WORKING CAPITAL MANAGEMENT

2

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

MANAGE FUNDS

EXCESS/SHORTFALL

DISBURSEFUNDS

COLLECTFUNDS

TRACKTRANSACTIONS

& BALANCES

CUSTOMERACCOUNT

BANKER’S PERSPECTIVE

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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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INFLOWS OUTFLOWS

INV

ES

TM

EN

TS

BO

RR

OW

ING R

EP

AY

RE

PA

YIN

VE

ST

DECELERATEACCELERATE

BO

RR

OW

WORKING CAPITALManaging Liquidity

Source: Essentials of Managing Corporate Cash

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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

PROFIT? CASH

BALANCE?

Stock

Pu

rch

ase

sS

ale

s

£20

£20

£40

£80

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Operating Cycle

Purchase Resources Pay Sell on Credit Receive Cash

Inventory Conversion Receivables Conversion

Payables Period 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 SheetShort Term Items

Current assets

Inventories 1,910 1,903

Trade and other receivables 1,713 1,625

Current tax assets 13 -

Other financial assets 43 78

Cash and short term assets 733 917

4,412 4,523

Current liabilities

Short term borrowings 355 555

Trade and other payables 1,690 1,735

Current tax liabilities 121 44

Other financial liabilities 119 13

Short term provisions 82 130

1,367 2,477

Turnover 9,577

Cost of goods sold 8,943

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Operating Cycle

Purchase Resources Pay Sell on Credit Receive Cash

Inventory Conversion 78 days Receivables Conversion

65 days

Payables Period Cash Conversion Cycle

69 days 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 FLOATFunction Float Responsibility

1. Order received Production float

2. Goods dispatched System float

3. Invoice issued Credit period

4. Payment due Customer float

5. Payment made Postal float

6. Payment received System float

7. Payment banked Bank float

8. Funds available Concentration float

9. Funds to correct account Information float

10. Advice of availability  

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 DatingThe 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 DatingThe 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 PaymentCheque 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 EDILook 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

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

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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 Monitor cash flow forecasts

annually / quarterly / monthly / weekly / daily

Determine:

Amount / currency { Now and atDuration / location { period end

Investment action

Confirmation

Recording / monitoring / reporting

Liquidation

INVESTMENTDECISION

Identify surpluses

External Factors:

Interest rates / trendsCurrency exchange ratesEconomic factorsAvailability

Internal policy covering

Investment typesRiskRatingsTime framesLiquidityPerformance objectivesFunding subsidiariesTax

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THE FINANCING DECISION PROCESS Monitor cash flow forecasts

annually / quarterly / monthly / weekly / daily

Determine:Amount / currencyDuration / location

Financing action

Documentation

Recording / monitoring / reporting

Liquidation

FINANCING DECISION

Identify deficits

External Factors:

Interest rates / trendsCurrency exchange ratesEconomic factorsLiquidity of market

Internal policy covering

Borrowing internallyInstrumentsFinancing policyExisting limitsPerformance objectivesExisting facilitiesBalance sheet/ratio impactTax

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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