Third instalment of a 10 part series from the presenters of Finding Cash in Your Business podcast and book. Get Cash in quicker, handle it better and leverage it's power.

1. Finding Cash in your BusinessWays to find cash you didn’t know you had, and attract cash you didn’t now you needed.The essential business guideModule 3 WCC within your Market

2. Learning objectives Meaning of Liquidity Guide the guide Top tip Know your market Liquidity Guide FCF Positioning Competitors and Company Matrix of Cash operations Regulatory effects Market dynamics

3. Liquidity:is a measure of the ability of a debtor to pay their debts as and when they fall due. Tales from the Bazaar Bazaars are amazing places, demonstrate the slightest bit of interest in an item, and vendors will be on you like flies on a cowpat. Many appearing like a genie from a bottle pushing their wares and accosting you with their sublime prices. At this point you step back and leave your guide to negotiate with the vendors and achieve the best deal; which will probably be with one of their relatives. The strange thing is that all the vendors are selling much the same thing – so how do you differentiate? You need to know your market – or at the very least make sure your guide is independent. Guide the guide A balanced investment portfolio strategy is generally the most common and successful. It enlists shares across a number of sectors both aggressive and defensive with a view to creating a balance between risk and reward. Investors rely on independent experts to guide them and they in turn look to you to articulate the reasons why your business is a better home for their cash than your competitors. This module sheds light on the comparative investment ratios used to understand you and your competitors investment potential.

4. Top tip: keep an eye on your key performance indicators both financial and customer centric Case study Rather than just explain the methods used to compare companies, this chapter takes on a case study approach. The case study compares one telecommunications company against four of its peers, and can easily be adopted and replicated to compare your company against its competitors. This case study will be broken down into six sections: Know your market: – background to investments in the sector Liquidity: – financial ratio analysis Positioning: – what the customers think Competitors and company: – what stage are these companies at in their evolution. Regulatory effects: - interference Market dynamics: - today’s situation

5. Know your market Over the last ten years the Communications market has moved from business cases based on a positive nailed up future outcome, where bonds and shares were traded at a premium, to being businesses where the only thing that matters is free cash flow. A quick return is now expected, time has run out - investor patience and a promissory note is not what a bond was created for. It is a bit like a game of poker where the investors are now looking for the cards to be placed on the table, and most Communications companies have come up wanting, and some such as WorldCom had been keeping cards up their sleeve. The investment community are now saying “OK I don’t just want to see your business case model I want to see the historical evidence that it is working and generating the expected returns before I invest”.

6. Liquidity As a guide, to be safe, an organisation requires a 2:1 ratio of current assets to current liabilities. That is for every £1 of current liabilities, £2 of current assets are required to ensure that the organisation does not run into cash flow difficulties. However, this is a very simplistic approach, as the required level of working capital will vary from industry to industry. A breakdown of working capital for five public limited companies in the Telecommunications industry is shown below. The figures are taken from annual reports.

7. The guide Optimum levels of working capital will vary, depending on the nature of the company’s transactions. The suggested 2:1 current ratio guide, is heavily dependant on whether the businesses transactions are carried out in credit or cash, and the impact that this is likely to have on it’s level of current assets and current liabilities. Using 2:1 as the guide only colt has an acceptable level of liquidity. The higher the current ratio, the more liquid a business is considered to be. As liquidity is vitally important to the survival of a business, a higher current ratio is normally preferred to a lower ratio. However, it is a fine balance, if a business has a very high ratio this may suggest that funds are being tied up in cash or other liquid assets and are not being used as productively as they might otherwise be. The acid test takes into account the fact that stock cannot readily be turned into cash, and provides a more stringent view of liquidity. Telecommunications companies generally require low levels of stock, as they are part of a service industry where the products are digitally derived and subsequently not perishable.

8. FCF Free Cash Flow: is the amount of cash left after a company has paid all of its expenses, including investments Up until the recent past EBITDA was considered to be a measure of profitability and on this basis each of the companies was considered successful. Now free cash flow has become the corporate mantra and the benchmark for the Communication sector, and so the chinks have begun to appear in the corporate armour. Using FCF as the measure of profitability only BT comes up with the goods. Companies are now focused on generating free cash flow, which has created new short-term objectives, and derailed certain business models. The annual reports listed previously are of companies at different stages in development of their business models, and short term cost reductions will hamper the infrastructure growth, and profit potential. The focus on free cash flow could make investments that are partially complete obsolete before they come into service, in some extreme cases this could be enough to kill the business model.

10. Number 1 for customer experience

11. Price is too high The survey highlighted the need to communicate the company strengths in all of the remaining key areas.

12. Thus The competitors 1 of 2 The level of working capital appears to be very low, the level of debtors high, but the current ratio is at an acceptable level. Back in 2002 this company was still in the development stage of its business model, and running a tight ship as it aimed to reach the goal of being cash flow positive by March 2004. BT The level of working capital appears to be very high. An examination of the nature of the business reveals that BT is in an enviable position. Most of the infrastructure costs have long since paid for themselves, and each day millions of residential customers will purchase services from BT. The residential market provides for consistent protected cash inflows even when the business market is experiencing an economic downturn. BT has a high level of debtors due to the fact that most of the residential bills are based on call usage, which can only be charged after the calls have been made. The BT residential infrastructure is low maintenance and the cost incurred by BT in creating residential sales is low, this means that the external exposure carried by the company to service such a high level of debtors is low. Failure to pay BT on time will result in termination of telephony services, which is now considered to be a basic essential to modern living. Historic forecasts allow managers to reliably predict daily sales levels, enabling BT to operate with relatively low levels of cash.

13. Colt The competitors 2 of 2 The level of working capital is very high, although the loss on ordinary activities is also very high. Colt is a company owned for the most part and underpinned by Fidelity Investment house. In 2002 Colt was still in the development stage of the business model. Colt understands the value of high levels of liquidity, it proved this by raising the capital to invest in the network infrastructure with shares and bonds in the boom years, and in the 2004 telecommunication’s slump bought back those bonds, at as little as 50% of face value generating more profit from bond trading than from normal operations. TeleWest(now part of Virgin media) The level of working capital is deep in the red, and the level of current liabilities is severely high. It comes as no surprise that this company has a very poor current ratio and is in the process of restructuring the payments to its creditors. TeleWest is a company that has tried to consolidate a large number of the local franchise cable companies, to benefit from economies of scale and scope. In the haste to invest and develop scale TeleWest has failed to integrate and consolidate acquisitions. TeleWest can no longer raise investment to expand the network infrastructure, and shows no sign of generating profit from ordinary activities. A Company in any other industry with this level of working capital deficit would be bust. Investors are generally the last to give up hope and in the global credit crunch the old adage is still true but needs to be extended…. Create a small debt and the bank owns you… Create a large debt and you own the bank… Create an enormous debt and the bank gets nationalised.

14. KCOM (previously know as Kingston communications) Back in 2002 KCOM was a rapidly growing UK communications company with strategic focus on three key areas of activity: The KCOM Hull franchise offers a cash-generative PTT (Public Telephone and Telegraph) asset that is steadily growing both revenues and EBITDA while reducing capital expenditure. New media activities include the DSL-based interactive television service, and international satellite communications. The groups business-to-business solutions division encompasses a broad portfolio of voice, data, Internet, mobile and managed services.

15. Matrix of Cash operations The Matrix will be used to used to categorise cash flow within the 3 business areas in relation to the market growth potential and the relative market share. Star – These are self-financing business areas that enjoy high market share in a growing market. They may require investment to ensure continued success Cash Cow – These are cash generating business areas usually at the mature phase of the life of the business. They enjoy high market share and require little investment to sustain their portion. Often they can be used as a source of finance for other projects. Question Marks – These are business areas that currently have only a low market share, but are in a growing market. A decision whether to withdraw or invest to turn into a star is needed. Dogs - These are a drain on finances with low market share and growth potential. Should usually divert, but may be necessary to retain, to keep a presence in a particular sector – The businesses products are in the decline part of Product Life Cycle.

16. PTT business New media activities Uniquely in the UK KCOM holds a monopoly on all communications in and out of Hull and has done so for nearly 100 years. The assets invested in this division have long since provided payback, and the high level of profits generated by this “cash cow” division provides the cash required for funding the business expansion in other areas. The business generated by this division is not going anywhere, is stable and the cash flow forecast is down to a fine art. KCOM’s activity in the area of new media provided a stable revenue stream with good margin back in 2002, another “cash cow” business expected to maintain high margins. Barriers to entry into the Satellite Teleport business are high due to the high initial investment required to enter and compete in the market, which means that it is unlikely that new competition will emerge. The cash flow generated by this division is stable and so the cash flow forecast is relatively easy to predict. Business to business This is the “rising star” and has, over the last 15 years, consistently provided high revenue growth. The main part of business to business division is the network based element which was started in 1993 with a view to creating a regional model that could be replicated around the country through organic growth and cash injected from the Hull PTT. KCOM realised that to achieve the critical mass from which to derive economies of scale, significant cash investment out with the internal resources was required. In 1998 it was decided to float a majority stake of the KCOM on the stock exchange, to allow the replication of the initial regional model at an accelerated rate. By floating the whole KCOM, and not just the Business to Business division, investors were enticed to realise an investment that was cash rich whilst providing significant growth potential. In 2000 significant investment was made to create an independent national network, and the division started to increase staffing levels to be able to provide the quality of service necessary to accommodate the business case projected number of customers. Amazingly much of the cash required to generate the investment was made in one days trading. Revenue growth and ongoing investments mean that cash flow is difficult to predict.

17. Regulatory effects In the UK the communications regulator, OFCOM, helped to create a separate trading company within the incumbent BT, Openreach, to promote the use of existing plant to deliver the “last mile” reducing the environmental damage of digging up the roads and the duplication of telecommunications equipment at the customer’s site. Using BT to provide the “last mile” changes the capex cost of digging into an opex cost and has a direct affect on the profitability of customer acquisition. It is true that directly connecting new customers to a network has a high cost in terms of cash flow, however, in the long run it provides the customer with the highest levels of service, and generates the highest return due to very small recurring operational costs. If payback on the initial investment is achieved within 3 years then the margin of the sale from year 4 of service onwards delivers margins higher than 60%. The high margins realised in year 4 onwards allows communications companies to go deep on discounts and keep customer churn low. EBITDA became the yardstick for the communications market because it takes into consideration that telecommunications investments have long payback horizons at which point the cash generative opportunities are vast. However, as capital becomes harder to raise communications companies are forced into leasing capacity from BT rather than building it and so the alternative communications business model begins to corrode. It will come as no surprise that most if not all of the alternative carriers have written down their network investments i.e. Colt alone wrote off £1 billion from their asset base in 2002.

18. Market dynamics The credit crunch has created a growth in trade debtors, and has increased the potential for debt to go bad. To reduce churn communications companies have made significant cuts in margin to maintain, develop and expand the customer base. The market was swamped with new entrants in the height of the Telecommunications boom in 2000, which were based on unrealistic market share predictions and a desire for the investment community to get Telecommunications shares into their balanced portfolios. The buoyant Telecommunications market with high margins of the 1990’s has been replaced by a plethora of companies, with written down assets, willing to accept a cash contribution regardless of real cost to provide the service so that they can meet their day to day cash requirements. In this way companies create false product margin analysis only taking into consideration the incremental costs and ignoring the historic costs associated with providing the service. Companies who are intent on getting cash in the door at any cost have already begun to eat themselves in an effort to satisfy short-term creditors, the characteristic of these companies is high revenues with low margin.

20. What are the competitors currently doing?

21. At what stage the competitors in their business model? Knowing the answers to the above and the key financial performance indicators means that the next time you’re in the bazaar you’ll sell out and cash in. As for communications companies well they invested £Billions in their network asset in an attempt to create alternative UK Communications Companies. Most of the network assets were supposed to be depreciated over 20 years. Then the short-term objectives of conserving cash jeopardised the benefit from the long-term investment in the network, and £Billions invested in networks were written off. The current Key financial yardsticks on which Communications companies are marked are FCF and EBITDA.

22. Quiz 1 of 2 What is Liquidity? “a measure of how soft or hard your water supply is” “working capital minus assets and interest” “a measure of the ability of a debtor to pay their debts as and when they fall due.” What is positioning? “a marketing term used to describe the relative competitive comparison of the company’s products as perceived by its target market” “a financial appraisal of the competition” “how much it cost to acquire a potential customer” What comparative areas should you keep an eye on? Financial ratios Customer specific Key performance indicators The competition All of the above

23. Quiz 2 of 2 For does FCF stand for? Fiber-optic Cash Formations Free Critical Faults Flow Cash Free Free Cash Flow How can you be in the best position to predict the consequences of regulation? By knowing your market By knowing the competition By understanding the market dynamics All of the above When is it easier to predict cash flow? When the bank tells you how much cash you need When your competitors are going out of business When the cash flows are stable and consistent When the company has been established for a long time.

24. To contact the author: craigscopy@gmail.com Finding Cash in your BusinessWays to find cash you didn’t know you had, and attract cash you didn’t now you needed. Here’s some other free resources you’ll enjoy. Podcast: http://itunes.apple.com/us/podcast/finding-cash-in-your-business/id420457227 Blog: http://craigscopy.blogspot.com/ Tweets: http://twitter.com/craigscopy Here’s the answers to the questions: 3. 4. 1. 4. 4. 4.

25. What next In the next Module we will investigate the second segment of the Cash Flow Formula. Finding the company, division or area where high growth is expected.