www.craigscopy.com I Module 4. cash flow formula v1.3


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Fourth part 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.

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www.craigscopy.com I Module 4. cash flow formula v1.3

  1. 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 4 WCC within your Company<br />
  2. 2. Learning objectives<br />Meaning of P&L<br />Why scrutinise Cash flows<br />Top tip<br />Case Study: WCC within a Communications company<br />Boom and bust<br />Why improve the WCC?<br />Bank loans based on EBITDA multiples<br />Order intake<br />Provisioning<br />Debtors<br />Creditors<br />Stock holding<br />Operational Overheads<br />Cash management<br />
  3. 3. Listen to the man he’s on the money<br />The American statesman, diplomat, author and inventor Benjamin Franklin once wrote:<br /> <br />For the want of a nail, the shoe was lost. <br />For the want of the shoe, the horse was lost. <br />For the want of the horse, the rider was lost. <br />For the want of a rider, the battle was lost. <br />For the want of the battle, the kingdom was lost. <br />All for the want of a horseshoe nail. <br /> <br />A paraphrase may read ‘greatness fell because of the absence of something small and yet so incredibly necessary.’ Nurturing an environment where people are constantly looking for ways to improve cash flows will free up cash to buy that nail. <br />You need to scour Cash Flow – looking for horseshoe nails that make a huge difference to profitability. <br />
  4. 4. Profit and Loss Statement (P&L):is a summary of a company’s income; the revenues, costs and expenses incurred over a specific period of time.<br /> <br />Why scour Cash flows <br />Cash represents the ‘life blood’ flowing through the arteries of your business if you start to haemorrhage cash and are unable to generate enough cash internally you will need to get a cash transfusion to survive. The transfusion comes at the cost of interest payments and potentially set up fees. <br />
  5. 5. Top tip: Calculate the Cash impact of business decisions<br />
  6. 6. Case study: The WCC within a communications company<br />This module will use KCOM case study as a guide of how to analyse the WCC within your company. The trends have been graphed by using the annual reports over a 5-year period. The table on below provides a comparison of the working capital cycle of 5 Telecommunications companies at an instant in time; it provides no indication of whether WCC improvements have taken place. <br />
  7. 7. Cont.<br />However, examining the trends over a period of time highlights the key areas for WCC improvements. Ratio analysis has been used to graph the trends below providing a fairer view of how the KCOM is handling cash by clearly showing the five-year trends. <br />
  8. 8. Boom and bust<br /> Late 2000 the “dot com” boom went bust, and the 3G mobile licences took significant chunks of investment out of the money markets. The number of profit warnings issued in 2008 is the highest since the dot-com crash. More companies are going into liquidation including alternative Telecommunications providers and so businesses are less inclined to switch from the incumbent, BT. <br /> <br />In our case study KCOM grew organically up until 1999 fuelled via the traditional parts of the business generating free cash flow. After 1999 the the high growth part of the business required resources beyond the internal cash generative means of the company, and so external funding to bring it into a free cash flow position was instigated.<br />
  9. 9. Why improve WCC?<br /> Reducing the WCC in terms of the cash tied up and increasing the speed at which cash comes in will improve profitability.<br />Improving the WCC will reduce:<br /><ul><li>The business’s requirement for cash,
  10. 10. The size of the bank loan
  11. 11. The amount of the business required in public ownership to raise equity. </li></ul>And increase the business’s ability to: <br /><ul><li>Create healthy profits
  12. 12. Service the interest payments
  13. 13. Generate dividends for shareholders.</li></li></ul><li>Bank loans based on EBITDA multiples<br /> Bank loans provide a gauge of how the Banks have changed their view of telecommunications investments. Before 2003 Communications companies were able to draw on loans based on up to a stratospheric 20 x EBITDA; 3G mobile licences. In 2008 the loans are based on a maximum of 3 x EBITDA. <br /> <br />The communications business model was to provide highly capitalised services, which require both a dig and installation of equipment. The loan requirement is based on the fact that the investment will see a return in the medium term, which will be much greater than the initial investment but this will adversely affect the cash flow situation in the short term by taking cash out of circulation.<br />
  14. 14. Order intake<br /> This may not normally be considered the point at which cash begins to flow out of the business, and would come under cost of sales in the P&L, but in reality the sales acquisition has involved cash leakage through the pre sales order process. Acquiring detailed prospect information, and creating the marketing communications to stimulate interest in the company, could require outside agencies to get involved creating external cost. <br /> <br /> The sales person going to site building and developing a relationship so that confidence can be built up and an order taken, in the UK this is estimated to cost around £400 per site visit. Credit vetting the customer to make sure he is able to pay for the service incurs external costs. Generating a feasibility study to understand the costs in providing service to the prospect can take up to 3 weeks and on average is estimated to cost around £1000. <br />
  15. 15. Order intake cont.<br />The opportunity costs of involving people in the sales order process that is not converted into customer orders to date has not been quantified. Neither has and the time taken in the sales cycle. The diagram sets out the key step in the sales cycle and shows that five months or more could have elapsed before income is generated.<br />
  16. 16. Provisioning<br /> This is the point at which classically we would begin to see capital expenditure attributed to the customer start. As an example, if the customer required a directly connected service this will involve an external planner contracting a team to dig up the street and lay the fibre for a notional cost of £50 per meter. <br />Once the dig has been completed the installation and maintenance engineer will deploy the customer premises equipment required to deliver service; the notional cost of this is around £1600. <br />The next stage is to provide a connection back to the local hub; most communications companies have written down the value of this asset, and chosen to accept a contribution from the customer service offering.<br />
  17. 17. Debtors<br /> Over the last 5 years trade debtors have been constantly rising. In the year, 2000 to 2001 this took a step change from £48million to £75million. <br /> At the same time debtor settlement rose to a new high of £128million. The concern for the business is that at any one point in time there is an average of £30milllion owed to KCOM. It is not just the amount outstanding but also the fact that it means high interest payments, and that cash is being tied up and cannot be used for more profitable purposes. The debtor settlement reveals an unhealthy trend: customers are taking longer to pay.<br />
  18. 18. Debtors cont.<br /> With the cost of sale beginning to outstrip turnover focus needs to be centred on areas, which will reduce the overall cost of sale. Prompt debt collection is an area that will inject cash back into the business, and reduce interest payments.<br /> The impact of interest repayment is shown by graphing the profit after interest, and before tax; shown opposite.<br /> <br />Reducing interest payments will have a direct affect on the bottom line; every pound saved will be equivalent to generating a profit of a much greater amount. i.e. if the business is running at an average margin of 33% then every £1 saved on interest payments is equivalent to new sales revenue of £3, assuming that the new sale is paid for promptly.<br />
  19. 19. Creditors<br /> Working capital is defined as current assets less current liabilities where the major element of current liabilities is trade creditors. Trade credit can be used as a source of financing, as a business increases sales so companies are willing to extend the repayment terms for goods received. <br /> <br />Trade credit is regarded as a ‘free’ source of finance and therefore a good thing for a business to use. The hidden cost associated with taking trade credit is that a business will not get the best deal, in terms of the price, priority, and ongoing support issues.<br /> <br />The figure shows that KCOM’s trade creditors in 2001 were beginning to accept terms approaching 240 days for repayment, KCOM may have been in danger of abusing it’s suppliers, and maybe the suppliers are reciprocating. Ultimately the supplier will only supply goods for cash payments.<br />As Marconi’s financial difficulties surfaced and it was de-listed on the London Stock Exchange, payment terms with customers moved from being by 60 days credit to being cash payments within 15 days of goods received. <br /> <br />
  20. 20. Stock Holding<br />Inventory management is vital to the smooth running of the business; too little and customer demand will not be met, too much stock and the business has tied up capital and obsolescence of stock becomes a serious issue.<br /> <br />One ratio that can be used to monitor stock levels is the stock turnover period. The stock turnover period is low and this is due to the nature of the business where the stock is held mainly for customer installations. Due to the cutting edge technology deployed at customer’s sites, equipment that is held in stock for too long a period can become unsupported by the suppliers. A new threat entered the telecommunications market when all of the major suppliers began to announce serious profit warnings, for a time there was a threat that equipment would become scarce. Marconi use to stockpile finished goods ready for shipment to customers; this changed to customers waiting up to 60 Days for delivery of equipment.<br /> <br />KCOM rationalised inventory and the number of storage sites after acquiring a number of companies, and the stock turnover period was expected to decline accordingly.<br />
  21. 21. Operational Overheads<br /> A major part of the operational overheads is the number of staff in the business. Over the 5 years period from 1997 to 2001 the staffing levels remained almost constant at around 1500 people. In 2003 the staffing level had reached 2400 employees. The growth in the curve can be attributed to the injection of cash from the city, and the company build up to cope with the forecasted growth levels of customers. This has had an immediate effect on the bottom line, as the projected level of customer growth was not been achieved. <br />The staffing level growth meant that the amount of cash required to service the organisation grew by a third, and a course of corporate liposuction was instigated. Removing fat from any area of the organisation requires careful planning to prioritise where job cuts would be most effective and least operationally affecting. <br />The graph shows that the cost of sale has now outstripped turnover.<br /> <br />
  22. 22. Cash Management<br />Cash Management is critical to the smooth running of a business, cash is the lifeblood of an organisation, and in a capital-intensive high growth industry cash is more important than profit. <br /> <br />Whilst the investment banks are rationing Capital, free cash flow is a hen laying golden eggs. The luxury of generating free cash flow is that it opens up investment choices, and takes away interest risk. <br /> <br />Proving that your company can generate free cash flow creates confidence in your business model and put it in the envious position of attracting new investments. Here is the word of caution ‘the investors have the security of knowing that if your investment choices cause the company to run out of cash, there is security in being able to strip the business back to the cash generative part and more than recovering their capital.’<br /> <br />KCOM’s ability to support the high growth of the business to business organisation through generating free cash flow both from the incumbent PTT business and New media activities ceased to generate the required levels of cash. The graph shows the working capital over a five-year period with predictable smoothness up until 1999. In July 1999 the Initial Public Offering (IPO) to the city generated £181 million in cash, the wild rise from 1999 through to 2000 is solely due to share offerings.<br /> <br />Why did KCOM have so much of it in 1999 through to 2000? Similar to Marconi’s war chest in thought and not in size once cash was raised from the IPO and the subsequent offering KCOM sought to invest the cash in the acquisition of synergistic high growth companies. <br />
  23. 23. Conclusion<br />Examine the trends of your business, concentrate on the areas that will provide the greatest improvement to the WCC in terms of the amount of cash tied up in the WCC and the speed at which cash comes into to the business, and you will find horseshoe nails.<br /> <br />For KCOM the area of concern for cash management is on the business to business division, and how to resolve the cash management in a business which is growing far behind the predictions at the IPO.<br />
  24. 24. Quiz 1 of 2<br />What is the P&L?<br />“stands for provisions and liabilities”<br />“a new organisation concerned with world peace and liberty” <br />“a summary of the company’s income.”<br />Why improve the WCC?<br />To reduce the cash requirement of the business.<br />To reduce the size of the bank loan<br />To reduce the amount of the business in pubic ownership.<br />To create healthy profits<br />To service the interest payments<br />To generate dividends for shareholders<br />All of the above<br />What should you try to understand when making business decisions?<br />The cash impact<br />Customer needs<br />What the competition are doing<br />All of the above<br />
  25. 25. Quiz 2 of 2<br />Why should you keep stock holding to a minimum? <br />Stock may expire.<br />Stock may not readily be changed into cash.<br />Warehousing costs are expensive.<br />All of the above<br />Why should you keep debtors to a minimum?<br />Because you will be paying Interest on their debt.<br />Because customers may default on the payments owed.<br />Because it ties up cash.<br />All of the above.<br />Why should you be wary of trade credit?<br />Your supplier may be using you to inflate their number of sales.<br />You may not get the best deal in terms of the price for goods.<br />You may not get the highest priority when you need assistance with support issues.<br />You may be being used as a warehouse for your suppliers goods.<br />All of the above<br />
  26. 26. To contact the author: craig@craigscopy.com<br />Finding Cash in your BusinessWays to find cash you didn’t know you had, and attract cash you didn’t now you needed.<br />Here’s some other free resources you’ll enjoy.<br />Podcast: http://itunes.apple.com/us/podcast/finding-cash-in-your-business/id347814983<br />Blog: http://craigscopy.blogspot.com/<br />Tweets: http://twitter.com/craigscopy<br />Here’s the answers to the questions:<br />3. 4. 7. 4. 5. 4.<br />
  27. 27. What next<br />In the next Module we will investigate the third segment of the Cash Flow Formula. Asking the question “how is your company performing against its business model?”, and looking into the 5-year trends of the financial ratios using publically available data. <br />