WORKING CAPITAL
MANAGEMENT
AGENDA

Working Capital, Definition

Float and Value Dating

Payment and Collection Instruments

Short-Term Investing

Short-Term Borrowing
2
Working Capital



Working Capital – All the items in the short
term part of the balance sheet
e.g. cash, short term debt, investments,
inventory, debtors (receivables), payables
(creditors) etc
Net Working Capital is the difference between
Current Assets and Current Liabilities
Cash Management, Liquidity Management
Interconnected terms.
3
CORPORATE DEFINITION OF
CASH MANAGEMENT

The effective planning, monitoring and
management of liquid / near liquid
resources including:
•
Day-to-day cash control
•
Money at the bank
•
Receipts
•
Payments
•
S-T investments and borrowings
4
CASH MANAGEMENT
ENVIRONMENT
BANKER’S PERSPECTIVE
COLLECT
FUNDS
DISBURSE
FUNDS
CUSTOMER
ACCOUNT
TRACK
TRANSACTIONS
& BALANCES
MANAGE
FUNDS
EXCESS/
SHORTFALL
5
BANK DEFINITION OF CASH
MANAGEMENT

The effective planning, monitoring and
management of liquid / near liquid resources
including:
•
•
•
•
•
•
•
Provision of bank accounts
Deposit / withdrawal facilities
Provision of information regarding bank
accounts and positions
Money transfers and collection services
Investment facilities
Financing facilities
Pooling and netting
6
BENEFITS OF GOOD CASH
MANAGEMENT




Control of financial risk
Opportunity for profit
Strengthened balance sheet
Increased customer, supplier, and
shareholder confidence
7
WORKING CAPITAL
Managing Liquidity
Source: Essentials of Managing Corporate Cash
8
DEFINITION OF LIQUIDITY
Having sufficient funds available to meet all
foreseen and unforeseen obligations
Liquidity has costs

Cash is unproductive

Spread between borrowing and deposit rates
and between long and short term rates
9
NEED FOR LIQUIDITY







Day to day transactions
Precautionary balances
Compensating balances
Obtaining discounts
Acid tests
Favourable opportunities
Overall avoiding bankruptcy!
10
THE CASH GENERATOR / ABSORBER
Sales
Purchases
Stock
PROFIT?
CASH BALANCE?
11
Operating Cycle
Purchase Resources
Pay
Sell on Credit
Inventory Conversion
Payables Period
Receive Cash
Receivables Conversion
Cash Conversion Cycle
Operating Cycle
From:Fundamentals of Contemporary Financial Management, 2nd ed
, by Moyer, McGuigan and Rao
12
The Various Cycles



Inventory Conversion
Inventory x 365
Cost of Goods Sold
Payables Conversion
Payables/Creditors x 365
Cost of Goods Sold
Receivables Conversion
Receivables/Debtors x 365
Turnover
13
Balance Sheet
Short Term Items
Current assets
Inventories
Trade and other receivables
Current tax assets
Other financial assets
Cash and short term assets
Current liabilities
Short term borrowings
Trade and other payables
Current tax liabilities
Other financial liabilities
Short term provisions
Turnover
9,577
Cost of goods sold 8,943
2011
1,910
1,713
13
43
733
4,412
2010
1,903
1,625
78
917
4,523
355
1,690
121
119
82
1,367
555
1,735
44
13
130
2,477
Work out the CCC for 2011
anb
14
Operating Cycle
Purchase Resources
Pay
Sell on Credit
Receive Cash
Inventory Conversion 78 days
Payables Period
69 days
Receivables Conversion
65 days
Cash Conversion Cycle
74 days
Operating Cycle
143
From:Fundamentals of Contemporary Financial Management, 2nd ed
, by Moyer, McGuigan and Rao
anb
15
Cash Conversion




We need to consider control in all areas of
working capital to maximise return, reduce
cost.
Some areas are not controlled by the Finance
Function – Stock/inventory
Some areas have shared control – payables
and receivables
Some areas are controlled by the Finance
Function – short term borrowing and
investment
16
Float



Any delay in the process of converting
materials and labour to receipt of
payment involves cost, float cost.
Similarly, any delay in making payments
will also give rise to float but this time to
our advantage
What is float?
17
FLOAT

Definition of bank float
The time lost between a payor making a payment and a
beneficiary receiving value

Cost of Float
principle amount due x no of days x cost of funds
360 or 365
18
WHY DOES FLOAT OCCUR?




Deliberately
Inefficiency
Logistical situations
Compensation mechanism
19
STAGES OF FLOAT
Function
Float
Responsibility
1. Order received
Production float
Supplier
2. Goods dispatched
System float
Supplier
3. Invoice issued
Credit period
Supplier
4. Payment due
Customer float
Buyer
5. Payment made
Postal float
Buyer/ postal service
6. Payment received
System float
Supplier
7. Payment banked
Bank float
Banks
8. Funds available
Concentration float
Banks
9. Funds to correct account
Information float
Banks
10. Advice of availability
20
Controlling Float




We need to look at controlling /
influencing float in three areas
* Ourselves
* Our Customers
* Our Banks
21
RECEIVABLES AND PAYABLES
MANAGEMENT

Good receivables and payables
management aids in:
•
Cash flow forecasting
•
Long-term funding and investment
decisions
•
Reduced risk of bad debts
•
Stronger liquidity
•
Stronger balance sheet ratios
22
RECEIVABLES IMPACT
Important because of costs arising from
 Float
 Bad debts
 Management time
 Legal fees
And
 Impact on analysts and creditors
23
RECEIVABLES MANAGEMENT 1

Clear instructions

Method of payment

Documentation

Account structures

Terms of Trade
24
INTERNATIONAL TRADE
PAYMENTS
Terms of trade

Settlement
•
•
•
•
•
•
Open account
Clean collection
Documentary collection

Against payment

Against acceptance
Revocable documentary letter of credit
Irrevocable documentary letter of credit

Unconfirmed

Confirmed
Advance payment
25
RECEIVABLES MANAGEMENT 2





Penalties
Post dated cheques
Legal process
Internal process
Stop supply
But do not forget Relationship
26
HOW TO
REDUCE/CONTROL FLOAT

Your Own Actions
•
Change own systems
•
Educate customers
•
Include costs in prices
•
Negotiate with bank
27
Controlling Float

Payment Methods
Payment methods are important
because of
- Cost
- Risk
- Value Dating
- Finality
28
VALUE DATING
Value
The moment when funds cease to be useable to the
originating party and instead become useable funds to
the beneficiary in the sense of reducing an overdraft or
accruing interest
29
VALUE DATING

Forward Value Dating
The time between a bank being notified of a
transaction in favor of a customer and the
customer receiving future value for the item

Back Value Dating
The time between a bank being notified of a
transaction to the customer’s account and the
item being valued on a date prior to the date of
the transaction
30
AVAILABILITY
The time when the beneficiary actually
has access to the funds i.e. to use to
make a payment
31
FINALITY
The time after which a payment is
considered to become irrevocable and
cannot be returned without the
permission of beneficiary account
holder.
32
DOMESTIC PAYMENT
INSTRUMENTS

Paper-based
Cash
• Cheques
• Bank transfers or giros
• Postal giros
• Bills of exchange
• Promissory notes
• Banker’s drafts
Search for ‘APACS’ on the internet
•
33
DOMESTIC PAYMENT
INSTRUMENTS

Electronic
•
Funds transfer


Urgent wires
Standard EFT
Automated clearing house payments
• Standing order
• Direct Debit
• Electronic bills of exchange
• Plastic (credit, charge, cheque guarantee, cash
dispenser, debit)
• Financial EDI
Look up ‘Voca’ on the internet, used to be BACS
Faster pay
•
34
CROSS-BORDER PAYMENTS

Paper-based
•
Foreign currency cheques
•
Banker’s drafts
•
Giros (Credit transfer)
•
Documentary collections
•
Cheque negotiations
35
CROSS-BORDER PAYMENTS

Electronic
•
•
•
•
•
Using correspondent banks
Using a global or pan-regional bank
Cross-border systems
- TARGET
- EBA EURO 1
- EBA Step 1
- CHAPS euro (NewCHAPS)
- RTGSplus – (EAF2)
Credit cards
Direct debits
36
Controlling Float

Bank Services
•
•
•
•
•
•
Lockbox
Intervention accounts
Remote disbursement
Controlled disbursement
Direct collections
Efficient collections structure
37
PAYABLES
Critical questions:

•
•
•
•
•
•
What is due?
When is it due?
Where should the payment be sent?
How should the payment be sent?
Are there funds to cover the
payment?
Is the payment properly authorized?
38
PAYABLES MANAGEMENT




The flip side of the coin
So
Hang on to it
Consider float versus control
Account structures
Discounts
But do not forget Relationship
39
SHORT-TERM INVESTING

The Decision Process
•
•
•
•
How much do I have to invest per
currency?
How long do I have to invest it?
Where are the funds located?
What is my appetite for risk?
40
INVESTMENT GUIDELINES

What are the company’s policies
regarding:
•
Currency exposure and hedging
•
Banks used and limits
•
Investment instruments and limits
•
Use of automated sweep accounts
•
Bank / investment ratings
41
FACTORS IN CHOOSING
INVESTMENTS


The need to make an adequate return
The need to take into account areas of
risk
•
•
•
•

Credit risk
Interest rate risk
Capital risk
Market risk
The need to consider liquidity
42
HOW RATES ARE QUOTED

At a discount: Instrument issued at less
than 100%

Coupon: Specific interest payments
made at specific times

Yield to redemption: Interest payments
over the lifetime of the instrument and
principal repaid may be greater or less
than 100%
43
SHORT-TERM INVESTMENTS

Commercial paper (CP)

Banker’s acceptances (BAs)

Repurchase agreements

Certificates of deposit (CDs)

Money market funds

Treasury instruments (bills, notes,
bonds)
44
INVESTMENT DECISION PROCESS
Monitor cash flow forecasts
annually / quarterly / monthly / weekly / daily
Identify surpluses
Determine:
Amount / currency
Duration / location
{
{
Now and at
period end
Internal policy covering
Investment types
Risk
Ratings
Time frames
Liquidity
Performance objectives
Funding subsidiaries
Tax
External Factors:
INVESTMENT
DECISION
Interest rates / trends
Currency exchange rates
Economic factors
Availability
Investment action
Confirmation
Recording / monitoring / reporting
Liquidation
45
SHORT-TERM FUNDING
INSTRUMENTS


Internal short-term funding
•
Least expensive source of funding
•
Cross-border and cross-currency intra-group
financing can be difficult
External short-term funding
•
Can act as a built-in hedge if sourced in the
same currency
•
Can be inexpensive to borrow local currency
in the currency center
46
SHORT-TERM BORROWING

The Decision Process
•
•
•
•
How much needs to be financed and in
what currency?
How long does the deficit need to be
financed?
Where does it need it be financed?
What is the maximum level of funding
needed?
47
FACTORS AFFECTING
BORROWING

These factors affect both amount
available and cost
•
Financial strength of the company
•
Key covenants
•
Industry
•
Available guarantee or security
•
Company’s ability to repay on time from
bank’s perspective
48
THE FINANCING DECISION
PROCESS
Monitor cash flow forecasts
annually / quarterly / monthly / weekly / daily
Identify deficits
Determine:
Amount / currency
Duration / location
Internal policy covering
Borrowing internally
Instruments
Financing policy
Existing limits
Performance objectives
Existing facilities
Balance sheet/ratio impact
Tax
External Factors:
FINANCING DECISION
Interest rates / trends
Currency exchange rates
Economic factors
Liquidity of market
Financing action
Documentation
Recording / monitoring / reporting
Liquidation
49
U.S. SHORT-TERM INVESTMENTS

Commercial paper (CP)

Banker’s acceptances (BAs)

Repurchase agreements

Certificates of deposit (CDs)

US Treasury instruments (bills, notes,
bonds & STRIPS)
50
INTERNATIONAL SHORT-TERM
INVESTMENTS

Banker’s Acceptances

Commercial paper
•
Euro
•
GBP

Treasury bills

Certificates of deposit
•
GBP
•
Eurodollar
51
BILLS OF EXCHANGE

Foreign currency

Commercial

GBP
•
Eligible
•
Ineligible
•
Trade bills
52
FACTORS IN CHOOSING
FUNDING

Are all-in borrowing costs being
offered?

Does the bank require security?

What are the terms and conditions?

Is interest able to be offset on tax
returns?
53
OTHER SOURCES OF
FUNDING

Factoring

Invoice discounting

Trade bills

Acceptance credits
54