MN10311 Working Capital

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  • Note: Bank of England rules cover only financial institutions and therefore foreign banks are not necessarily covered.
  • Single currency, notional pooling is available from most major banks where there is nation-wide banking - Tax implications and restrictions as to ownership of the accounts
  • Note: Bank of England rules cover only financial institutions only and therefore foreign banks are not necessarily covered.
  • Note: Bank of England rules cover only financial institutions only and therefore foreign banks are not necessarily covered.
  • Note: Bank of England rules cover only financial institutions only and therefore foreign banks are not necessarily covered.
  • Note: Bank of England rules cover only financial institutions only and therefore foreign banks are not necessarily covered.
  • Note: Bank of England rules cover only financial institutions only and therefore foreign banks are not necessarily covered.
  • Note: Bank of England rules cover only financial institutions only and therefore foreign banks are not necessarily covered.
  • Note: Bank of England rules cover only financial institutions only and therefore foreign banks are not necessarily covered.
  • Note: Bank of England rules cover only financial institutions only and therefore foreign banks are not necessarily covered.
  • Note: Bank of England rules cover only financial institutions only and therefore foreign banks are not necessarily covered.
  • Note: Bank of England rules cover only financial institutions only and therefore foreign banks are not necessarily covered.
  • Note: Bank of England rules cover only financial institutions only and therefore foreign banks are not necessarily covered.
  • Note: Bank of England rules cover only financial institutions only and therefore foreign banks are not necessarily covered.
  • Note: Bank of England rules cover only financial institutions only and therefore foreign banks are not necessarily covered.
  • Note: Bank of England rules cover only financial institutions only and therefore foreign banks are not necessarily covered.
  • Note: Bank of England rules cover only financial institutions only and therefore foreign banks are not necessarily covered.
  • Note: Bank of England rules cover only financial institutions only and therefore foreign banks are not necessarily covered.
  • Note: Bank of England rules cover only financial institutions only and therefore foreign banks are not necessarily covered.
  • Note: Bank of England rules cover only financial institutions only and therefore foreign banks are not necessarily covered.
  • Note: Bank of England rules cover only financial institutions only and therefore foreign banks are not necessarily covered.
  • Note: Bank of England rules cover only financial institutions only and therefore foreign banks are not necessarily covered.
  • Note: Bank of England rules cover only financial institutions only and therefore foreign banks are not necessarily covered.
  • Note: Bank of England rules cover only financial institutions only and therefore foreign banks are not necessarily covered.
  • MN10311 Working Capital

    1. 1. WORKING CAPITAL MANAGEMENT
    2. 2. AGENDA <ul><li>Working Capital, Definition </li></ul><ul><li>Float and Value Dating </li></ul><ul><li>Payment and Collection Instruments </li></ul><ul><li>Short-Term Investing </li></ul><ul><li>Short-Term Borrowing </li></ul>
    3. 3. Working Capital <ul><li>Working Capital – All the items in the short term part of the balance sheet </li></ul><ul><li>e.g. cash, short term debt, investments, inventory, debtors (receivables), payables (creditors) etc </li></ul><ul><li>Net Working Capital is the difference between Current Assets and Current Liabilities </li></ul><ul><li>Cash Management, Liquidity Management </li></ul><ul><li>Interconnected terms. </li></ul>
    4. 4. CORPORATE DEFINITION OF CASH MANAGEMENT <ul><li>The effective planning, monitoring and management of liquid / near liquid resources including: </li></ul><ul><ul><ul><li>Day-to-day cash control </li></ul></ul></ul><ul><ul><ul><li>Money at the bank </li></ul></ul></ul><ul><ul><ul><li>Receipts </li></ul></ul></ul><ul><ul><ul><li>Payments </li></ul></ul></ul><ul><ul><ul><li>S-T investments and borrowings </li></ul></ul></ul>
    5. 5. CASH MANAGEMENT ENVIRONMENT BANKER’S PERSPECTIVE
    6. 6. BANK DEFINITION OF CASH MANAGEMENT <ul><li>The effective planning, monitoring and management of liquid / near liquid resources including: </li></ul><ul><ul><ul><li>Provision of bank accounts </li></ul></ul></ul><ul><ul><ul><li>Deposit / withdrawal facilities </li></ul></ul></ul><ul><ul><ul><li>Provision of information regarding bank accounts and positions </li></ul></ul></ul><ul><ul><ul><li>Money transfers and collection services </li></ul></ul></ul><ul><ul><ul><li>Investment facilities </li></ul></ul></ul><ul><ul><ul><li>Financing facilities </li></ul></ul></ul><ul><ul><ul><li>Pooling and netting </li></ul></ul></ul>
    7. 7. BENEFITS OF GOOD CASH MANAGEMENT <ul><li>C ontrol of financial risk </li></ul><ul><li>O pportunity for profit </li></ul><ul><li>S trengthened balance sheet </li></ul><ul><li>I ncreased customer, supplier, and shareholder confidence </li></ul>
    8. 8. WORKING CAPITAL Managing Liquidity Source: Essentials of Managing Corporate Cash
    9. 9. DEFINITION OF LIQUIDITY <ul><li>Having sufficient funds available to meet all foreseen and unforeseen obligations </li></ul><ul><li>Liquidity has costs </li></ul><ul><li>Cash is unproductive </li></ul><ul><li>Spread between borrowing and deposit rates and between long and short term rates </li></ul>
    10. 10. NEED FOR LIQUIDITY <ul><li>Day to day transactions </li></ul><ul><li>Precautionary balances </li></ul><ul><li>Compensating balances </li></ul><ul><li>Obtaining discounts </li></ul><ul><li>Acid tests </li></ul><ul><li>Favourable opportunities </li></ul><ul><li>Overall avoiding bankruptcy! </li></ul>
    11. 11. THE CASH GENERATOR / ABSORBER PROFIT? CASH BALANCE? Stock Purchases Sales £20 £20 £40 £80
    12. 12. Operating Cycle <ul><li>Purchase Resources Pay Sell on Credit Receive Cash </li></ul><ul><li>Inventory Conversion Receivables Conversion </li></ul><ul><li>Payables Period Cash Conversion Cycle </li></ul><ul><li>Operating Cycle </li></ul><ul><li>From:Fundamentals of Contemporary Financial Management, 2 nd ed </li></ul><ul><li>, by Moyer, McGuigan and Rao </li></ul>
    13. 13. The Various Cycles <ul><li>Inventory Conversion </li></ul><ul><li>Inventory x 365 </li></ul><ul><li>Cost of Goods Sold </li></ul><ul><li>Payables Conversion </li></ul><ul><li>Payables/Creditors x 365 </li></ul><ul><li>Cost of Goods Sold </li></ul><ul><li>Receivables Conversion </li></ul><ul><li>Receivables/Debtors x 365 </li></ul><ul><li>Turnover </li></ul>
    14. 14. Balance Sheet Short Term Items <ul><li>Current assets </li></ul><ul><li>Inventories 1,910 1,903 </li></ul><ul><li>Trade and other receivables 1,713 1,625 </li></ul><ul><li>Current tax assets 13 - </li></ul><ul><li>Other financial assets 43 78 </li></ul><ul><li>Cash and short term assets 733 917 </li></ul><ul><li>4,412 4,523 </li></ul><ul><li>Current liabilities </li></ul><ul><li>Short term borrowings 355 555 </li></ul><ul><li>Trade and other payables 1,690 1,735 </li></ul><ul><li>Current tax liabilities 121 44 </li></ul><ul><li>Other financial liabilities 119 13 </li></ul><ul><li>Short term provisions 82 130 </li></ul><ul><li>1,367 2,477 </li></ul><ul><li>Turnover 9,577 </li></ul><ul><li>Cost of goods sold 8,943 </li></ul>
    15. 15. Operating Cycle <ul><li>Purchase Resources Pay Sell on Credit Receive Cash </li></ul><ul><li>Inventory Conversion 78 days Receivables Conversion </li></ul><ul><li>65 days </li></ul><ul><li>Payables Period Cash Conversion Cycle </li></ul><ul><li>69 days 74 days </li></ul><ul><li>Operating Cycle </li></ul><ul><li>143 </li></ul>
    16. 16. Cash Conversion <ul><li>We need to consider control in all areas of working capital to maximise return, reduce cost. </li></ul><ul><li>Some areas are not controlled by the Finance Function – Stock/inventory </li></ul><ul><li>Some areas have shared control – payables and receivables </li></ul><ul><li>Some areas are controlled by the Finance Function – short term borrowing and investment </li></ul>
    17. 17. Float <ul><li>Any delay in the process of converting materials and labour to receipt of payment involves cost, float cost. </li></ul><ul><li>Similarly, any delay in making payments will also give rise to float but this time to our advantage </li></ul><ul><li>What is float? </li></ul>
    18. 18. FLOAT <ul><ul><li>Definition of bank float </li></ul></ul><ul><li>The time lost between a payor making a payment and a beneficiary receiving value </li></ul><ul><ul><li>Cost of Float </li></ul></ul><ul><ul><li>principle amount due x no of days x cost of funds </li></ul></ul><ul><ul><li>360 or 365 </li></ul></ul>
    19. 19. WHY DOES FLOAT OCCUR? <ul><li>Deliberately </li></ul><ul><li>Inefficiency </li></ul><ul><li>Logistical situations </li></ul><ul><li>Compensation mechanism </li></ul>
    20. 20. STAGES OF FLOAT 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   Function Float Responsibility Supplier Supplier Supplier Buyer Buyer/ postal service Supplier Banks Banks Banks  
    21. 21. Controlling Float <ul><li>We need to look at controlling / influencing float in three areas </li></ul><ul><li>* Ourselves </li></ul><ul><li>* Our Customers </li></ul><ul><li>* Our Banks </li></ul>
    22. 22. HOW TO REDUCE/CONTROL FLOAT <ul><ul><ul><li>Your Own Actions </li></ul></ul></ul><ul><ul><ul><ul><li>Change own systems </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Educate customers </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Include costs in prices </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Negotiate with bank </li></ul></ul></ul></ul>
    23. 23. RECEIVABLES AND PAYABLES MANAGEMENT <ul><li>Good receivables and payables management aids in: </li></ul><ul><ul><ul><li>Cash flow forecasting </li></ul></ul></ul><ul><ul><ul><li>Long-term funding and investment decisions </li></ul></ul></ul><ul><ul><ul><li>Reduced risk of bad debts </li></ul></ul></ul><ul><ul><ul><li>Stronger liquidity </li></ul></ul></ul><ul><ul><ul><li>Stronger balance sheet ratios </li></ul></ul></ul>
    24. 24. RECEIVABLES IMPACT <ul><li>Important because of costs arising from </li></ul><ul><li>Float </li></ul><ul><li>Bad debts </li></ul><ul><li>Management time </li></ul><ul><li>Legal fees </li></ul><ul><li>And </li></ul><ul><li>Impact on analysts and creditors </li></ul>
    25. 25. RECEIVABLES MANAGEMENT 1 <ul><li>Clear instructions </li></ul><ul><li>Method of payment </li></ul><ul><li>Documentation </li></ul><ul><li>Account structures </li></ul><ul><li>Terms of Trade </li></ul>
    26. 26. Controlling Float <ul><li>Payment Methods </li></ul><ul><li>Payment methods are important because of </li></ul><ul><li>- Cost </li></ul><ul><li>- Risk </li></ul><ul><li>- Value Dating </li></ul><ul><li>- Finality </li></ul>
    27. 27. INTERNATIONAL TRADE PAYMENTS <ul><ul><li>Terms of trade </li></ul></ul><ul><ul><li>Settlement </li></ul></ul><ul><ul><ul><li>Open account </li></ul></ul></ul><ul><ul><ul><li>Clean collection </li></ul></ul></ul><ul><ul><ul><li>Documentary collection </li></ul></ul></ul><ul><ul><ul><ul><li>Against payment </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Against acceptance </li></ul></ul></ul></ul><ul><ul><ul><li>Revocable documentary letter of credit </li></ul></ul></ul><ul><ul><ul><li>Irrevocable documentary letter of credit </li></ul></ul></ul><ul><ul><ul><ul><li>Unconfirmed </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Confirmed </li></ul></ul></ul></ul><ul><ul><ul><li>Advance payment </li></ul></ul></ul>
    28. 28. RECEIVABLES MANAGEMENT 2 <ul><li>Penalties </li></ul><ul><li>Post dated cheques </li></ul><ul><li>Legal process </li></ul><ul><li>Internal process </li></ul><ul><li>Stop supply </li></ul><ul><li>But do not forget Relationship </li></ul>
    29. 29. VALUE DATING <ul><li>Forward Value Dating </li></ul><ul><ul><li>The time between a bank being notified of a transaction in favor of a customer and the customer receiving future value for the item </li></ul></ul><ul><li>Back Value Dating </li></ul><ul><ul><li>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 </li></ul></ul>
    30. 30. FINALITY <ul><li>The time after which a payment is considered to become irrevocable and cannot be returned without the permission of beneficiary account holder. </li></ul>
    31. 31. DOMESTIC PAYMENT INSTRUMENTS <ul><li>Paper-based </li></ul><ul><ul><li>Cash </li></ul></ul><ul><ul><li>Cheques </li></ul></ul><ul><ul><li>Bank transfers or giros </li></ul></ul><ul><ul><li>Postal giros </li></ul></ul><ul><ul><li>Bills of exchange </li></ul></ul><ul><ul><li>Promissory notes </li></ul></ul><ul><ul><li>Banker’s drafts </li></ul></ul><ul><ul><li>Search for ‘APACS’ on the internet </li></ul></ul>
    32. 32. Method of Payment Cheque Clearing, UK
    33. 33. DOMESTIC PAYMENT INSTRUMENTS <ul><li>Electronic </li></ul><ul><ul><li>Funds transfer </li></ul></ul><ul><ul><ul><li>Urgent wires </li></ul></ul></ul><ul><ul><ul><li>Standard EFT </li></ul></ul></ul><ul><ul><li>Automated clearing house payments </li></ul></ul><ul><ul><li>Standing order </li></ul></ul><ul><ul><li>Direct Debit </li></ul></ul><ul><ul><li>Electronic bills of exchange </li></ul></ul><ul><ul><li>Plastic (credit, charge, cheque guarantee, cash dispenser, debit) </li></ul></ul><ul><ul><li>Financial EDI </li></ul></ul><ul><ul><li>Look up ‘Voca’ on the internet, used to be BACS </li></ul></ul>
    34. 34. CROSS-BORDER PAYMENTS <ul><li>Paper-based </li></ul><ul><ul><li>Foreign currency cheques </li></ul></ul><ul><ul><li>Banker’s drafts </li></ul></ul><ul><ul><li>Giros (Credit transfer) </li></ul></ul><ul><ul><li>Documentary collections </li></ul></ul><ul><ul><li>Cheque negotiations </li></ul></ul>
    35. 35. CROSS-BORDER PAYMENTS <ul><li>Electronic </li></ul><ul><ul><li>Using correspondent banks </li></ul></ul><ul><ul><li>Using a global or pan-regional bank </li></ul></ul><ul><ul><li>Cross-border systems </li></ul></ul><ul><ul><ul><li>TARGET </li></ul></ul></ul><ul><ul><ul><li>EBA EURO 1 </li></ul></ul></ul><ul><ul><ul><li>EBA Step 1 </li></ul></ul></ul><ul><ul><ul><li>CHAPS euro (NewCHAPS) </li></ul></ul></ul><ul><ul><li>Credit cards </li></ul></ul><ul><ul><li>Direct debits </li></ul></ul>
    36. 36. Clearing House Automated Transfer System
    37. 37. Controlling Float <ul><ul><ul><li>Bank Services </li></ul></ul></ul><ul><ul><ul><ul><li>Lockbox </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Intervention accounts </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Remote disbursement </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Controlled disbursement </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Direct collections </li></ul></ul></ul></ul><ul><ul><ul><ul><li>Efficient collections structure </li></ul></ul></ul></ul>
    38. 38. PAYABLES <ul><ul><li>Critical questions: </li></ul></ul><ul><ul><ul><li>What is due? </li></ul></ul></ul><ul><ul><ul><li>When is it due? </li></ul></ul></ul><ul><ul><ul><li>Where should the payment be sent? </li></ul></ul></ul><ul><ul><ul><li>How should the payment be sent? </li></ul></ul></ul><ul><ul><ul><li>Are there funds to cover the payment? </li></ul></ul></ul><ul><ul><ul><li>Is the payment properly authorized? </li></ul></ul></ul>
    39. 39. PAYABLES MANAGEMENT <ul><li>The flip side of the coin </li></ul><ul><li>So </li></ul><ul><li>Hang on to it </li></ul><ul><li>Consider float versus control </li></ul><ul><li>Account structures </li></ul><ul><li>Discounts </li></ul><ul><li>But do not forget Relationship </li></ul>
    40. 40. SHORT-TERM INVESTING <ul><li>The Decision Process </li></ul><ul><ul><ul><li>How much do I have to invest per currency? </li></ul></ul></ul><ul><ul><ul><li>How long do I have to invest it? </li></ul></ul></ul><ul><ul><ul><li>Where are the funds located? </li></ul></ul></ul><ul><ul><ul><li>What is my appetite for risk? </li></ul></ul></ul>
    41. 41. INVESTMENT GUIDELINES <ul><li>What are the company’s policies regarding: </li></ul><ul><ul><ul><li>Currency exposure and hedging </li></ul></ul></ul><ul><ul><ul><li>Banks used and limits </li></ul></ul></ul><ul><ul><ul><li>Investment instruments and limits </li></ul></ul></ul><ul><ul><ul><li>Use of automated sweep accounts </li></ul></ul></ul><ul><ul><ul><li>Bank / investment ratings </li></ul></ul></ul>
    42. 42. FACTORS IN CHOOSING INVESTMENTS <ul><li>The need to make an adequate return </li></ul><ul><li>The need to take into account areas of risk </li></ul><ul><ul><ul><li>Credit risk </li></ul></ul></ul><ul><ul><ul><li>Interest rate risk </li></ul></ul></ul><ul><ul><ul><li>Capital risk </li></ul></ul></ul><ul><ul><ul><li>Market risk </li></ul></ul></ul><ul><li>The need to consider liquidity </li></ul>
    43. 43. HOW RATES ARE QUOTED <ul><li>At a discount: Instrument issued at less than 100% </li></ul><ul><li>Coupon: Specific interest payments made at specific times </li></ul><ul><li>Yield to redemption: Interest payments over the lifetime of the instrument and principal repaid may be greater or less than 100% </li></ul>
    44. 44. SHORT-TERM INVESTMENTS <ul><ul><li>Commercial paper (CP) </li></ul></ul><ul><ul><li>Banker’s acceptances (BAs) </li></ul></ul><ul><ul><li>Repurchase agreements </li></ul></ul><ul><ul><li>Certificates of deposit (CDs) </li></ul></ul><ul><ul><li>Money market funds </li></ul></ul><ul><ul><li>Treasury instruments (bills, notes, bonds) </li></ul></ul>
    45. 45. SHORT-TERM BORROWING <ul><li>The Decision Process </li></ul><ul><ul><li>How much needs to be financed and in what currency? </li></ul></ul><ul><ul><li>How long does the deficit need to be financed? </li></ul></ul><ul><ul><li>Where does it need it be financed? </li></ul></ul><ul><ul><li>What is the maximum level of funding needed? </li></ul></ul>
    46. 46. FACTORS AFFECTING BORROWING <ul><li>These factors affect both amount available and cost </li></ul><ul><ul><li>Financial strength of the company </li></ul></ul><ul><ul><li>Key covenants </li></ul></ul><ul><ul><li>Industry </li></ul></ul><ul><ul><li>Available guarantee or security </li></ul></ul><ul><ul><li>Company’s ability to repay on time from bank’s perspective </li></ul></ul>
    47. 47. SHORT-TERM FUNDING INSTRUMENTS <ul><li>Internal short-term funding </li></ul><ul><ul><li>Least expensive source of funding </li></ul></ul><ul><ul><li>Cross-border and cross-currency intra-group financing can be difficult </li></ul></ul><ul><li>External short-term funding </li></ul><ul><ul><li>Can act as a built-in hedge if sourced in the same currency </li></ul></ul><ul><ul><li>Can be inexpensive to borrow local currency in the currency center </li></ul></ul>
    48. 48. FACTORS IN CHOOSING FUNDING INSTRUMENTS <ul><li>All-in borrowing cost </li></ul><ul><li>Security required </li></ul><ul><li>Terms & conditions </li></ul><ul><li>Tax & balance sheet aspects </li></ul>
    49. 49. INVESTMENT DECISION PROCESS
    50. 50. THE FINANCING DECISION PROCESS Monitor cash flow forecasts annually / quarterly / monthly / weekly / daily Determine: Amount / currency Duration / location Financing action Documentation Recording / monitoring / reporting Liquidation FINANCING DECISION Identify deficits External Factors: Interest rates / trends Currency exchange rates Economic factors Liquidity of market Internal policy covering Borrowing internally Instruments Financing policy Existing limits Performance objectives Existing facilities Balance sheet/ratio impact Tax
    51. 51. U.S. SHORT-TERM INVESTMENTS <ul><ul><li>Commercial paper (CP) </li></ul></ul><ul><ul><li>Banker’s acceptances (BAs) </li></ul></ul><ul><ul><li>Repurchase agreements </li></ul></ul><ul><ul><li>Certificates of deposit (CDs) </li></ul></ul><ul><ul><li>US Treasury instruments (bills, notes, bonds & STRIPS) </li></ul></ul>
    52. 52. INTERNATIONAL SHORT-TERM INVESTMENTS <ul><li>Banker’s Acceptances </li></ul><ul><li>Commercial paper </li></ul><ul><ul><ul><li>Euro </li></ul></ul></ul><ul><ul><ul><li>GBP </li></ul></ul></ul><ul><li>Treasury bills </li></ul><ul><li>Certificates of deposit </li></ul><ul><ul><ul><li>GBP </li></ul></ul></ul><ul><ul><ul><li>Eurodollar </li></ul></ul></ul>
    53. 53. BILLS OF EXCHANGE <ul><li>Foreign currency </li></ul><ul><li>Commercial </li></ul><ul><li>GBP </li></ul><ul><ul><li>Eligible </li></ul></ul><ul><ul><li>Ineligible </li></ul></ul><ul><ul><li>Trade bills </li></ul></ul>
    54. 54. FACTORS IN CHOOSING FUNDING <ul><li>Are all-in borrowing costs being offered? </li></ul><ul><li>Does the bank require security? </li></ul><ul><li>What are the terms and conditions? </li></ul><ul><li>Is interest able to be offset on tax returns? </li></ul>
    55. 55. OTHER SOURCES OF FUNDING <ul><li>Factoring </li></ul><ul><li>Invoice discounting </li></ul><ul><li>Trade bills </li></ul><ul><li>Acceptance credits </li></ul>

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