WORKING CAPITAL MANAGEMENT

AGENDA

    

Working Capital, Definition Float and Value Dating Payment and Collection Instruments Short-Term Investing Short-Term Borrowing

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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.
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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
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CASH MANAGEMENT ENVIRONMENT
BANKER’S PERSPECTIVE
CO LLEC T FNS UD D BRE IS U S F NS UD

CU T M S O ER A CCO N UT

TA R CK T A S CT N R N A IO S &B LA CES A N

MN G AA E FNS UD EX S CES / S OTA H R F LL

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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
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BENEFITS OF GOOD CASH MANAGEMENT
   

Control of financial risk Opportunity for profit Strengthened balance sheet Increased customer, supplier, and shareholder confidence

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WORKING CAPITAL
Managing Liquidity
INVESTMENTS
REPAY

INVEST

FO IN

M R

IO AT

N

IN FO

RM AT

IO

N

ACCELERATE

INFLOWS

OUTFLOWS
IN FO

DECELERATE

BORROWING

Source: Essentials of Managing Corporate Cash

BORROW

IN

FO

R M

A TI

O N

R M A TI

REPAY

O N

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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
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NEED FOR LIQUIDITY
      

Day to day transactions Precautionary balances Compensating balances Obtaining discounts Acid tests Favourable opportunities Overall avoiding bankruptcy!

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THE CASH GENERATOR / ABSORBER
£40 £2 0
Purchases
Stock

Sales

£8 0

£20

PROFIT? CASH BALANCE?
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Operating Cycle
Purchase Resources Pay Sell on Credit Receive Cash

Inventory Conversion Payables Period

Receivables Conversion Cash Conversion Cycle

Operating Cycle

From:Fundamentals of Contemporary Financial Management, 2nd ed , by Moyer, McGuigan and Rao

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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

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Balance Sheet Short Term Items
Current assets Inventories Trade and other receivables Current tax assets Other financial assets Cash and short term assets 1,910 1,713 13 43 733 4,412 1,903 1,625 78 917 4,523

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

355 1,690 121 119 82 1,367

555 1,735 44 13 130 2,477

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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

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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
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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?

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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

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WHY DOES FLOAT OCCUR?
   

Deliberately Inefficiency Logistical situations Compensation mechanism

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STAGES OF FLOAT
Function 1. Order received 2. Goods dispatched 3. Invoice issued 4. Payment due 5. Payment made 6. Payment received 7. Payment banked 8. Funds available 9. Funds to correct account 10. Advice of availability Float Production float System float Credit period Customer float Postal float System float Bank float Concentration float Information float Responsibility Supplier Supplier Supplier Buyer Buyer/ postal service Supplier Banks Banks Banks

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Controlling Float

  

We need to look at controlling / influencing float in three areas * Ourselves * Our Customers * Our Banks

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HOW TO REDUCE/CONTROL FLOAT

Your Own Actions

Change own systems Educate customers Include costs in prices Negotiate with bank

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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

• • •

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RECEIVABLES IMPACT
Important because of costs arising from  Float  Bad debts  Management time  Legal fees And  Impact on analysts and creditors
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RECEIVABLES MANAGEMENT 1

Clear instructions Method of payment Documentation Account structures Terms of Trade

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Controlling Float

Payment Methods Payment methods are important because of - Cost - Risk - Value Dating - Finality

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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
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• •

RECEIVABLES MANAGEMENT 2
    

Penalties Post dated cheques Legal process Internal process Stop supply But do not forget Relationship

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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
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FINALITY
The time after which a payment is considered to become irrevocable and cannot be returned without the permission of beneficiary account holder.

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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
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Method of Payment Cheque Clearing, UK

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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

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CROSS-BORDER PAYMENTS

Paper-based
• • • • •

Foreign currency cheques Banker’s drafts Giros (Credit transfer) Documentary collections Cheque negotiations

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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) Credit cards Direct debits
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Clearing House Automated Transfer System

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Controlling Float

Bank Services
• • • • • •

Lockbox Intervention accounts Remote disbursement Controlled disbursement Direct collections Efficient collections structure

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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?

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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
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   

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?

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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

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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

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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%

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SHORT-TERM INVESTMENTS
     

Commercial paper (CP) Banker’s acceptances (BAs) Repurchase agreements Certificates of deposit (CDs) Money market funds Treasury instruments (bills, notes, bonds)

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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?

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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

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SHORT-TERM FUNDING INSTRUMENTS

Internal short-term funding
• •

Least expensive source of funding Cross-border and cross-currency intra-group financing can be difficult Can act as a built-in hedge if sourced in the same currency Can be inexpensive to borrow local currency in the currency center

External short-term funding

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FACTORS IN CHOOSING FUNDING INSTRUMENTS
   

All-in borrowing cost Security required Terms & conditions Tax & balance sheet aspects

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INVESTMENT DECISION PROCESS
M i o c s fo f r c ss o t r ah l woe at n a n al /q at ry/mnhy/we l /diy n ul y urel ot l e ky al I e tf s r l s s dni y upue

Dt r i e eem : n A o n /c r e c m t ur ny u Dr t o /l c to uai n oai n I t r a p lc c vrn nenl oi y o ei g I vsm tt ps n et e y e n Rk i s Rt n s ai g T efa e i m rm s L udt i i iy q Prom c o j ci e ef r a e be t vs n Fn i gs bi i re u dn u sdai s Tx a Et r a Fcos xenl a t r : I VS MN N ET E T DC I N EI O S I t r s r t s/t e d neet ae r n s Cre c e c a g r t s ur ny xhn e ae Eo o i f cos c nm at r c Aal blt vi a i i y { { Nw n a o ad t pro e d ei d n

I vsm ta t o n et e ci n n

Cni m i n o fr a o t

Rc r i g/mnt rn /r p ri g e odn o ioi g e ot n

L udt o i i ai n q

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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

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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)

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INTERNATIONAL SHORT-TERM INVESTMENTS
 

Banker’s Acceptances Commercial paper
• •

Euro GBP

 

Treasury bills Certificates of deposit
• •

GBP Eurodollar

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BILLS OF EXCHANGE
  

Foreign currency Commercial GBP
• • •

Eligible Ineligible Trade bills

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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?

  

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OTHER SOURCES OF FUNDING
   

Factoring Invoice discounting Trade bills Acceptance credits

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