insight into how efficiently the business is using up the resources
invested in fixed assets and working capital.
Ratio
Comments
Credit Given
/ "Debtor
Days"
The "debtor days" ratio indicates whether debtors are being allowed excessive
credit. A high figure (more than the industry average) may suggest general
problems with debt collection or the financial position of major customers.
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“How the Company manage their Working Capital and at the same time manage their Liquidity?”
Credit taken /
"Creditor
Days"
6.1.3
A similar calculation to that for debtors, giving an insight into whether a
business is taking full advantage of trade credit available to it.
Liquidity Ratios
A company’s ability to pay its debts as they fall due can be measured by the liquidity ratios.
These ratios are not presented as percentages like their counterparts (profitability ratios):
Ratio
Comments
Current Ratio
A simple measure that estimates whether the business can pay debts due within
one year from assets that it expects to turn into cash within that year. A ratio of
less than one is often a cause for concern, particularly if it persists for a
lengthy amount of time.
Quick Ratio
Not all assets can be turned into cash quickly or easily. Some - notably raw
materials and other stocks - must first be turned into final product, then sold
and the cash collected from debtors. The Quick Ratio therefore adjusts the
Current Ratio to eliminate all assets that are not already in cash (or "nearcash") form.
or
Test"
"Acid
6.1.4
Stability Ratios
These ratios concentrate on the long-term health of a business - particularly the effect of the
capital/finance structure on the business:
Ratio
Comments
Gearing
Gearing (otherwise known as "leverage") measures the proportion of assets
invested in a business that are financed by borrowing.
Interest
cover
This measures the ability of the business to "service" its debt. Are profits
sufficient to be able to pay interest and other finance costs?
6.1.5
Investor Ratios
There are several ratios commonly used by investors to assess the performance of a business as
an investment:
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“How the Company manage their Working Capital and at the same time manage their Liquidity?”
Ratio
Comments
Earnings
per A requirement of the London Stock Exchange - an important ratio. EPS measures
share ("EPS")
the overall profit generated for each share in existence over a particular period.
Price-Earnings
At any time, the P/E ratio is an indication of how highly the market "rates" or
Ratio
("P/E "values" a business. A P/E ratio is best viewed in the context of a sector or market
Ratio")
average to get a feel for relative value and stock market pricing.
Ratio analysis is used to get the true picture of a firm's financial position,
following are some commonly used ratios:
1- Profitability ratios:
a - Profitability ratio: (Gross profit / sales) X 100 b - Net profit Margin: (Net
profit / sales) X 100 c - Return on capital employed: (net profit / financial cost) /
(equity + long term debt) d - return on asset: (net profit / total assets) X 100
2- Liquidity ratios:
a - Current ratio: current assets / current liabilities b - Quick ratio/acid test
ratio: quick assets / current liabilities
-Note- quick assets = current assets - inventory.
c - Cash ratio: (cash + Marketable securities) / Current liabilities
3- Efficiency ratios:
a - Inventory turnover: CGS / Average inventory
-note- average inventory = (inventory a + inventory b) / 2
b - Days inventory: no of days / inventory turnover c - Receivable turn over:
sales (credit) / Average receivable d - Days receivable: no of days / receivable
turnover e - Payable turnover: Purchases (credit) / Average Payable f - days
payable turnover: no of days / payable turnover
4- Leverage Ratios:
a - Debt to equity ratio: debt / equity
-note- debt here is considered as total debt = long + short
b - Debt to Assets ratio: Debt / Total assets c - Debt/Equity: Debt / total
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“How the Company manage their Working Capital and at the same time manage their Liquidity?”
capitalization
-note- we will only take long term debt here, total capitalisation = total debt +
equity
5- Coverage ratios:
a – Cover ratio: Earnings Before Interest & Tax / Financial Cost
6.2 Explanation of Analysis
6.2.1
Liquidity
Current Ratio

Current ratio is a simple measure that estimates whether the business can pay
debts due within one year from assets that it expects to turn into cash within
that year. A ratio of less than one is often a cause for concern, particularly if it
persists for any length of time.

Current ratio for shell has fairly remained constant between years 2004 to
2008 at approximately 1.15 which illustrates a decent liquidity position of the
company (The only exceptional figure coming in 2003 when the current ratio
was valued at ‘0.89’). This tells us that Shell’s current liabilities are being
adequately covered by its current assets. Whereas on the other hand BP
(Shells major competitor) has maintained its current ratio (over 2004 to 2008)
at 1.0 illustrating a satisfactory position in terms of its current liabilities and
current assets. The only exception here being the year 2003 when the ratio
dropped down to ‘0.9’. (Figures taken from appendix 1).
Quick Ratio

All assets cannot be turned into cash in a timely manner or easily. Some assets
such as stocks and inventories - must first be turned into the final product,
then sold and the cash collected from debtors. The Quick Ratio therefore
adjusts the Current Ratio to eliminate all assets that are not already in cash (or
"near-cash") form. Once again, a ratio of less than one would start to send out
danger signals.

Shell’s quick ratio has had a value between 0.85 and 0.92 in the years 2004 to
2008 with the only exception being in the year 2003 where it dropped down to
a dangerous ‘0.63’. This represents an insufficient capability of the company
to cover its current liabilities by its current assets without its inventory, where
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“How the Company manage their Working Capital and at the same time manage their Liquidity?”
as for BP this has varied from 0.6 to 0.7 in years 2003-2007 which represents
a worse position to cover its current liabilities by the current assets excluding
inventory if liabilities comes to payable at once.

6.2.2
Inventory in Oil and Gas industry does not stay for a long period which means
that the quick ratios of 0.85 and 0.7 of Shell and BP’s respectively are as per
industry norms.
Management Efficiency Ratios
Debtors collection / Receivable days

Receivable days decreased from 76 days in 2007 to 65 days in 2008 (2006: 68
days) which shows a better performance within credit control, however it is
still important to ensure that it must not be at the cost of losing revenues.

BP has improved its debtor collection days down from 55 days in 2007 to 34
days in 2008 (2006: 53 days) which proves the BP’s better performance in its
credit control, but it is very important to make sure that it must not be at cost
of losing revenues.

Receivables are recognised initially at fair value based on amounts exchanged
and subsequently at amortised cost less any impairment. Where fair value is
not applied subsequent to initial recognition but is required for disclosure
purposes, it is based on market prices where available, otherwise it is
calculated as the net present value of expected future cash flows.
Creditors payments / Payable days

The payment to the creditors has seen fluctuations from 2006 to 2008. As
payable period moved down from 93 in 2007 to 78 days in 2008 (2006: 86
days). Although it is good to hold cash as long as it can but Shell’s 93 days in
2007 creditor payment period seems excessive.

BP’s payable days have declined to 61 days in 2007 to 36 days in 2008 (2006: 73
days).

Generally increasing payable days suggest advantage is being taken of available
credit but as there are risks:
o losing supplier goodwill
o losing prompt payment discounts
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“How the Company manage their Working Capital and at the same time manage their Liquidity?”
o supplier increase the price to compensate


6.2.3
It means Shell may not suffer from the above-mentioned risks but on
the other hand it may show a sound credit agreement with its
suppliers that have trust to get their payment within agreed time.
All the above mentioned ratios suggest that Shell has a better control over its working
capital and is using it effectively to produce more sales for every $1 of working
capital used.
Financial Ratios
Gearing
 The gearing ratio is a measure of Shell’s financial leverage reflecting the degree to
which Shell’s operations are financed by debt and certain other off-balance sheet
obligations. The amount of debt that Shell will commit to depends on cash inflow
from operations, divestment proceeds and cash outflow in the form of capital
investment (including acquisitions), dividend payments and share repurchases. Shell
has a central financing and debt programme currently containing four different debt
instruments. Shell aims to maintain an efficient balance sheet to be able to finance
investment and growth, after the funding of dividends. During 2007, the gearing
ratio increased from 13.7% to 14.3 %. In 2008, the gearing ratio increased to 18.05%
mainly due to an increase in total debt and in operating lease obligations.

At 31 December 2008, BP’s gearing was 52.4 % (2007: 44.8%) towards the bottom
of the targeted band as BP continue to believe that a gearing band 40-50% provides
an efficient capital structure and the appropriate level of financial flexibility.
Interest Cover

Shell’s interest cover decreased by 5.6% to 44 times to its finance cost payable in
2008 compared to 45 times in 2007 (2006: 40 times) which shows its best policy
towards finance taking and fully using its current available resources which makes
the company more attractive to invest and to lend the finance with flexible terms.

BP’s interest cover is declined by 1.9% to 22 times to cover is finance cost in 2008
from 23 times in 2007 (2006: 36 times) that shows the improper use of its available
capital and taking of more finance, may be on high interest and hard terms to support
its projects, that makes BP the slightly risky than Shell. But the both companies have
the ability of the business to "service" its debt and have earned sufficient profits to be
able to pay interest and other finance costs.
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“How the Company manage their Working Capital and at the same time manage their Liquidity?”
(Source: The Shell Global Annual Accounts (2009)). More details refer to appendix (1).
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“How the Company manage their Working Capital and at the same time manage their Liquidity?”
7.0
SWOT
SWOT ANALYSIS
Analysis is
a
strategic
the Strengths, Weaknesses, Opportunities,
planning
and Threats
method
involved
used
in
to
evaluate
a project or
in
a business venture. It involves specifying the objective of the business venture or project and
identifying the internal and external factors that are favourable and unfavourable to achieve that
objective. It is a very popular tool with business and marketing professionals because it is quick
and easy to understand. Therefore we will analyse the overall strategic position of Shell by
keeping in the view of Oil & Gas industry’s condition.
Strengths: “By the end of 2009, unprecedented economic-stimulus packages and the
irrepressible growth of key Asian nations appeared to turn around the global economy. We
responded swiftly to the downturn, restructuring Shell to make it more competitive. And we did
so without diluting the talents that make our company strong. At the same time, we retained our
long-term view”. The aforementioned statement by Shell’s chairman illustrates a main area of
Shell’s key strength in today’s ever increasing challenging business environment. It clearly
represents the flexibility of Shell in the current environment and due to its global nature, its
ability to swiftly move its capital to the emerging markets of Asia, where growth is exceeding
expectations. Amongst others Shell’s key strengths include the development and application of
technology, the financial and project management skills that allow them to undertake large oil
and gas projects, and the management of integrated value chains. Shell’s strategy of more
upstream, profitable downstream remains unchanged.
Weaknesses: “In 2009 the world felt the acute effects of the global recession. Oil demand
experienced its steepest drop since 1982. Consumption of natural gas in the European Union fell
more than it ever has before. Refining margins were put under great pressure, as were the
margins in the petrochemicals business. Financing of projects tightened as banks rebuilt their
balance sheets. And the treasuries of many countries came under severe strain.” This statement
by the chairman in the annual report of 2009 suggests that Shell (though being one of the top
companies in the world through market capitalisation) is still vulnerable to the severe economic
depression and decrease in both the price and demand for oil. Against the background of low
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“How the Company manage their Working Capital and at the same time manage their Liquidity?”
energy prices, competition for access to resources remains intense. Cost inflation continues at a
high rate, in certain cases strengthened by the US dollar. Further research confirmed other
potential technical weaknesses in Shell’s business model which are:

Shell’s strong focus on oil and gas requires it to search continually for replacement
supplies, and exploration is a high-cost element of its operations.

Shell still uses the technique of flaring and burning gas from oil extracting sites as a way of
dealing with unwanted by-products of its operations: this is considered to be
environmentally unacceptable by many.

Shell has a strong presence in Nigeria, but this area is politically volatile and operations
have been fraught with security problems for staff and attacks on production. The company
may be forced to withdraw, compromising its network of resources and threatening its
ability to meet production obligations.

The company is reported to be reviewing involvement with a wind power development
near Blackpool, raising questions regarding its commitment to alternative energy sources.
Opportunities: “We had a good year in 2009 in exploration. We discovered gas in shale
formations of North America and off shore western Australia. There were 11 notable discoveries.
Additions to our proved reserves were more than double our production volumes for the year.
We have agreed with our partners to begin construction on one of the world’s largest natural gas
developments: the Gorgon offshore gas field of Australia, the project will nearly double
Australia’s LNG output. It is also expected to pioneer the large scale capture and storage of
carbon dioxide. In late 2009, we secured an important position in Iraq with the government
contract for developing the Majnoon field – a huge field in a country with great potential.”
This statement by the chief executive officer in his summary of the financial year of 2009 for
Shell represents a number of opportunities currently present to Shell in its upstream business of
exploration. We have to keep in mind that Oil is an energy resource that will never lose
importance and remains a backbone component of every developing or growing economy. The
analysis presents the following opportunities as most significant:
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“How the Company manage their Working Capital and at the same time manage their Liquidity?”

New oil and gas reserves are still being found, and there is the potential to discover more.

Shell has been able to move into areas rich in reserves which were previously too risky to
operate in, for example Iraq.

Shell’s active response to criticisms of environmentally unfriendly activities may lead to
less antagonistic relationships with environmental groups.

Emerging economies have a large and growing demand for fossil fuels.

Diversification into new products and alternative fuels may open up new markets.
Threats: Apart from the volatility in oil prices (having experienced a sharp decline in 2009)
which has a detrimental impact on Shell’s business activities, potentially reducing profits
substantially, the other major threats Shell can face are mentioned below in chronological order:

Political issues in some regions, Nigeria in particular, threaten operations. A court order
has demanded Shell hand over a site on the Niger Delta to local ownership.

Summer 2008 saw strikes by tanker drivers working for Hoyer, suppliers of Shell, resulting
in negative publicity, criticism of Shell’s high profits and a supply problem for Shell
forecourts.

The economic downturn has led to a decrease in demand for fossil fuels, possibly
aggravated by changes in driving habits in response to high fuel prices earlier in 2008.

Weather can have significant effects on production, with refineries particularly hit recently
by Hurricane Ike.
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“How the Company manage their Working Capital and at the same time manage their Liquidity?”
8.0
REFINING INDUSTRY OUTLOOK 2010
Volatile commodity prices, larger stocking of oil and unstable demand made companies cautious
with their investment plans in 2009. Global oil and gas spending went down around 18% in 2009
versus 2008 after rising around 26% in 2008 versus 2007. The capital expenditure plans for 2009
are noticeably different in terms of the scope and strategy adopted by the large companies.
Furthermore, many companies are reluctant to invest; in mature basins which typically have
higher costs, in regions with high geo-political risk and in countries with unstable fiscal regimes.
Making the right investment decisions in a volatile price environment is one of the greatest
challenges faced by the leading oil and gas companies and many companies have not finalized
their investment plans for the coming year. The global refining industry is witnessing a slump
following the global economic downturn after a high return period in the past few years.
Uncertain product demand, decreasing refinery margins and a surplus refining capacity are
having a combined negative effect on the profitability of refining operations. This will continue
to cast a shadow of uncertainty over the future of refinery margins thereby compelling integrated
companies to divest their non-profitable assets to fund other businesses.
In 2009 the refining industry margins remained significantly unstable, particularly in the USA,
amid global decrease in demand for products. In the absence of any major disruptions, refining
margins are expected to trend lower in 2010 than 2008 with new conversion capacities expected
to come on-stream and the prospect for slower global economic growth (due to the recessionary
conditions observed across major economies). However, eventual levels are uncertain and will
be strongly influenced by the pace of global economic growth, the effect of persistently high oil
prices on product demand and start-up timing of expected refinery expansions. The crude oil
price has recovered by 57% to around $75 per barrel from $45 per barrel in January 2009.
Currently crude oil and natural gas are trading at around $82 per barrel and $5.7 per Mcf. The
global economic environment and the short and long term outlook for commodity prices play a
vital role in the capital expenditure plans of exploration and production companies. With the
major economies showing some signs of recovery in the second half of 2009, global economic
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“How the Company manage their Working Capital and at the same time manage their Liquidity?”
conditions are expected to improve in 2010. Emerging economies such as India and China will
be the key growth drivers for the global resurgence.
The capital expenditure (capex) of oil and gas companies, witnessed a significant decrease in
2009, after the surge in 2007–08. However, in 2010 capex activity is expected to rise, driven
mainly by large National Oil Companies (NOCs). Analysts forecast a 12% growth in the oil and
gas sector capital expenditure in 2010 and expect the total capex of the leading listed oil and gas
companies to exceed $798 billion, driven mainly by the investments of NOCs. The total capital
expenditure by the listed NOCs (for which data is publicly available) is expected to register a
16% growth to around $375 billion in 2010. The graph below details forecasted Capex activity in
the refining industry across the year 2010.
Capex Activity 2010 ($ Bn)
900
800
700
600
500
400
Capex Activity 2010 ($ Bn)
300
200
100
0
NOCS's
Integrated Independant Independant Total Capex
E & P's Upstream &
Downstream
Figure 1.6 (Source: InvestorsIdeas.com (2010)
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“How the Company manage their Working Capital and at the same time manage their Liquidity?”
Figure 1.7 (Source: EnergyInsights.net)
The graph above (Figure 1.7) clearly represents the increasing forecasted oil demand from the
emerging markets (Asian economies of India, China and Pakistan).
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“How the Company manage their Working Capital and at the same time manage their Liquidity?”
Figure 1.8 (Source: Thomson Reuters (2010)
Figure 1.8 above shows the trend of oil prices over the years with the 2010 and 2011 averages
forecasted. One can clearly see the sharp decline observed after the year 2008 (due to the global
economic crisis).
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“How the Company manage their Working Capital and at the same time manage their Liquidity?”
9.0
CONCLUSION
Shell is one of the largest independent oil and gas organizations in the world (by numerous
measures, which include market capitalisation, operating cash flow and oil and gas production).
Oil and gas (part of the Upstream business line) is, by far the largest of Shell’s business activities
(including the oil and gas related revenues from the Exploration & Production, Gas & Power, Oil
Sands and Oil Products areas). Shell markets oil products in more countries than any other oil
company in the world. It retains a strong position not only in the major industrialised countries
but also in the developing ones (emerging markets: Asian Economies).
The following represent the four major segments in Shell’s business strategy that would be the
biggest concern from an investor’s point of view:

Challenging Market Conditions in 2009

Sharpening the focus on delivery and affordability

Future forecasted growth programme for 2011-12 are on track

Strong opportunity set for the long-term
Despite Shell’s best efforts the economic recessionary conditions observed across major
economies, the 2009 earnings totalled to $12.7 billion. This was substantially down from $26.5
billion the preceding year. Production decreased because of lower demand for natural gas and
oil, although divestments and OPEC quotas are to blame as well. Lower oil and gas prices also
contributed significantly to lower Upstream revenues. Global demand for oil products weakened
and refining margins declined to historical lows, reducing Downstream earnings. Lower sales
volumes and margins affected our chemicals performance.
The following graphs paint an accurate picture of the challenging economic conditions faced by not only
Shell but the refining industry in general:
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“How the Company manage their Working Capital and at the same time manage their Liquidity?”
To counter the economic recession Shell underwent a major restructuring of its business that was
completed in the year 2009. This restructuring and reorganisation enabled the company to become more
efficient in terms of managing their employees, assets and business divisions. The previous structure was
as follows:





Exploration & Production
Gas & Power
Oil Sands
Oil Products
Chemicals
The new structure divides the business of Shell into three major segments which are commonly (
throughout the project) known as Upstream (including Exploration & Production, Gas & Power and Oil
sands), Downstream (including Oil products & Chemicals) and Production and Technology which
encompasses major technological innovative products across all the five previous sectors. This
restructuring also enabled Shell to:
1) Reduce senior management positions by 20%
2) Assigning the top 600 managers to their particular area of expertise
This illustrates how Shell has revolutionized its production process (by including a new business stream:
Production & Technology), redeployed capital efficiently and reduced on operational costs (which can be
seen by comparing the income statements of year 2009 with 2008).
Figure 1.9
In the years prior to the recession Shell had strong growth in all major sectors of its business.
Company’s sales revenue moved up by about 16% in a couple of years and was forecasted for
good performance in the coming years. Their gross profits margins remained high, control
measures’ strong (operating costs are in control) and it is expected to outsource the bulk of its
information technology division next year, a move that could affect about 3,200 jobs.
However, in 2009 the world felt the acute effects of the global recession. Oil demand
experienced its steepest drop since 1982. Consumption of natural gas in the European Union fell
more than it ever has before. Refining margins were put under great pressure, as were the
margins in the petrochemicals business. Financing of projects tightened as banks rebuilt their
balance sheets. Shell was no exception to this as revenues fell severely as expected (in line with
oil demand and price). This certainly changed the outlook for the company going forward and
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“How the Company manage their Working Capital and at the same time manage their Liquidity?”
restructuring plans mentioned earlier took effect immediately. The following diagrams paint an
accurate picture regarding the recession on Shell’s business activities:
Figure 2.0
By considering the statistics mentioned above-one would become cautious about the financial
future of Shell and would strongly consider looking at the figures seems to reveal a picture quite
parallel from what it portrays.
Judging from an investor’s point of view the option and ability to invest in the oil market is
continually increasing due to the volatility observed in the commodity. Choosing to invest takes
a substantial amount of time, effort, and research necessary to evaluate whether or not seeking a
portion of the future earnings of Shell will come as a negative or positive impact to the investor’s
economic portfolio. Using financial ratios and data analysis techniques, both the company and
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“How the Company manage their Working Capital and at the same time manage their Liquidity?”
the investor are able to look at current performance figures and determine which direction the
firm will move in the market.
It must be kept in mind that there is no such thing as a safe, secure investment. However, the
ability to reduce risk and thereby loss is undoubtedly welcomed when valuable money is at stake.
Shell, unlike its competitors in the refining industry in the industry, has a very low risk
assessment as is clearly illustrated in the debt / equity ratio. For this reason, shareholders seem to
be willing to pay a premium to buy into Shell’s future earnings. As Warren Buffet famously
exclaimed, “It is better to buy a wonderful company at a fair price than to buy a fair company at
a wonderful price.”
While Shell remains a lower risk investment than its competitors, the market still demands solid
returns for its shareholders. We can judge from the Price / Earnings ratio, that while the entire
industry has taken a slide downward in the last five years, Shell still by far exceeds the industry
average. The market seems consistent about expecting positive performance from the company,
including strong sense of security.
Overall judging by the data analysis done previously it is assured that Shell will remain as a
positive investment and attractive opportunity for the investor and private equity world, however
it remains to be seen what the future holds as the Chairman of Shell famously quoted in his
financial year 2009 report “Making the world’s energy supply secure, affordable and sustainable
is not just a worthy goal; it is a global imperative. It will take time, and it will take a lot of effort.
But with our far-sightedness and technical prowess, we can contribute to the endeavour even as
we deliver the results that our shareholders expect in the long term”.
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“How the Company manage their Working Capital and at the same time manage their Liquidity?”
BIBLIOGRAPHY
Books:
1. Brealey, R. A. & Myers, S. C. (2002), Capital Investment and Valuation, McGraw-Hill
Professional
2. Madura, J. (2009), International Financial Management, 9th Edition, Abridged Edition
3. Kaplan Publishing, ACCA Paper 2.4, (n.d), Financial Management and Control
4. Kaplan Publishing, ACA (ICAEW), (n.d), Knowledge Module Audit and Assurance
5. Kaplan’s publishing, (ACCA paper F9 Manual), (2008), Financial Management &
control
6. McDaniel and gates (2006), Marketing Research with SPSS, 7th edition
7. Moyer, R. C., McGuigan, J. R. William & Kretlow, J. (1995), Contemporary Financial
Management
8. Sushma Vishnani and Bupesh kr. Shah (n.d), Impact of working capital management
policies on corporate performance
Journals:
1. Ernst & Young LLP (2009), All tied up-working capital management report
2. KPMG frontiers in finance journal (September 2009)
Articles:
3. REL Consultancy, a unit of Hackett group (2008 ), Blue print for cash culture research
Websites:
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<http://www.bp.com/bodycopyarticle.do?categoryId=1&contentId=7052055>
2. Danskebank.com (2009), Working Capital Management 2009 – A Survey of Nordic
companies, Accessed: 16/05/10, [Online] <http://www.danskebank.com/en-uk/aboutus/news-archives/Documents/Report%20Working%20Capital_ENG-2009.pdf>
3. Economist.com (n.d.) The Economist, Accessed: 14/04/10, [Online]
<http://www.economist.com/>
4. EnergyInsights.net (n.d.), Energy Insights: Oil, Gas Analysis, Energy News, Accessed:
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5. Finance Marketers’ Alliance (2010), Crisis has Companies Focused on Cash, Accessed:
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<http://www.ft.com/home/uk>
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London, Accessed: 21/03/10, [Online] <http://www.ft.com/home/uk>
8. Financial Time (02 July 2007), Non-financial Risks: Testing times for oil's biggest
names, Mike Scott, Accessed: 22/03/10, [Online] <http://www.ft.com/home/uk>
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18/04/10, [Online] <http://www.investorideas.com/research>
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<http://www.londonstockexchange.com/home/homepage.htm>
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<http://exinfm.com/>
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<http://www.oliverwyman.com/ow/pdf_files/WorkCapManagement.pdf>
13. QFinance – The Ultimate Finance Resource (2009), Working Capital Management,
Accessed: 20/05/10, [Online] <http://www.qfinance.com/cash-flow-management-bestpractice/best-practice-working-capital-management-techniques-for-optimizinginventories-receivables-and-payables?page=1>
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20/04/10, [Online]
<http://www.faoi.shell.com/2008/downstream/financialandoperatingdataoilproducts/refin
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15. Sage Journals Online, Impact of Working Captial Managemnet Policies on Corporate
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<http://gbr.sagepub.com/cgi/content/abstract/8/2/267>
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<http://business-financial-planning.suite101.com/>
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22/03/10, [Online] <http://www.shell.com/>
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<www.thomsonreuters.com>
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“How the Company manage their Working Capital and at the same time manage their Liquidity?”
APPENDIX I
Shell Data
Heading
(Dollar Millions) ($)
Sales
2003
195236
2004
266386
2005
306731
2006
318845
2007
355782
2008
458361
Cost of Sales
162192
223259
252622
262989
296697
395639
Accounts Receivables
29013
37473
66386
59668
74238
82040
Accounts Payable
32383
37909
69013
62556
75697
85091
Inventories
12960
15375
19776
23215
31503
19342
Current Assets
43820
62049
97892
91885
115397
116570
Non Current Assets
114597
125397
121624
143391
154073
165831
Current Liabilities
48874
54852
84964
76748
94384
105529
equity share capital
fixed term interest bearing liabilities (short and long term
debt)
72497
91383
97924
114945
125968
128866
20127
14592
12916
15773
18099
23269
Profit before interest and tax
23059
43827
45635
45777
51684
52001
1324
1059
1068
1149
1108
1181
Net profit
12313
18450
25311
25442
31331
26476
Gross Profit
33215
43127
54109
54109
59085
62722
Interest charges
Operating Profit
21323
19491
26568
26311
31926
26476
158417
187446
219516
235276
269470
282401
Financial Ratio's
Current Ratio
0.897
1.131
1.152
1.197
1.223
1.105
Quick Ratio
0.631
0.851
0.919
0.895
0.889
0.921
Accounts Receivable Payment Period
54.241
51.345
78.997
68.305
76.161
65.330
Inventory Turnover
12.515
14.521
12.774
11.328
9.418
20.455
Capital Employed (current and non current assets)
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“How the Company manage their Working Capital and at the same time manage their Liquidity?”
Inventory Turnover Period
29.165
25.136
28.573
32.220
38.755
17.844
Accounts Payable Payment Period
72.875
61.976
99.713
86.821
93.123
78.501
Sales Revenue/net working capital
-38.630
37.013
23.726
21.064
16.932
41.514
3.602
6.263
7.582
7.287
6.960
5.538
Interest cover ratio
17.416
41.385
42.729
39.841
46.646
44.031
Net Profit Margin (%)
6.31%
6.93%
8.25%
7.98%
8.81%
5.78%
Gross Profit Margin (%)
17.01%
16.19%
17.64%
16.97%
16.61%
13.68%
Operating Profit Margin (%)
10.92%
7.32%
8.66%
8.25%
8.97%
5.78%
Gearing Ratio
Earnings Per Share ($/share)
1.81
2.74
3.79
3.97
5
4.27
7.77%
9.84%
11.53%
10.81%
11.63%
9.38%
Sales
2003
169441
2004
199876
2005
239792
2006
265906
2007
284365
2008
361143
Cost of Sales
130108
153237
184118
210976
224991
293738
Accounts Receivable
27881
37099
40902
38692
43152
33644
Accounts Payable
29740
38540
42136
42236
38020
29261
Inventories
11597
15645
19760
18915
26554
16821
Current Assets
45074
61443
75290
75339
80202
66384
Non Current Assets
123011
127230
121830
129771
140169
152019
Current Liabilities
49783
63126
71947
75352
77231
69793
equity share capital
fixed term interest bearing liabilities (short and long term
debt)
70595
76656
80765
85465
94652
92109
22325
23091
35069
37637
42452
48452
Profit before interest and tax
17954
25242
32682
35158
32352
35239
513
440
616
986
1393
1547
4729
9360
22632
22286
21169
216666
15673
19246
31921
34642
31611
34283
ROCE
BP Data
Heading
Interest charges
Net profit
Operating Profit
(Dollar Millions) ($)
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“How the Company manage their Working Capital and at the same time manage their Liquidity?”
Capital Employed (current and non current assets)
168085
188673
197120
205110
220371
218403
Financial Ratio's
Current Ratio
0.905
0.973
1.046
1.000
1.038
0.951
Quick Ratio
0.672
0.726
0.772
0.749
0.695
0.710
Accounts Receivable Payment Period
60.060
67.748
62.259
53.111
55.388
34.003
Inventory Turnover
11.219
9.795
9.318
11.154
8.473
17.463
Inventory Turnover Period
32.534
37.265
39.173
32.724
43.078
20.902
Accounts Payable Payment Period
83.431
83.531
-35.982
71.730
73.071
20454.308
61.679
Sales Revenue/net working capital
91.800
118.762
95.714
36.360
105.938
3.162
3.320
2.303
2.271
2.230
1.901
Interest cover ratio
34.998
57.368
53.055
35.657
23.225
22.779
Net Profit Margin (%)
2.79%
4.68%
9.44%
8.38%
7.44%
59.99%
Operating Profit Margin (%)
9.25%
9.63%
13.31%
13.03%
11.12%
9.49%
47.27
72.08
105.74
109.84
108.76
112.59
2.81%
4.96%
11.48%
10.87%
9.61%
99.20%
Gearing Ratio
Earnings Per Share (cents/share)
ROCE
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“How the Company manage their Working Capital and at the same time manage their Liquidity?”
APPENDIX II
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-1-