s1 automated group learning (agl) agl no. 10 - financial management of working capital daily work...

S1 AUTOMATED GROUP LEARNING (AGL)S1 AUTOMATED GROUP LEARNING (AGL)

AGL NO. 10 - AGL NO. 10 -

FINANCIAL MANAGEMENTFINANCIAL MANAGEMENT

OF WORKING CAPITALOF WORKING CAPITAL

DAILY WORK PACK - PART IDAILY WORK PACK - PART I

Copyright: RGAB/PW 2005/4.3Copyright: RGAB/PW 2005/4.3

AGL

S2 WELCOME TO THE PROGRAMS2 WELCOME TO THE PROGRAM a.a. AGL - two/three days of learning, tested with over 2000 AGL - two/three days of learning, tested with over 2000 managers in twenty countries around the world. managers in twenty countries around the world.

b.b. Helps you to understand and use the reports issued Helps you to understand and use the reports issued by your finance and accounting division.by your finance and accounting division.

c. Provides a controlled learning environment where you c. Provides a controlled learning environment where you find the answers to all your questions in the groups find the answers to all your questions in the groups and materials provided.and materials provided.

e. Requires hard work, but you have fun and learn a lot.e. Requires hard work, but you have fun and learn a lot.

S3 ABBREVIATIONSS3 ABBREVIATIONS

IND - IND - INDIVIDUALINDIVIDUAL SG -SG - SMALL GROUPSMALL GROUP CSG - CSG - COMBINED SMALL GROUPCOMBINED SMALL GROUP MG MG - - MAIN GROUPMAIN GROUP ASS - ASS - ACCOUNTING STEP BY STEP ACCOUNTING STEP BY STEP PL - PL - PROGRAM LEARNINGPROGRAM LEARNING L - L - LECTURELECTURE D D - - DISCUSSIONDISCUSSION LRTLRT - - LEARNING RECALL TAPELEARNING RECALL TAPE CAICAI - - COMPUTER ASSISTED COMPUTER ASSISTED

INSTRUCTION INSTRUCTION

S4 ASSIGNMENT 1.0 - INTRODUCTION S4 ASSIGNMENT 1.0 - INTRODUCTION (30 minutes) 1.1 SPECIFIC OBJECTIVES(30 minutes) 1.1 SPECIFIC OBJECTIVES

The program provides members with the opportunity to The program provides members with the opportunity to understand financial management terms, techniques understand financial management terms, techniques

and and reports so that they become more complete managers. reports so that they become more complete managers.

This broadening of knowledge and skills will enable This broadening of knowledge and skills will enable them tothem to

capitalise on business opportunities and to accelerate capitalise on business opportunities and to accelerate their their

career development. career development.

S5 1.1 SPECIFIC OBJECTIVESS5 1.1 SPECIFIC OBJECTIVES a.a. Understand accounting language and the concepts of Understand accounting language and the concepts of financial management.financial management.

b. Recognize the need for financial forecasting of : cash, b. Recognize the need for financial forecasting of : cash, funds, income statements and balance sheets.funds, income statements and balance sheets.

c. c. Develop practical skills in using financial data to manage Develop practical skills in using financial data to manage working capital effectively.working capital effectively.

d.d. Recognize "creative accounting" in financial reporting, Recognize "creative accounting" in financial reporting, despite IAS (International Accounting Standards) and despite IAS (International Accounting Standards) and motivate further study in the future motivate further study in the future

S6 1.2 AUTOMATED GROUP LEARNINGS6 1.2 AUTOMATED GROUP LEARNING (AGL) (AGL)

The AGL method is designed to achieve rapidThe AGL method is designed to achieve rapid individual learning using special materials and theindividual learning using special materials and the stimulus of group activity without a formal stimulus of group activity without a formal

instructor. instructor. The groups use the materials to find the answers toThe groups use the materials to find the answers to all problems and questions.all problems and questions.

S7 1.3 GROUP ARRANGEMENTSS7 1.3 GROUP ARRANGEMENTS The work will be done:The work will be done:

INDIND - Individually, or in- Individually, or in

SGSG - Small Group (in small groups of four members - Small Group (in small groups of four members which will change daily), or inwhich will change daily), or in

CSG - Combined Small Group (two small groupsCSG - Combined Small Group (two small groups together), or intogether), or in MGMG - Main Group (for short taped lectures on key- Main Group (for short taped lectures on key learning points with visual aids).learning points with visual aids).

S8 1.4 SG - SMALL GROUPSS8 1.4 SG - SMALL GROUPS

Group names provided on the flip charts. Group names provided on the flip charts.

Please note the name of your SG and namesPlease note the name of your SG and names of the other members.of the other members.

S9 1.5 LEARNING MATERIALSS9 1.5 LEARNING MATERIALS

(a)(a) Retained by membersRetained by members TextText Notebook - for recording every key pointNotebook - for recording every key point Daily Course DiaryDaily Course Diary Learning Recall TapeLearning Recall Tape Articles (2)Articles (2)

(b) Used but not retained by members:(b) Used but not retained by members: Daily work packs including: lectures, cases,Daily work packs including: lectures, cases, exercises and key learning points. exercises and key learning points.

S10 1.5 LEARNING MATERIALS S10 1.5 LEARNING MATERIALS (continued)(continued)

Use your notebook. Do not mark the Daily Use your notebook. Do not mark the Daily Workpack Workpack

which must be handed back at the end of each which must be handed back at the end of each day.day.

You receive all the materials in your SG. You receive all the materials in your SG.

Don't look ahead in the workpack until you are Don't look ahead in the workpack until you are specifically asked to do so!specifically asked to do so!

S11 S11 1.61.6 METHODMETHOD

Try to complete every task in the time allowed. Try to complete every task in the time allowed. A pattern of learning methods will be used A pattern of learning methods will be used

including:including:• Study notesStudy notes• Case analysisCase analysis• LecturesLectures• QuizzesQuizzes• Learning patternsLearning patterns• Homework readingHomework reading• Learning Recall Tape (LRT) & CAILearning Recall Tape (LRT) & CAI

S12 1.7 LEARNING PATTERNS - REVIEWS12 1.7 LEARNING PATTERNS - REVIEW 1. Objectives

LanguageLanguage

Ratios Concepts Ratios Concepts

Forecasting Risk & ReturnForecasting Risk & Return

Working Capital Creative Accounting Working Capital Creative Accounting

CONFIDENCECONFIDENCE

S13 1.7S13 1.7 LEARNING PATTERNS - REVIEWLEARNING PATTERNS - REVIEW2. Learning

IND SG CSG MG

Study Notes Small GroupsStudy Notes Small Groups

Lectures Combined Small Groups Lectures Combined Small Groups

Cases & Exercixes Main GroupCases & Exercixes Main Group

LRT CAILRT CAI

LEARNING FOR YOULEARNING FOR YOU

S14 1.7 LEARNING PATTERNS - REVIEWS14 1.7 LEARNING PATTERNS - REVIEW 3 3. Methods

S15 S15 1.81.8 INSTRUCTIONS (15 minutes)INSTRUCTIONS (15 minutes)

Assemble in SG's to introduce yourself, indicate your Assemble in SG's to introduce yourself, indicate your pastpast

experience in finance and what you hope to contribute experience in finance and what you hope to contribute to and gain from the course.to and gain from the course.

Complete the registration sheet in the Daily Course Complete the registration sheet in the Daily Course Diary.Diary.

NOTE: Please check that you have a full set of learning NOTE: Please check that you have a full set of learning materials now.materials now.

S16 ASSIGNMENT 3.0 - STUDY S16 ASSIGNMENT 3.0 - STUDY (60 MINUTES)(60 MINUTES)

3.13.1 INSTRUCTIONS - INDIVIDUAL WORK INSTRUCTIONS - INDIVIDUAL WORK

a. Re-assemble in SG and study the lecture and discuss in a. Re-assemble in SG and study the lecture and discuss in SG.SG. b. Record significant points on the flip chart.b. Record significant points on the flip chart.

c. Review the glossary for any difficulties with new wordsc. Review the glossary for any difficulties with new words

d. Record significant points in your noteboo and ssembled. Record significant points in your noteboo and ssemble in MG when the bell rings in MG when the bell rings

S17 ASSIGNMENT 4.0 - LECTURE ON S17 ASSIGNMENT 4.0 - LECTURE ON FINANCIAL MANAGEMENTFINANCIAL MANAGEMENT

4.14.1 METHODMETHOD

Read aloud, listen carefully and respond verbally Read aloud, listen carefully and respond verbally to to

any questions.any questions.

S18 4.2 FINANCIAL MANAGEMENTS18 4.2 FINANCIAL MANAGEMENT a.a. Deals with four major problems:Deals with four major problems:

SIZE - what size should the firm be?SIZE - what size should the firm be? GROWTH - what rate of growth of sales, assets, cash GROWTH - what rate of growth of sales, assets, cash flow, profits. etc.?flow, profits. etc.?

FINANCING - how should the firm be financed, andFINANCING - how should the firm be financed, and at what risk?at what risk?

INVESTMENT - what kind of assets should be acquired, INVESTMENT - what kind of assets should be acquired, and at what rate?and at what rate?

S19 4.2S19 4.2 FINANCIAL MANAGEMENT FINANCIAL MANAGEMENT (continued)(continued)

b.b. Most important is ... CASH FLOW and Most important is ... CASH FLOW and SURVIVAL ... SURVIVAL ...

to increase the long term VALUE of the business to increase the long term VALUE of the business for ALL for ALL

of the "players": customers, shareholders, of the "players": customers, shareholders, management, management,

workers, suppliers, banks, communities, workers, suppliers, banks, communities, government, government,

trade unions, environmental groups etctrade unions, environmental groups etc

S19A 4.2S19A 4.2 FINANCIAL MANAGEMENT FINANCIAL MANAGEMENT (continued) (continued)

c. To achieve EVA in a company, the manager of c. To achieve EVA in a company, the manager of each each

division must produce:division must produce:

OP/NAE X 100% = above CoCOP/NAE X 100% = above CoC where: where: OP = Operating Profit after taxOP = Operating Profit after tax NAE = Net assets employed (FA & CA & OA NAE = Net assets employed (FA & CA & OA

less CL)less CL) CoC = Cost of CapitalCoC = Cost of Capital

S19B 4.2S19B 4.2 FINANCIAL MANAGEMENT FINANCIAL MANAGEMENT (continued) (continued)

d. The value of a business or a share may be simply d. The value of a business or a share may be simply computed as: OCF/(r-g) which is explained later.computed as: OCF/(r-g) which is explained later.

In 1995, shareholders may be powerful pension In 1995, shareholders may be powerful pension funds, funds,

insurance companies and mutual funds, who mayinsurance companies and mutual funds, who may REQUIRE management to provide both dividends REQUIRE management to provide both dividends

and and increased share value ... or move over ... increased share value ... or move over ...

S20 4.3 FINANCIAL OBJECTIVE, S20 4.3 FINANCIAL OBJECTIVE, METHOD AND SKILLSMETHOD AND SKILLS

a.a. Objective -Objective - increase the long term value of the increase the long term value of the businessbusiness with with EVA (Economic Value Added) and SVA EVA (Economic Value Added) and SVA (Share Value Added). (Share Value Added).

b.b. Method - raise money and use it effectively to achieve Method - raise money and use it effectively to achieve standards of financial performancestandards of financial performance

c.c. Skills - risk evaluation, raising cash, using time effectively, Skills - risk evaluation, raising cash, using time effectively, and maintaining relationships with the “stakeholders”: and maintaining relationships with the “stakeholders”: customers, employees, owners, bankers, financial customers, employees, owners, bankers, financial markets. government, auditors, community etc.. by markets. government, auditors, community etc.. by developing appropriate attitudes towards risk- taking.developing appropriate attitudes towards risk- taking.

S21 4.4S21 4.4 SHORT AND LONG TERM SHORT AND LONG TERM FINANCIAL MANAGEMENTFINANCIAL MANAGEMENT

a. Diagnosis to determine whether business has a short a. Diagnosis to determine whether business has a short term or long term need for fundsterm or long term need for funds

b. Short term:b. Short term:

1. Investment in cash, receivables (debtors) and 1. Investment in cash, receivables (debtors) and inventory inventory

(stock) (stock)

2. Finance from payables (creditors). advances. bank 2. Finance from payables (creditors). advances. bank loans etc.loans etc.

S22 4.4 S22 4.4 SHORT AND LONG TERMSHORT AND LONG TERM FINANCIAL MANAGEMENT (continued) FINANCIAL MANAGEMENT (continued)

c. Long termc. Long term

1. Investment in fixed assets, investments, R&D. etc.1. Investment in fixed assets, investments, R&D. etc. 2. Finance by long term loans or equity.2. Finance by long term loans or equity.

Note: NET working capital is:Note: NET working capital is:

current assets less current liabilities.current assets less current liabilities.

S23 4.5 FINANCIAL ANALYSISS23 4.5 FINANCIAL ANALYSIS Use the LAPP system to evaluate the healthUse the LAPP system to evaluate the health of a business: of a business: Rough StandardRough Standard Liquidity (and Gearing):Liquidity (and Gearing): Quick assets : quick liabilitiesQuick assets : quick liabilities 1/2 : 1 1/2 : 1 Current assets : current liabilitiesCurrent assets : current liabilities 2 : 1 2 : 1 Equity : debtEquity : debt 2 ; 1 or 1 : 1 2 ; 1 or 1 : 1

Activity-Activity- S/A (times turned over)S/A (times turned over) 1+ 1+ Cost of goods sold/InventoryCost of goods sold/Inventory 2-502-50 Days of Sales 30-90Days of Sales 30-90 Days of Purchases 30-90Days of Purchases 30-90

S24 4.5 FINANCIAL ANALYSIS S24 4.5 FINANCIAL ANALYSIS (continued)(continued)

Rough Standard Rough Standard Proftability:Proftability: Gross profit/sales x 100%Gross profit/sales x 100% improving improving Net profit/sales x 100%Net profit/sales x 100% improving improving Net profit/owners equity x 100%Net profit/owners equity x 100% improving improving Operating profit/assets empluyed greater than CoCOperating profit/assets empluyed greater than CoC

Note:Note: Rough standards are not adequate! Rough standards are not adequate! Relate ratios to industry averages. Relate ratios to industry averages. Look at past trends, compare with target. Look at past trends, compare with target. Forecast forward to see the future effect of operations! Forecast forward to see the future effect of operations!

S25 4.5 FINANCIAL ANALYSIS S25 4.5 FINANCIAL ANALYSIS (continued)(continued)

Potential:Potential: SalesSales ProductsProducts MarketsMarkets FacilitiesFacilities FinanceFinance OrganizationOrganization ResearchResearch etc.etc.

S26 4.6 FORECASTING FUNDSS26 4.6 FORECASTING FUNDS

Funds flow shows source and use of funds.Funds flow shows source and use of funds.

Sources are: profit, depreciation, new capital and loans.Sources are: profit, depreciation, new capital and loans.

Uses are: fixed assets, dividends, working capital.Uses are: fixed assets, dividends, working capital.

Funds flow statements reveal key management decisions - Funds flow statements reveal key management decisions - past and future. past and future.

Forecast forward to provide funds as required 1 - 5 years Forecast forward to provide funds as required 1 - 5 years ahead.ahead.

S27 4.7 FORECASTING - CASHS27 4.7 FORECASTING - CASH

Arrange now for the cash required in the future.Arrange now for the cash required in the future.

Cash flow is cash (received and paid) in the shorter term.Cash flow is cash (received and paid) in the shorter term.

Continually re-forecast monthly for 12 months ahead to be Continually re-forecast monthly for 12 months ahead to be sure cash is available when required. sure cash is available when required. Some businesses need weekly or even daily cash forecastingSome businesses need weekly or even daily cash forecasting and control due to seasonal fluctuations of the industry.and control due to seasonal fluctuations of the industry.

Review the past cash flows against target, and plan future Review the past cash flows against target, and plan future cash flows.cash flows.

S28 4.7 FORECASTING - CASH (continued) S28 4.7 FORECASTING - CASH (continued)

Look for peak requirement and duration - watch seasonal Look for peak requirement and duration - watch seasonal and monthly effects.and monthly effects.

Don't keep too much cash in hand earning nothing.Don't keep too much cash in hand earning nothing.

Debt capacity (equity: debt relationship) is real KEY to Debt capacity (equity: debt relationship) is real KEY to liquidity. liquidity.

The quick ratio and current ratio are only partThe quick ratio and current ratio are only part of the story! of the story!

S29 4.8 MANAGEMENT OFS29 4.8 MANAGEMENT OF WORKING CAPITAL WORKING CAPITAL

(a)(a) Manage the assets and sources of finance:Manage the assets and sources of finance:

(b)(b) Assets:Assets:

Cash - reduce amount on hand, get it to the bank Cash - reduce amount on hand, get it to the bank faster!faster!

Inventory - reduce inventory or get suppliers to Inventory - reduce inventory or get suppliers to hold it! hold it!

Research high values and slow moving items ...,Research high values and slow moving items ...,

S30 4.8 MANAGEMENT OFS30 4.8 MANAGEMENT OF WORKING CAPITAL (continued) WORKING CAPITAL (continued)

Receivables - reduce by credit control, expeditingReceivables - reduce by credit control, expediting payment, cash discounts, change of customers,deposits, payment, cash discounts, change of customers,deposits, factoring, etc. factoring, etc.

Identify the long paying receivables. Research the reasons Identify the long paying receivables. Research the reasons why ... Invoice errors? Credit note delays? Documents ? why ... Invoice errors? Credit note delays? Documents ? Forex? Special needs? ... Forex? Special needs? ...

Get all the managers (marketing, production, finance etc.) Get all the managers (marketing, production, finance etc.) to “own” the WC problem ....to “own” the WC problem ....


(c)(c) Liabilities:Liabilities:

Suppliers - "stretch" but don't miss discounts; get longer Suppliers - "stretch" but don't miss discounts; get longer credit;credit;

seek alterative suppliers?seek alterative suppliers?

Banks - borrow more from the same or several banks?Banks - borrow more from the same or several banks?

Leasing - lease rather than buy fixed assets, to release Leasing - lease rather than buy fixed assets, to release cash cash

for working capital.for working capital.


Management of short term working capital is the Management of short term working capital is the management of CASH FLOW.management of CASH FLOW.

Watch out for contingent liabilities for: FOREX, legal Watch out for contingent liabilities for: FOREX, legal and and

environmental claims, lease payments etc.environmental claims, lease payments etc.

S33 4.8 MANAGEMENT OF S33 4.8 MANAGEMENT OF WORKING CAPITAL (continued)WORKING CAPITAL (continued)

(d)(d) Cash is vital - so many businesses that go bankrupt Cash is vital - so many businesses that go bankrupt are making a profit - they just run short of cash. Cash are making a profit - they just run short of cash. Cash needs vary at different times both within the month needs vary at different times both within the month and the season.and the season.

(e)(e) Plan for sustainable positive OCF (Operational Cash Plan for sustainable positive OCF (Operational Cash Flow)Flow)

which provides for : increase in working capital needs which provides for : increase in working capital needs and “normal” new capital expenditure, A positive OCFand “normal” new capital expenditure, A positive OCF makes cash available for new profitable investments makes cash available for new profitable investments that give EVA.that give EVA.

S34 4.8 MANAGEMENT OF S34 4.8 MANAGEMENT OF WORKING CAPITAL (continued)WORKING CAPITAL (continued)

(f)(f) "Benchmark" with other companies to set new "Benchmark" with other companies to set new WCWC

performance standards,performance standards,

Get ALL managers (production, marketing and Get ALL managers (production, marketing and finance)finance)

to "own" the working capital problem!to "own" the working capital problem!

S35 4.9 CHECK LIST ON S35 4.9 CHECK LIST ON ANNUAL REPORTSANNUAL REPORTS

Be careful with company's annual reports; evaluateBe careful with company's annual reports; evaluate reports using a check list:reports using a check list:

(a) Cash, orders and activity(a) Cash, orders and activity (b) Profitability, prospects and resources(b) Profitability, prospects and resources (c) Long term finance(c) Long term finance (d) Shareholders and management(d) Shareholders and management (e) Exceptional transactions and notes to the(e) Exceptional transactions and notes to the financial statementsfinancial statements (g) Secret reserves and contingent liabilities for : (g) Secret reserves and contingent liabilities for : leasing, legal, environment, FOREX and INTEREST leasing, legal, environment, FOREX and INTEREST DERIVATIVES etc.DERIVATIVES etc. (h) Check for reconciliation of net profit with IAS. (h) Check for reconciliation of net profit with IAS.

S36 4.10 SIMPLIFIED COST OF CAPITAL, S36 4.10 SIMPLIFIED COST OF CAPITAL, EVA AND SVAEVA AND SVA

(a) In very simple terms, the Cost of Capital is the average (a) In very simple terms, the Cost of Capital is the average after-tax cost of raising long term funds for the after-tax cost of raising long term funds for the

business. business.

(b) Such funds can come either from long term debt (b) Such funds can come either from long term debt (liabilties) or equity. Normally debt (say 8%) costs less (liabilties) or equity. Normally debt (say 8%) costs less than equity (say 16%).than equity (say 16%).

(c) Hence the E:D ratio set by Management (2:1 or 1:1 or (c) Hence the E:D ratio set by Management (2:1 or 1:1 or 1:2) can affect the average Cost of Captial (say 13.3% 1:2) can affect the average Cost of Captial (say 13.3% or 12% or 9.3%).or 12% or 9.3%).

S37 4.10 SIMPLIFIED COST OF CAPITAL,S37 4.10 SIMPLIFIED COST OF CAPITAL, EVA AND SVA (continued) EVA AND SVA (continued)

(d) EVA (Economic Value Added) is produced when (d) EVA (Economic Value Added) is produced when the the

net assets employed (A-CL) produce an OCF net assets employed (A-CL) produce an OCF after after

tax (say 12%) which is greater than the Cost oftax (say 12%) which is greater than the Cost of Capital (say 9.3%). Capital (say 9.3%).

S38 4.10 SIMPLIFIED COST OF CAPITAL,S38 4.10 SIMPLIFIED COST OF CAPITAL, EVA AND SVA (continued) EVA AND SVA (continued)

EVA (Economic Value Added) is produced when the net EVA (Economic Value Added) is produced when the net assets employed (A-CL) produce an OCF after tax (say assets employed (A-CL) produce an OCF after tax (say

11%) 11%) which is greater than the CoC (SAY 9.3%).which is greater than the CoC (SAY 9.3%).

EVA may be simply computed as V = OCF/(r-g), where: EVA may be simply computed as V = OCF/(r-g), where:

OCF = Operating Cash Flow (say 100)OCF = Operating Cash Flow (say 100) r = Cost of Captal (say 9.3%)r = Cost of Captal (say 9.3%) g = Growth Rate (say 5.3%)g = Growth Rate (say 5.3%) V = 100/(0.93-0.53) = 250V = 100/(0.93-0.53) = 250

S39 4..10 SIMPLIFIED COST OF CAPITAL,S39 4..10 SIMPLIFIED COST OF CAPITAL, EVA AND SVA (continued) EVA AND SVA (continued)

(e) SVA (Share Value Added) is produced when the (e) SVA (Share Value Added) is produced when the sustainable cash flows and dividends lead to sustainable cash flows and dividends lead to increased short term and long term share value.increased short term and long term share value.

(f) Most companies control capital expenditure well (f) Most companies control capital expenditure well but fail to control investment in WC which is cr is but fail to control investment in WC which is cr is critical to achieving EVA and SVA.critical to achieving EVA and SVA.

S40 4.11 OVERALL (continued)S40 4.11 OVERALL (continued)

Plan short term cash and long term needs.Plan short term cash and long term needs.

Set financial management objectives.Set financial management objectives.

Manage the WC or it will manage itself - very badly!!Manage the WC or it will manage itself - very badly!!

Seek SEVEN alternatives before setting financial Seek SEVEN alternatives before setting financial policies.policies.

Ensure that short term plans have good long term Ensure that short term plans have good long term effects.effects.


Watch for daily, weekly, monthly and seasonal Watch for daily, weekly, monthly and seasonal fluctuations influctuations in

cash needs!cash needs!

Seek creative not merely routine financial Seek creative not merely routine financial management.management.

Always use good financial forecasts 1-3 years ahead Always use good financial forecasts 1-3 years ahead ... with ... with

the key underlying assumptions clearly outlined.the key underlying assumptions clearly outlined.


There are always SEVEN alternatives ...There are always SEVEN alternatives ...

for every financial problem ...for every financial problem ...

so, seek them out ... before ...so, seek them out ... before ... you make that final decision ...you make that final decision ...

and ... do a PFD ... before you make the and ... do a PFD ... before you make the commitment ...commitment ...

S43 4.12 LEARNING PATTERNS - REVIEWS43 4.12 LEARNING PATTERNS - REVIEW

1. FINANCIAL MANAGEMENT1. FINANCIAL MANAGEMENT

• SIZE

• GROWTH

• FINANCING

• INVESTMENT ......................... FOR EVA/SVA


2.2. W C MANAGEMENTW C MANAGEMENT

• SOURCES - P and ISOURCES - P and I

• USES - C, R and IUSES - C, R and I

S45 4.12S45 4.12 LEARNING PATTERNS - REVIEW LEARNING PATTERNS - REVIEW

3.3. FINANCIAL ANALYSISFINANCIAL ANALYSIS

• L & GL & G• AA• PP• PP

S46 4.13 INSTRUCTIONS (10 MINUTES)S46 4.13 INSTRUCTIONS (10 MINUTES)

(a)(a) Reassemble in SG.Reassemble in SG.

(b)(b) Study the lecture very carefully and record key Study the lecture very carefully and record key points in your notebook.points in your notebook.

(c)(c) Discuss any outstanding questions in SG.Discuss any outstanding questions in SG.

(d)(d) When the bell rings carry on with the case study When the bell rings carry on with the case study which follows.which follows.

S47 ASSIGNMENT 6.0 LECTURES47 ASSIGNMENT 6.0 LECTURE PENELOPE TIMBER CO. (PTC) PENELOPE TIMBER CO. (PTC)

6.1 STORY OF THE CASE6.1 STORY OF THE CASE

PTC an owner operated wholesale timber merchant of good PTC an owner operated wholesale timber merchant of good reputation with two buildings, 20 employees, no salesreputation with two buildings, 20 employees, no sales representatives and annual staff bonuses of 40% of salaries. representatives and annual staff bonuses of 40% of salaries.

Increased sales lead to increased receivables and inventory Increased sales lead to increased receivables and inventory financed by a bank loan and stretching of payables; sales financed by a bank loan and stretching of payables; sales discounts increase but shortage of cash prevents taking discounts increase but shortage of cash prevents taking purchase discounts. purchase discounts. Should further planned expansion be financed by bank loans Should further planned expansion be financed by bank loans or payables or something else? or payables or something else?

S48 6.2 FINANCIAL HEALTHS48 6.2 FINANCIAL HEALTH

a. Liquidity & Gearing :a. Liquidity & Gearing :

Quick ratio and current ratios below industry Quick ratio and current ratios below industry average. average.

Equity: debt only .5:1 (industry 1:1)Equity: debt only .5:1 (industry 1:1)

Bank loan 48,000 insufficient to allow taking Bank loan 48,000 insufficient to allow taking purchase purchase

discounts; payables stretched; cash extremely discounts; payables stretched; cash extremely short. short.

S49 6.2 FINANCIAL HEALTH S49 6.2 FINANCIAL HEALTH (continued)(continued)

b. Activity:b. Activity:

Sales/assets ratio above average but inventory turnover Sales/assets ratio above average but inventory turnover weaker; weaker;

Receivables 38 days (industry 30 days) and payables 85 Receivables 38 days (industry 30 days) and payables 85 days (industry 20 days).days (industry 20 days).

Very active company possibly over trading for its low Very active company possibly over trading for its low equity equity

base. base.

S50 6.2 FINANCIAL HEALTHS50 6.2 FINANCIAL HEALTH (continued) (continued)

c. Profitability:c. Profitability:

Gross profit percentage to sales falling (12.2%) Gross profit percentage to sales falling (12.2%) but up to but up to

industry average (12%). industry average (12%).

Net profit to owners equity good; very profitable Net profit to owners equity good; very profitable company company

even after charging very high staff bonuses! even after charging very high staff bonuses!

S51 6.2 FINANCIAL HEALTH S51 6.2 FINANCIAL HEALTH (continued)(continued)

d. Potential: d. Potential:

Sales potential good, facilities and staff Sales potential good, facilities and staff adequate,.adequate,.

Management good.Management good.

But finance probably inadequate for the planned But finance probably inadequate for the planned expansion. expansion.

S52 6.3 FUNDS FLOW & OCFS52 6.3 FUNDS FLOW & OCF

Funds flow indicates key management decisions on sources Funds flow indicates key management decisions on sources and uses of funds; no additional capital. and uses of funds; no additional capital.

Very little expended on fixed assets and nothing on Very little expended on fixed assets and nothing on dividends.dividends.

Funds flow confirms the need for further funds to finance a Funds flow confirms the need for further funds to finance a higher level of activity. Will substantial new fixed assets also higher level of activity. Will substantial new fixed assets also be necessary soon?be necessary soon?

OCF confirms poor EVA focus.OCF confirms poor EVA focus.

S53 6.4 EFFECT OF SALES EXPANSION S53 6.4 EFFECT OF SALES EXPANSION ON FINANCIAL HEALTHON FINANCIAL HEALTH

Sales increase naturally lead to increase in receivables Sales increase naturally lead to increase in receivables and inventory; high sales cash discounts allowed to and inventory; high sales cash discounts allowed to get cash quickly. get cash quickly.

Increased profits substantially distributed to employees Increased profits substantially distributed to employees as bonus leaving relatively little in the business toas bonus leaving relatively little in the business to finance expansion. finance expansion.

In the past assets were financed equally by equity In the past assets were financed equally by equity and debt (1:1) but in the last year financed mainly by and debt (1:1) but in the last year financed mainly by liabilities (.5:1). liabilities (.5:1).

S54 6.4 EFFECT OF SALES EXPANSIONS54 6.4 EFFECT OF SALES EXPANSION ON FINANCIAL HEALTH (continued) ON FINANCIAL HEALTH (continued)

Higher leverage and risk of failure! Higher leverage and risk of failure!

Sales and profit expansion has led to high profitability,Sales and profit expansion has led to high profitability, high risk and relatively poor financial health.high risk and relatively poor financial health.

Cost of losing purchase discounts of 2% 10 days net Cost of losing purchase discounts of 2% 10 days net 30 days is 2%, for the additional 20 days of credit30 days is 2%, for the additional 20 days of credit i. e. 36% per annum (365/20 x 2%) ... i. e. 36% per annum (365/20 x 2%) ...

... but only 4% if the 30 days become 182 days... but only 4% if the 30 days become 182 days ... 365/182 x 2% = 4% ... ... 365/182 x 2% = 4% ...

S55 6.5 NEW FORECASTS AND CASH S55 6.5 NEW FORECASTS AND CASH REQUIREMENTSREQUIREMENTS

Underlying assumptions may prove to be not valid: Underlying assumptions may prove to be not valid:

(a)(a) Gross profit optimistic 14% (last year 12.2%, Gross profit optimistic 14% (last year 12.2%, industry 12%).industry 12%). {b){b) Receivables 30 days (last year 30 days).Receivables 30 days (last year 30 days). (c)(c) Inventory turnover 5 times (last year 4 times). Inventory turnover 5 times (last year 4 times). (d)(d) Bank loan for 48, 000 may not continue.Bank loan for 48, 000 may not continue.

NOTE: Forecast shows need of 64,000 but the existing bank NOTE: Forecast shows need of 64,000 but the existing bank may withdraw, thus creating a need for more than 112, 000. may withdraw, thus creating a need for more than 112, 000.

Can the company afford to give away so much in sales cash Can the company afford to give away so much in sales cash discounts? discounts?

S56 6.6 PROVIDING NECESSARY CASHS56 6.6 PROVIDING NECESSARY CASH

(a)(a) Asset ManagementAsset Management

Cash - reduce the minimum cash balance?Cash - reduce the minimum cash balance?

Receivables - reduce by: selecting better paying Receivables - reduce by: selecting better paying customers,customers,

expediting more efficiently, billing on time, changing the expediting more efficiently, billing on time, changing the cash discount policy, site research visits, error free cash discount policy, site research visits, error free

invoicing, invoicing, rapid credit note processing, benchmarking, and getting all rapid credit note processing, benchmarking, and getting all managers to "own" the problem. managers to "own" the problem.

S57 6.6 PROVIDING NECESSARY CASHS57 6.6 PROVIDING NECESSARY CASH

(a)(a) Asset Management (continued}Asset Management (continued}

Inventory - reduce by: getting suppliers to hold Inventory - reduce by: getting suppliers to hold inventory, inventory,

cutting back on requirements, standardisation, JIT, cutting back on requirements, standardisation, JIT, site site

research visits, benchmarking, and getting all research visits, benchmarking, and getting all managers managers

to "own" the problem. to "own" the problem.

S58 6.6 PROVIDING NECESSARY CASHS58 6.6 PROVIDING NECESSARY CASH (continued) (continued)

(b)(b) New SourcesNew Sources

Payables well "stretched' but the discounts lost have cost Payables well "stretched' but the discounts lost have cost about 36% p.a. cheaper to borrow from the bank even at about 36% p.a. cheaper to borrow from the bank even at 10%! 10%!

Possible factoring of debtors to get immediate payment for Possible factoring of debtors to get immediate payment for mounts outstanding!mounts outstanding!

Possible bank loan? Possible bank loan?

NOTE: Overall, to what extent can planned expansion beNOTE: Overall, to what extent can planned expansion be cut back to reduce need for funds?cut back to reduce need for funds?

S59 6.7 FINANCIAL PROBLEMS ANDS59 6.7 FINANCIAL PROBLEMS AND ALTERNATIVES ALTERNATIVES

Difficult to determine whether the problem is shortDifficult to determine whether the problem is short term or long term without a five year financial term or long term without a five year financial

forecasts. forecasts.

Initial forecast shows need for at least 64,000 of Initial forecast shows need for at least 64,000 of additional funds. additional funds.

S60 6.7 FINANCIAL PROBLEMS ANDS60 6.7 FINANCIAL PROBLEMS AND ALTERNATIVES (continued) ALTERNATIVES (continued)

Profits must be retained in the business to reduce reliance on Profits must be retained in the business to reduce reliance on suppliers (to avoid stretching payables excessively and tosuppliers (to avoid stretching payables excessively and to take purchase cash discounts).take purchase cash discounts). Equity: debt relationship of .5:1 is below industry average and Equity: debt relationship of .5:1 is below industry average and therefore not healthy.therefore not healthy.

Could be accepted as a "bridging situation" depending long Could be accepted as a "bridging situation" depending long term finance from profits or new equity; will further fixed term finance from profits or new equity; will further fixed assets be necessary with the increasing turnover? assets be necessary with the increasing turnover?

S61 6.7 FINANCIAL PROBLEMS AND S61 6.7 FINANCIAL PROBLEMS AND ALTERNATIVES (continued)ALTERNATIVES (continued)

Alternatives available: bank, suppliers, factoring, Alternatives available: bank, suppliers, factoring, mortgage, long term loans, new equity, or reduction of mortgage, long term loans, new equity, or reduction of assets? assets?

NOTE: Stretching payables is only cheap after cash NOTE: Stretching payables is only cheap after cash discounts discounts

already lost, but rather risky; when equity: debt already lost, but rather risky; when equity: debt becomes becomes

very weak. very weak.

Survival may depend more on suppliers than Survival may depend more on suppliers than management! management!

S62 6.8S62 6.8 DECISION AND JUSTIFICATION DECISION AND JUSTIFICATION

(a)(a) Decision - depends upon the risk level which Decision - depends upon the risk level which Penelope Penelope

will accept, his personal objectives for expansion and will accept, his personal objectives for expansion and the possible need to expand merely to survive. the possible need to expand merely to survive.

If sales can be kept to 1,200,000 (not 1,600,000) then If sales can be kept to 1,200,000 (not 1,600,000) then receivables and inventory could be cut back receivables and inventory could be cut back substantially and very little additional finance needed substantially and very little additional finance needed either from banks or equity. either from banks or equity.

S63 6.8S63 6.8 DECISION AND JUSTIFICATION DECISION AND JUSTIFICATION (continued )(continued )

If, however, business expansion is vital for survival t hen If, however, business expansion is vital for survival t hen new funds must finance the increased receivables and new funds must finance the increased receivables and inventory.inventory.

Funds from banks or stretching payables is high risk Funds from banks or stretching payables is high risk approach. A lower risk approach to expansion would be toapproach. A lower risk approach to expansion would be to provide new equity funds thus increasing the equity base provide new equity funds thus increasing the equity base and improving the general financial health.and improving the general financial health.

Bank may refuse new loan and (try to) withdraw existing loan Bank may refuse new loan and (try to) withdraw existing loan if PTC goes to another bank.if PTC goes to another bank.

S64 6.8S64 6.8 DECISION AND JUSTIFICATION DECISION AND JUSTIFICATION (continued)(continued)

(b)(b) Recommendation : increase the equity base now Recommendation : increase the equity base now while while

the business is very profitable; alternatively get a the business is very profitable; alternatively get a temporary bank loan as "bridging" finance whilst temporary bank loan as "bridging" finance whilst seeking new equity.seeking new equity.

(c)(c) Justification there is no point in taking excessive Justification there is no point in taking excessive risks risks

with a successful business; don't push bank too with a successful business; don't push bank too hard hard

too soon! too soon!

Don't pursue sales regardless of financial risk Don't pursue sales regardless of financial risk and and

requirements.requirements.

NOTE: There are several acceptable alternativeNOTE: There are several acceptable alternative solutions; evaluate them in terms of the level solutions; evaluate them in terms of the level

of of risk PTC should accept!risk PTC should accept!

S65 6.8S65 6.8 DECISION AND JUSTIFICATION DECISION AND JUSTIFICATION (continued(continued

S66 6.9S66 6.9 LEARNING POINTSLEARNING POINTS

(a)(a) Health of the business may be determined lnHealth of the business may be determined ln terms of liquidity (and gearing), activity, terms of liquidity (and gearing), activity,

profitability profitability and potential.and potential.

(b)(b) Ratios must be compared with industry averages to Ratios must be compared with industry averages to

determine their significance.determine their significance.

(c)(c) Increased sales lead to increased working capital in Increased sales lead to increased working capital in receivables and inventory.receivables and inventory.

S67 6.9S67 6.9 LEARNING POINTS (continued)LEARNING POINTS (continued)

(d)(d) Profits produce funds for financing increasedProfits produce funds for financing increased working capital provided they are not distributed working capital provided they are not distributed as dividends.as dividends.

(e)(e) Working capital may be managed either byWorking capital may be managed either by reducing the uses, or increasing the sources, reducing the uses, or increasing the sources, of funds.of funds.

(f)(f) Must determine whether the financial need is Must determine whether the financial need is short term or long term, since the solutions will short term or long term, since the solutions will

differ.differ.

S68 6.9 LEARNING POINTS (continued)S68 6.9 LEARNING POINTS (continued)

(g) (g) Creative financing considers all alternatives Creative financing considers all alternatives before before

making a decision.making a decision.

h)h) Cash flow, funds flow and forecasted income Cash flow, funds flow and forecasted income statements and balance sheets help to clarifystatements and balance sheets help to clarify financial needs.financial needs.

(i)(i) Funds flow reveals key management decisions.Funds flow reveals key management decisions.

S69 6.9S69 6.9 LEARNING POINTS (continued)LEARNING POINTS (continued)

(j) "Bridging" finance is short term money pending (j) "Bridging" finance is short term money pending raising of long term funds.raising of long term funds.

(k)(k) Management must decide the level of risk that Management must decide the level of risk that it will accept before deciding upon the it will accept before deciding upon the

expansion expansion and planning the financing.and planning the financing.

(l)(l) Financing of working capital easier if company Financing of working capital easier if company has facilities from more than one bank.has facilities from more than one bank.

S70 6.9S70 6.9 LEARNING POINTS (continued)LEARNING POINTS (continued). .

(m)(m) Always seven alternatives ro every finnncial Always seven alternatives ro every finnncial problem.problem.

(n) Cut receivables and inventories in ten ways plus (n) Cut receivables and inventories in ten ways plus benchmarking and getting all managers to "own" benchmarking and getting all managers to "own"

the the problem. problem.

(o) Research inventory values, turnover, (o) Research inventory values, turnover, standardisation, standardisation,

supplier cooperation opportunities.supplier cooperation opportunities.

S71 6.10S71 6.10 LEARNING PATTERNS LEARNING PATTERNS

1. SALES EXPANSION– RECEIVABLES +RECEIVABLES +• INVENTORIES +

• CASH -

S72 6.10 LEARNING PATTERNS S72 6.10 LEARNING PATTERNS (continued)(continued)

2. SHORT-TERM TO LONG-TERM

PROFIT NOW ..... DISASTER LATER?

S73 6.10 LEARNING PATTERNSS73 6.10 LEARNING PATTERNS (continued) (continued)

3. WORKING CAPITAL 3. WORKING CAPITAL

MANAGEMENTMANAGEMENT

PROBLEM "OWNED" BY ALL PROBLEM "OWNED" BY ALL MANAGERS ...MANAGERS ...

S74 6.11 INSTRUCTIONSS74 6.11 INSTRUCTIONS

(a)(a) Re-assemble in CSGRe-assemble in CSG

(b)(b) Study the lecture and discuss in CSG.Study the lecture and discuss in CSG. (c)(c) Record significant points in your notebookRecord significant points in your notebook

(d)(d) Reassemble in MG when the bell rings Reassemble in MG when the bell rings

S75 ASSIGNMENT 7.0 - STUDY - FINANCING S75 ASSIGNMENT 7.0 - STUDY - FINANCING EXPANSION (75 MINUTES)EXPANSION (75 MINUTES)

7.17.1 INSTRUCTIONSINSTRUCTIONS

(a)(a) Re-assemble in new SG, and study the lecture and Re-assemble in new SG, and study the lecture and discuss in SG.discuss in SG.

(b)(b) Record significant points on the flip chart.Record significant points on the flip chart.

(c)(c) Review the glossary for any difficulties with new wordsReview the glossary for any difficulties with new words

(d)(d) Record significant points in your notebook andRecord significant points in your notebook and re-assemble in MG when the bell rings anre-assemble in MG when the bell rings an

S76 ASSIGNMENT 8.0 - LECTURE ONS76 ASSIGNMENT 8.0 - LECTURE ON FINANCING EXPANSION FINANCING EXPANSION

8.18.1 METHODMETHOD

Read aloud, listen ,,,Read aloud, listen ,,,

and respond verbally ... to any questions.and respond verbally ... to any questions.

S77 8.2 PLANNING FOR THE FUTURES77 8.2 PLANNING FOR THE FUTURE

Need to plan the size, growth and profit stability of Need to plan the size, growth and profit stability of the company.the company.

Funds flow is the key to long term financing.Funds flow is the key to long term financing.

Cash flow is the key to short term financing.Cash flow is the key to short term financing.

Forecast forward both cash and funds to determineForecast forward both cash and funds to determine whether financial needs are short term or long term.whether financial needs are short term or long term.

S78 8.3 RISK AND THE CRITICAL FEWS78 8.3 RISK AND THE CRITICAL FEW

Decide upon "critical few" factors which really make Decide upon "critical few" factors which really make for profit in the particular business. Analyze the industry, for profit in the particular business. Analyze the industry, economy, size of the business and finally the personal economy, size of the business and finally the personal values of the chief executive.values of the chief executive.

Determine the risk level the company will accept.Determine the risk level the company will accept.

Evaluate the risk of various possible disasters.Evaluate the risk of various possible disasters.

Set financial policies to deal with the "critical few"Set financial policies to deal with the "critical few" profit-making features at the appropriate risk level.profit-making features at the appropriate risk level.

S79 8.4 EFFECT OF EXPANSIONS79 8.4 EFFECT OF EXPANSION

Expansion of sales leads naturally to expansionExpansion of sales leads naturally to expansion of current assets (receivables, inventory and theof current assets (receivables, inventory and the minimum cash balance).minimum cash balance).

Management of receivables and inventory is the Management of receivables and inventory is the cheapest "source" of finance, i.e. reduce the cheapest "source" of finance, i.e. reduce the investment.investment.

S80 8.4 EFFECT OF EXPANSION S80 8.4 EFFECT OF EXPANSION (continued)(continued)

Suppliers may provide “cheap finance” with or without Suppliers may provide “cheap finance” with or without cash discounts. cash discounts.

Loss of cash discounts is costly - i.e. 2% 10 days net 30 days, Loss of cash discounts is costly - i.e. 2% 10 days net 30 days, is 2% for the extra 20 days of credit or 36% per annum!!is 2% for the extra 20 days of credit or 36% per annum!!

Alternative sources of short term finance include: other Alternative sources of short term finance include: other suppliers, factoring, loans. customer deposits,banks, etc.suppliers, factoring, loans. customer deposits,banks, etc.

Get suppliers to give 2% 30 days or take 9 months to pay or Get suppliers to give 2% 30 days or take 9 months to pay or change suppliers? change suppliers?

S81 8.5 BANK RELATIONSHIPSS81 8.5 BANK RELATIONSHIPS

Commercial banks serve customers by financing current Commercial banks serve customers by financing current business (not like merchant banks which provide long term business (not like merchant banks which provide long term capital)capital)

Key to bank financing is the mutual confidence between Key to bank financing is the mutual confidence between banker and customer.banker and customer.

Bankers like: short term financing which turns over Bankers like: short term financing which turns over regularly; regularly;

they like "accounts" that are actively going from red tothey like "accounts" that are actively going from red to black to red, etc. black to red, etc.

S82 8.5 BANK RELATIONSHIPS (continued)S82 8.5 BANK RELATIONSHIPS (continued)

Banks provide a widening range of services today.Banks provide a widening range of services today.

Banks believe that "the customer does not have to Banks believe that "the customer does not have to tell tell

us all the truth but he must never deliberately lie or us all the truth but he must never deliberately lie or bebe

irresponsible".irresponsible".

Commercial banks have associates that do merchant Commercial banks have associates that do merchant banking.banking.

S83 8.6 CRITERIA FOR BANK FINANCES83 8.6 CRITERIA FOR BANK FINANCE Commercial banks lend not just against physical security Commercial banks lend not just against physical security but on the following criteria: but on the following criteria:

(a) Personal relationship with banker(a) Personal relationship with banker (b) purpose(b) purpose (c) profitability(c) profitability (d) payback (is it possible?)(d) payback (is it possible?) (e) security.(e) security.

Bankers may say "all loans are repayable on demand Bankers may say "all loans are repayable on demand if the rules are broken”, but in reality they never demand it ,if the rules are broken”, but in reality they never demand it , unless in danger. Banks hold security in the hope of NEVERunless in danger. Banks hold security in the hope of NEVER having to use it.having to use it.

S84 8.6 CRITERIA FOR BANK FINANCE S84 8.6 CRITERIA FOR BANK FINANCE (continued)(continued)

Banks give information to each other in a special code Banks give information to each other in a special code which which

is discreet and confidential.is discreet and confidential.

Relationship with the bank manager is the key!Relationship with the bank manager is the key!

Banks sometimes insist that "equity base" be increased Banks sometimes insist that "equity base" be increased as a as a

condition for further loans. condition for further loans.

Banks are normally conservative and tough! Banks are normally conservative and tough!

S85 8.7 CONTROL OF WORKING CAPITALS85 8.7 CONTROL OF WORKING CAPITAL Frequent (monthly) reporting with reliable financial Frequent (monthly) reporting with reliable financial statements to all managers (production, marketing, statements to all managers (production, marketing, finance etc,) to get them to “own” the WC problem..finance etc,) to get them to “own” the WC problem..

Regular and effective forecasting of peak and duration of Regular and effective forecasting of peak and duration of cash needs.cash needs.

Timely financial data.Timely financial data.

Forecast forward the income statements, balance sheets, Forecast forward the income statements, balance sheets, cash and funds flow, and then evaluate risk. cash and funds flow, and then evaluate risk.

S86 8.7 CONTROL OF WORKING CAPITAL S86 8.7 CONTROL OF WORKING CAPITAL (continued) (continued)

Never go to the banker when you need money; goNever go to the banker when you need money; go when you don't need money and arrange to have it when you don't need money and arrange to have it available when you want it.available when you want it.

““I need ECU 500,000. Can you handle it or should I I need ECU 500,000. Can you handle it or should I deal deal

directly with your general manager?"directly with your general manager?"

S87 8.8 CONTROL OF RECEIVABLESS87 8.8 CONTROL OF RECEIVABLES Make frequent aging of receivables to identify slow payers Make frequent aging of receivables to identify slow payers and assess DOS (days of sales) performance.and assess DOS (days of sales) performance.

For external causes: visit selected customers to identifyFor external causes: visit selected customers to identify the reasons for delay which may include: invoice errors, the reasons for delay which may include: invoice errors, order errors, credit claim delays, non-delivery, quality order errors, credit claim delays, non-delivery, quality issues, INCORRECT DOCUMENTATION etc.issues, INCORRECT DOCUMENTATION etc.

For internal causes: investigate, slow invoicing, pricing For internal causes: investigate, slow invoicing, pricing complexities, credit note delays, shipment errors, poor complexities, credit note delays, shipment errors, poor expediting, discount errors, failure to drop poor accounts etc.expediting, discount errors, failure to drop poor accounts etc.

S88 8.8 CONTROL OF RECEIVABLESS88 8.8 CONTROL OF RECEIVABLES

Benchmark with other companies in collaboration Benchmark with other companies in collaboration with with

marketing, production, quality, finance managers to marketing, production, quality, finance managers to jointly: “own” the problem, set targets and monitor jointly: “own” the problem, set targets and monitor progress. progress.

S89 8.9S89 8.9 CONTROL OF INVENTORYCONTROL OF INVENTORY

Make frequent aging of inventories to identify slow Make frequent aging of inventories to identify slow moving moving

high value items and to assess DOP (days of purchases) high value items and to assess DOP (days of purchases) and DOS (days of sales) performance.and DOS (days of sales) performance.

For external causes: visit selected suppliers to identify For external causes: visit selected suppliers to identify the reasons for high inventory which may include: the reasons for high inventory which may include:

excess excess order quantities, long delivery lead times, poor order quantities, long delivery lead times, poor standardization, lack of JIT systems etc.standardization, lack of JIT systems etc.

S90 8.9 CONTROL OF INVENTORY S90 8.9 CONTROL OF INVENTORY (continued)(continued)

For internal causes: investigate delayed usage, excess For internal causes: investigate delayed usage, excess storage, lack of standardization, poor design specification, storage, lack of standardization, poor design specification, failure to control high value items daily, excess storage failure to control high value items daily, excess storage space/costs, poor standardisation, lack of JIT systems, space/costs, poor standardisation, lack of JIT systems,

poor poor supplier selection etc.supplier selection etc.

Benchmark with other companies in collaboration with Benchmark with other companies in collaboration with marketing, production, quality, finance managers to marketing, production, quality, finance managers to jointly: “own” the problem, set targets and monitor jointly: “own” the problem, set targets and monitor

progress. progress.

S91 8.10 INFLUENCE OF THES91 8.10 INFLUENCE OF THE CHIEF EXECUTIVE CHIEF EXECUTIVE

Age. experience, reputation, skills, attitudes and Age. experience, reputation, skills, attitudes and knowledge knowledge

of the chief executive are key factors in the decision to of the chief executive are key factors in the decision to finance expansion by banks. suppliers or merely reduce finance expansion by banks. suppliers or merely reduce the working capital investment.the working capital investment.

Overall expansion of sales involves increase in assets Overall expansion of sales involves increase in assets employed in the business; financing of those assets is a employed in the business; financing of those assets is a management decision; but there are always many management decision; but there are always many alternatives.alternatives.

S92 8.10 INFLUENCE OF THES92 8.10 INFLUENCE OF THE CHIEF EXECUTIVE (continued) CHIEF EXECUTIVE (continued)

"Bridging" of long term needs by short term finance "Bridging" of long term needs by short term finance is cceptable provided the risk is clearly recognized is cceptable provided the risk is clearly recognized and there is an achievable long term plan to and there is an achievable long term plan to

recover recover financial health.financial health.

S93 8.10 INFLUENCE OF THE S93 8.10 INFLUENCE OF THE CHIEF EXECUTIVE (continued)CHIEF EXECUTIVE (continued)

May accept temporary high risk, and unhealthy financial May accept temporary high risk, and unhealthy financial position provided: high profits, planned recovery of healthposition provided: high profits, planned recovery of health planned reduction of risk to "normal" level.planned reduction of risk to "normal" level.

Note: Before every financial negotiation, always make other Note: Before every financial negotiation, always make other contacts to work out what you could do WITHOUT the othercontacts to work out what you could do WITHOUT the other party ... then negotiate (gently) from strength ... not party ... then negotiate (gently) from strength ... not weakness ... because you have good alternatives ...weakness ... because you have good alternatives ... without him/her ... without him/her ...

S94 8.10 INFLUENCE OF THE S94 8.10 INFLUENCE OF THE CHIEF EXECUTIVE (continued)CHIEF EXECUTIVE (continued)

Management have a high “ego” priority to use “excess cash” Management have a high “ego” priority to use “excess cash” for expansion and diversfication projects. for expansion and diversfication projects.

By contrast shareholders may have priority for EVA targetsBy contrast shareholders may have priority for EVA targets in terms of dividends and SVA. in terms of dividends and SVA.

Thus the sharehiolders may insist that unless new Thus the sharehiolders may insist that unless new acquisitionsacquisitions

or mergers can achieve EVA then the excess cash is betteor mergers can achieve EVA then the excess cash is bette returned to shareholders as dividends or share buy-backreturned to shareholders as dividends or share buy-back (equity reduction).(equity reduction).


1. BANK FINANCING1. BANK FINANCING

P P P P & SP P P P & S

S87 8.11 LEARNING PATTERNS - REVIEWS87 8.11 LEARNING PATTERNS - REVIEW (continued) (continued)

2. CONTROL OF R & I2. CONTROL OF R & I

INTERNALINTERNAL

EXTERNALEXTERNAL

S88 8.11 LEARNING PATTERNS - REVIEWS88 8.11 LEARNING PATTERNS - REVIEW (continued) (continued)

3. CEO3. CEO

CHIEF EXECUTIVE OFFICER CHIEF EXECUTIVE OFFICER

CUSTOMERS EMPLOYEES OWNERSCUSTOMERS EMPLOYEES OWNERS

S89 8.12 INSTRUCTIONS (10 MINUTES)S89 8.12 INSTRUCTIONS (10 MINUTES)

(a)(a) Reassemble in SGReassemble in SG

(b)(b) Study the lecture carefullyStudy the lecture carefully

(c)(c) Record key points in your notebookRecord key points in your notebook

(d)(d) Discuss outstanding questionsDiscuss outstanding questions

(e)(e) When the bell rings, carry on with the case When the bell rings, carry on with the case study which study which

followsfollows

S90 ASSIGNMENT 10.0 LECTURE ON S90 ASSIGNMENT 10.0 LECTURE ON LUMSDEN (A)LUMSDEN (A)

10.1 STORY OF THE CASE10.1 STORY OF THE CASE

Expansion financed by long term bank loan 140,000 Expansion financed by long term bank loan 140,000 capital capital

expenditure and 160,000 for working capital. expenditure and 160,000 for working capital.

Lumsden commits for increased capital expenditure of Lumsden commits for increased capital expenditure of aboutabout

400, 000 before consulting the bank and thus breaks 400, 000 before consulting the bank and thus breaks the the

agreement. agreement.

S91 10.2 HEALTH OF THE COMPANYS91 10.2 HEALTH OF THE COMPANY

(a)(a) Liquidity & GearingLiquidity & Gearing

Quick ratio is a little weak, although stronger than previous Quick ratio is a little weak, although stronger than previous

years; current ratio is strong.years; current ratio is strong. Equity:debt ratio of 2.4: 1 is very strong indeed, both Equity:debt ratio of 2.4: 1 is very strong indeed, both compared with previous years and the industry.compared with previous years and the industry. Overall, fairly liquid and well able to meet its commitments Overall, fairly liquid and well able to meet its commitments at the present level of operations.at the present level of operations.

S92 10.2 HEALTH OF THE COMPANY S92 10.2 HEALTH OF THE COMPANY (continued)(continued)

(b)(b) ActivityActivity

Turnover of assets and inventories fair. Turnover of assets and inventories fair.

Receivables better than industry average.Receivables better than industry average.

Payables settled with cash discounts; overall, a fairly Payables settled with cash discounts; overall, a fairly active active

company. company.


(c) Profitability(c) Profitability

Gross profit percentage very high in the first seven months Gross profit percentage very high in the first seven months (un-audited!).(un-audited!).

Similarly net profit to sales higher than the industry (why? Similarly net profit to sales higher than the industry (why? manipulated?).manipulated?).

Overall return on equity is very good. Overall return on equity is very good.

Subject to possible manipulation of inventory value (need an Subject to possible manipulation of inventory value (need an audit), profitability seems very good indeed. audit), profitability seems very good indeed.


(d)(d) PotentialPotential Market potential good; management effective Market potential good; management effective but a little old and unreliable; production but a little old and unreliable; production expanding. expanding.

NOTE: Overall a healthy company, with cash and NOTE: Overall a healthy company, with cash and funds flow funds flow

adequate to finance current operations. adequate to finance current operations.

S95 10.3 FUNDS FLOW & OCFS95 10.3 FUNDS FLOW & OCF Funds flow indicates major management decisions regarding Funds flow indicates major management decisions regarding

source and use of funds. source and use of funds.

Only a small past increase working capital, since profits Only a small past increase working capital, since profits mainly used for fixed assets and mortgage repayments. mainly used for fixed assets and mortgage repayments.

Funds raised from the bank to finance fixed assets and Funds raised from the bank to finance fixed assets and working capital expansion. Is this wise? working capital expansion. Is this wise?

Substantial increase in assets financed largely by accrualsSubstantial increase in assets financed largely by accruals for taxes; no draining off of profits into dividends. Confirmed for taxes; no draining off of profits into dividends. Confirmed by OCF.by OCF.

S96 10.4 ORIGINAL BANK LOANS96 10.4 ORIGINAL BANK LOAN

Criteria for bank finance: Criteria for bank finance:

(a)(a) Personal relationship with the bank Lumsden well Personal relationship with the bank Lumsden well known known

to the bank for some years but a little old (health to the bank for some years but a little old (health risk?).risk?).

(b)(b) Purpose : expansion to meet outstanding orders;Purpose : expansion to meet outstanding orders; market seems to warrant such expansion.market seems to warrant such expansion.

(c)(c) Profitability : company very profitable and healthy.Profitability : company very profitable and healthy.

S97 10.4 ORIGINAL BANK LOAN S97 10.4 ORIGINAL BANK LOAN (continued)(continued)

(d)(d) Payback no drain.off of profits into dividends; Payback no drain.off of profits into dividends; profitability should enable payback in the time allowed.profitability should enable payback in the time allowed.

(e)(e) Security general security of the business including Security general security of the business including property, inventory, etc. seems adequate for the loan.property, inventory, etc. seems adequate for the loan.

NOTE: Lumsden well qualified for the original loan of 140, 000 NOTE: Lumsden well qualified for the original loan of 140, 000 for capital expenditure and 160, 000 for working capital; bank for capital expenditure and 160, 000 for working capital; bank acted wisely in making loan because it met the criteria. acted wisely in making loan because it met the criteria.

S98 10.5 BANK AGREEMENTS98 10.5 BANK AGREEMENT

Lumsden has broken the bank agreement because he has Lumsden has broken the bank agreement because he has committed for more than 140, 000 of new capital committed for more than 140, 000 of new capital

expenditure;expenditure; bank could call in loan immediately.bank could call in loan immediately.

Bank only committed in Sept last year to 80, 000 Bank only committed in Sept last year to 80, 000 outstanding; outstanding;

could be repaid with no loss to the bank.could be repaid with no loss to the bank.

The substantial cash balance could be immediately offset The substantial cash balance could be immediately offset against the loan and Lumsden could get finance from against the loan and Lumsden could get finance from another bank or financial source. another bank or financial source.

S99 10.5 BANK AGREEMENT(continued)S99 10.5 BANK AGREEMENT(continued)

New cash needed for fixed assets is 400, 000 and working New cash needed for fixed assets is 400, 000 and working capital 160, 000, but no forecasts available for five years capital 160, 000, but no forecasts available for five years

to to ensure these amounts will be adequate. ensure these amounts will be adequate.

Is the estimate of 400, 000 reliable for a new plant? Will Is the estimate of 400, 000 reliable for a new plant? Will 160, 000 be adequate for working capital if sales increase 160, 000 be adequate for working capital if sales increase from 1 to 3 million? from 1 to 3 million?

Probably more money needed.Probably more money needed.

S100 10.6 FURTHER BANK FINANCES100 10.6 FURTHER BANK FINANCE (a) Criteria for a new loan:(a) Criteria for a new loan:

Personal relationship with the bank : Personal relationship with the bank :

Lumsden broke his agreement once and therefore can he Lumsden broke his agreement once and therefore can he be relied upon in the future? Is the breach a serious one? be relied upon in the future? Is the breach a serious one? Probably not since only 80, 000 is outstanding at the moment. Probably not since only 80, 000 is outstanding at the moment.

Can Lumsden manage bigger plant? Labor problems? Can Can Lumsden manage bigger plant? Labor problems? Can he adapt to new scale of operations which is three times he adapt to new scale of operations which is three times what he is used to? He is quite old and may find it difficult. what he is used to? He is quite old and may find it difficult.

S101 10.6 FURTHER BANK FINANCE S101 10.6 FURTHER BANK FINANCE (continued)(continued)

Purpose: additional plant to meet market need; Purpose: additional plant to meet market need; Lumsden Lumsden

only a "marginal supplier" and the economy might only a "marginal supplier" and the economy might turn down. turn down.

Profitability: Lumsden still profitable but no Profitability: Lumsden still profitable but no auditedaudited

accounts available for last year. accounts available for last year.


Payback: larger amount harder to pay back out of Payback: larger amount harder to pay back out of profits; profits;

depends upon the general success of Lumsden and depends upon the general success of Lumsden and good good

cash flow from profits. cash flow from profits.

Security: still fairly strong since the plant could be Security: still fairly strong since the plant could be sold if sold if

necessary; less security for a larger loan than a necessary; less security for a larger loan than a smaller one. smaller one.

S103 10.6 FURTHER BANK FINANCE S103 10.6 FURTHER BANK FINANCE (continued) (continued)

NOTE: Overall, Lumsden still a good financial risk, subject to NOTE: Overall, Lumsden still a good financial risk, subject to his ability to work well with the bank and to restrain himself his ability to work well with the bank and to restrain himself from excessive expansion and meet new business from excessive expansion and meet new business management problems! management problems!

Total money requirement probably higher because of the Total money requirement probably higher because of the uncertainty; loan terms should tryn to restrict Lumsden's uncertainty; loan terms should tryn to restrict Lumsden's activities and require very close reporting and control.activities and require very close reporting and control.

Bank policy is to be aggressive in seeking and keeping Bank policy is to be aggressive in seeking and keeping clients. clients.


(b)(b) Alternatives open to Lumsden:Alternatives open to Lumsden:

Get the money from another bankGet the money from another bank Get loans from suppliers of equipmentGet loans from suppliers of equipment Factor receivablesFactor receivables Lease rather than buy the plantLease rather than buy the plant Raise new equity but keep control of the companyRaise new equity but keep control of the company Don't expandDon't expand Sell outSell out

NOTE: Many opportunities open to Lumsden if the bank NOTE: Many opportunities open to Lumsden if the bank refuses. refuses.

S105 10.7 FINANCIAL POLICIESS105 10.7 FINANCIAL POLICIES

(a)(a) LumsdenLumsden

Recognize the risks involved in such extensive expansion; Recognize the risks involved in such extensive expansion; play safe by increasing equity base now but keep control of play safe by increasing equity base now but keep control of the company. the company.

Set up alternative financial sources to avoid reliance on Set up alternative financial sources to avoid reliance on one lender. Consider leasing the plant rather than buying it. one lender. Consider leasing the plant rather than buying it.

Achieve better relationship with the bank or with severalAchieve better relationship with the bank or with several banks to provide flexibility (and strength!) banks to provide flexibility (and strength!)

S106 10.7 FINANCIAL POLICIES S106 10.7 FINANCIAL POLICIES (continued)(continued)

Overall accept the loan if offered, but keep to the Overall accept the loan if offered, but keep to the terms terms

and seek equity soon while the company is still and seek equity soon while the company is still healthy healthy

and profitable. and profitable.

NOTE: ALWAYS SET UP ALTERNATIVE FINANCING ... NOTE: ALWAYS SET UP ALTERNATIVE FINANCING ... BEFORE ... BEFORE ...

NEGOTIATING WITH A BANK ... NEGOTIATE FROM NEGOTIATING WITH A BANK ... NEGOTIATE FROM STRENGTH ...STRENGTH ...

NOT WEAKNESS ...!!!NOT WEAKNESS ...!!!


(b) Bank(b) Bank

Decide if Lumsden can be relied upon to remain a good Decide if Lumsden can be relied upon to remain a good client; if not, reclaim the money immediately and seek client; if not, reclaim the money immediately and seek business elsewhere.business elsewhere. If Lumsden remains a client, give the loan provided heIf Lumsden remains a client, give the loan provided he also increases the equity base! also increases the equity base!

Set controls upon him in terms of monthly audited reporting Set controls upon him in terms of monthly audited reporting and inspection of the plant, to ensure that the bank is well and inspection of the plant, to ensure that the bank is well informed of developments in time. informed of developments in time.


(c) Justification(c) Justification

Expansion by bank finance is "bridging" until moreExpansion by bank finance is "bridging" until more equity financing can be found.equity financing can be found.

In the future avoid commitment before providingIn the future avoid commitment before providing financial resources. financial resources.


NOTE: Always do a PFD before activity major NOTE: Always do a PFD before activity major financial financial

decisions, to check again the underlying decisions, to check again the underlying assumptions: assumptions:

economic, marketing, technical, financial, economic, marketing, technical, financial, management management

etc. and the possible EI ...etc. and the possible EI ...

S110 10.8S110 10.8 LEARNING POINTSLEARNING POINTS

(a)(a) Criteria for bank lending includes: personal Criteria for bank lending includes: personal relationship, relationship,

purpose, profitability, payback and security.purpose, profitability, payback and security.

(b)(b) Breach of a bank loan agreement, gives the bank Breach of a bank loan agreement, gives the bank the the

right to reclaim money immediately and to offset all right to reclaim money immediately and to offset all balances.balances.

(c)(c) Bank confidence in the client is key to bank Bank confidence in the client is key to bank financing.financing.


(d)(d) Many alternatives for financing of working capital Many alternatives for financing of working capital including reduction of activity, factoring, financing by including reduction of activity, factoring, financing by supp liers, leasing, etc.supp liers, leasing, etc.

(e)(e) Set up alternative financial plans before negotiating a Set up alternative financial plans before negotiating a final deal, so as to be flexible to negotiate from strength.final deal, so as to be flexible to negotiate from strength.

(f)(f) No need to own the whole business and keep all the No need to own the whole business and keep all the profits. Increasing the equity base of the business means profits. Increasing the equity base of the business means sharing: profits, risks and losses.sharing: profits, risks and losses.


(g) Financial control involves regular, reliable and (g) Financial control involves regular, reliable and timely timely

monthly or weekly data, audited when necessary.monthly or weekly data, audited when necessary.

(h)(h) "Bridging" finance provides short term resources "Bridging" finance provides short term resources pending pending

long term financing arrangements.long term financing arrangements.

(i)(i) Need financial forecasts for five years ahead to Need financial forecasts for five years ahead to determine whether problems are short term or long determine whether problems are short term or long

term.term.


(j) (j) Unaudited financial statements are not Unaudited financial statements are not reliable; reliable;

they may have been manipulated.they may have been manipulated.

(k)(k) Think creatively about financing problems and Think creatively about financing problems and seek out all (SEVEN) alternatives before seek out all (SEVEN) alternatives before making a critical fianancial decision.making a critical fianancial decision.


(l)(l) Decide very carefully about the extent and Decide very carefully about the extent and duration of the risk level to be accepted.duration of the risk level to be accepted.

(m) Keep options and relationships open.(m) Keep options and relationships open.

(n) Benchmark to help to set better standards for(n) Benchmark to help to set better standards for working capital management.working capital management.

S115 10.9 LEARNING PATTERNSS115 10.9 LEARNING PATTERNS

1. MAXIMISING GOALS1. MAXIMISING GOALS

SALESSALES

PROFITSPROFITS

CASH FLOWCASH FLOW

SVA ...SVA ...


2.2. INVESTMENT INVESTMENT

MUST RETURN ABOVE C. OF C. MUST RETURN ABOVE C. OF C.

FIXED INVESTMENT - WELL CONTROLLEDFIXED INVESTMENT - WELL CONTROLLED

WC INVESTMENT - WC INVESTMENT -

NOT CONTROLLED ...NOT CONTROLLED ...


3. FINANCIAL MANAGEMENT SKILLS3. FINANCIAL MANAGEMENT SKILLS

TIMING ...TIMING ...

S118 10.10 INSTRUCTIONSS118 10.10 INSTRUCTIONS

(a)(a) Re-assemble in CSGRe-assemble in CSG

(b)(b) Study the lecture and discuss in CSG. Study the lecture and discuss in CSG.

(c)(c) Record significant points in your notebookRecord significant points in your notebook

(d)(d) Reassemble in MG when the bell rings.Reassemble in MG when the bell rings.

S119 ASSIGNMENT 11.0 - SUMMARYS119 ASSIGNMENT 11.0 - SUMMARY LECTURE FOR PART I LECTURE FOR PART I

11.1 FINANCIAL MANAGEMENT11.1 FINANCIAL MANAGEMENT

(a)(a) Deals with four major problems: Deals with four major problems: 1.1. Size - what size should the firm be?Size - what size should the firm be? 2.2. Growth - what rate of growth of sales, assets, profits. Growth - what rate of growth of sales, assets, profits.

etc.?etc.? 3.3. Financing - how should the firm be financed, and atFinancing - how should the firm be financed, and at what risk?what risk? 4.4. Investment - what kind of assets should be acquired,Investment - what kind of assets should be acquired, and at what rate? and at what rate?

S120 11.1 FINANCIAL MANAGEMENTS120 11.1 FINANCIAL MANAGEMENT

(b)(b) Financial health of the business depends uponFinancial health of the business depends upon both its resources, the environment in which it both its resources, the environment in which it

operates operates and its financial policies. and its financial policies.

Financial management is dynamic and depends Financial management is dynamic and depends upon upon

flows or cash and funds not a static situation.flows or cash and funds not a static situation.

S121 11.1 FINANCIAL MANAGEMENT S121 11.1 FINANCIAL MANAGEMENT (continued)(continued)

(c)(c) Most important is ... CASH FLOW and Most important is ... CASH FLOW and SURVIVAL ... SURVIVAL ...

to increase the long term VALUE of the business to increase the long term VALUE of the business for ALLfor ALL

of the "stakeholders": customers, shareholders, of the "stakeholders": customers, shareholders, management, workers, suppliers, banks, management, workers, suppliers, banks,

communities,communities, government, trade unions, environmental government, trade unions, environmental

groups etc. groups etc.

S122 11.1 FINANCIAL MANAGEMENT S122 11.1 FINANCIAL MANAGEMENT (continued)(continued)

(d) To achieve EVA in a company, the manager of (d) To achieve EVA in a company, the manager of each each

division must produce:division must produce:

OP/NAE X 100% = above CoCOP/NAE X 100% = above CoC where: where: OP = Operating Profit after taxOP = Operating Profit after tax NAE = Net Assets Employed (FA & CA & OA NAE = Net Assets Employed (FA & CA & OA

less CL)less CL) CoC = Cost of CapitalCoC = Cost of Capital

S122A 4.2S122A 4.2 FINANCIAL MANAGEMENT FINANCIAL MANAGEMENT (continued) (continued)

(e) The value of a business or a share may be simply (e) The value of a business or a share may be simply computed as: OCF/(r-g) ,computed as: OCF/(r-g) ,

(f(f In quoted companies, shareholders may be powerful In quoted companies, shareholders may be powerful pension funds, insurance companies and mutualpension funds, insurance companies and mutual funds, who are highly skilled in finance ; they may funds, who are highly skilled in finance ; they may require management to provide both dividends require management to provide both dividends and increased share value ... or move over ... thus in and increased share value ... or move over ... thus in 1995, SVA is becoming a key financial objective! 1995, SVA is becoming a key financial objective!

S123 11.2 OBJECTIVE, METHOD AND S123 11.2 OBJECTIVE, METHOD AND SKILLS SKILLS

a.a. Objective -Objective - increase the long term value of increase the long term value of the the

business with EVA (Economic Value Added) and business with EVA (Economic Value Added) and SVA SVA

(Share Value Added). (Share Value Added).

b.b. Method - raise money and use it effectively to Method - raise money and use it effectively to achieve achieve

standards of financial performancestandards of financial performance

c.c. Skills - timing to balance risk and rewardSkills - timing to balance risk and reward

S124 11.3 SHORT TERM/LONG TERM S124 11.3 SHORT TERM/LONG TERM FINANCINGFINANCING

(a)(a) Short term finance used for: cash, receivables, Short term finance used for: cash, receivables, inventory. prepayments, etc.inventory. prepayments, etc.

(b)(b) Sources of short term finance: suppliers, banks, Sources of short term finance: suppliers, banks, factoring, leasing, or reduction of the need for cash, factoring, leasing, or reduction of the need for cash, receivables and inventory.receivables and inventory.

(c)(c) Long term financing deals with long term assets Long term financing deals with long term assets and the financing of those assets by proportions and the financing of those assets by proportions of equity and debt.of equity and debt.

S125 11.4 FORECASTINGS125 11.4 FORECASTING

(a)(a) Cash forecasting used to provide cash Cash forecasting used to provide cash resources upresources up

to one year ahead.to one year ahead.

Concentrate on the duration and peak need Concentrate on the duration and peak need within: within:

weekly, monthly, yearly, seasonal, etc. periodsweekly, monthly, yearly, seasonal, etc. periods

S126 11.4 FORECASTING (continued) S126 11.4 FORECASTING (continued)

Distinguish:Distinguish:

CF - cash flow - net profit plus depreciationCF - cash flow - net profit plus depreciation

EBIT - earnings before interest and taxesEBIT - earnings before interest and taxes

OCF - operating cash flow - cash flow plus interest, less OCF - operating cash flow - cash flow plus interest, less working capital changes, less “normal” capital working capital changes, less “normal” capital expenditure. Often called “Free Cash Flow” expenditure. Often called “Free Cash Flow” because it is cash availble for new profitable because it is cash availble for new profitable investment opportunities.investment opportunities.

S127 11.4 FORECASTINGS127 11.4 FORECASTING (b)(b) Funds flow reveals the key financial decisions of past Funds flow reveals the key financial decisions of past and future.and future.

Sources of funds: profit. depreciation. new equity and Sources of funds: profit. depreciation. new equity and long term loans.long term loans.

Uses of funds: fixed assets, dividends, repaymenUses of funds: fixed assets, dividends, repaymen of long term loans and working capital.of long term loans and working capital.

Net working capital is:Net working capital is: current assets less current Liabilities.current assets less current Liabilities.

S128 11.4 FORECASTING (continued)S128 11.4 FORECASTING (continued)

(c)(c) Forecasted income statements and balance Forecasted income statements and balance sheets sheets

reveal future financial health.reveal future financial health.

(d)(d) Materiality is the key - concentrate on large Materiality is the key - concentrate on large amountsamounts

and long time periods. Don't get involved with and long time periods. Don't get involved with the the

peanuts ...! Small errors don't matter at all ...!peanuts ...! Small errors don't matter at all ...!

S129 11.5 BANK RELATIONSHIPSS129 11.5 BANK RELATIONSHIPS

(a)(a) Relationship with the banker is key to the managementRelationship with the banker is key to the management of working capital.of working capital.

(b)(b) Criteria for bank loans: person, purpose, profitability, Criteria for bank loans: person, purpose, profitability, payback, and then security.payback, and then security.

(c)(c) Many alternatives available to bank finance (they Many alternatives available to bank finance (they may cost more): factoring, deposits. loans, leasing. may cost more): factoring, deposits. loans, leasing. stretching creditors, other banks, etc.stretching creditors, other banks, etc.

(d)(d) Old bank customers normally get better treatment Old bank customers normally get better treatment than new ones. Cultivate a relationship with yourthan new ones. Cultivate a relationship with your bank manager.bank manager.

S130 11.6 FINANCIAL ANALYSISS130 11.6 FINANCIAL ANALYSIS

(a)(a) LAPP system of financial analysis: liquidity (and LAPP system of financial analysis: liquidity (and gearing),gearing),

activity, profitability, potential.activity, profitability, potential.

(b)(b) Need to forecast cash and funds and provideNeed to forecast cash and funds and provide adequate flows to finance assets acquired and adequate flows to finance assets acquired and

required.required.

(c)(c) Be creative in seeking and using financial Be creative in seeking and using financial alternatives.alternatives.

(d)(d) Avoid "emotional investment"Avoid "emotional investment"

S131 11.7 CONTROL OF WORKING S131 11.7 CONTROL OF WORKING CAPITALCAPITAL

Frequent (monthly) reporting with reliable financial Frequent (monthly) reporting with reliable financial statements to all managers (production, marketing, statements to all managers (production, marketing, finance etc.) to get them ALL to “own” the WC finance etc.) to get them ALL to “own” the WC problem..problem..

Regular and effective forecasting of peak and duration of Regular and effective forecasting of peak and duration of cash needs.cash needs.

Timely financial data.Timely financial data.

Forecast forward the income statements, balance sheets, Forecast forward the income statements, balance sheets, cash and funds flow, and then evaluate risk. cash and funds flow, and then evaluate risk.

S132 11.7 CONTROL OF WORKING S132 11.7 CONTROL OF WORKING CAPITAL (continued) CAPITAL (continued)

Never go to the banker when you need money; goNever go to the banker when you need money; go when you don't need money and arrange to have it when you don't need money and arrange to have it available when you want it.available when you want it.

““I need ECU 500,000. Can you handle it or should I I need ECU 500,000. Can you handle it or should I deal deal

directly with your general manager?"directly with your general manager?"

S133 11.8 CONTROL OF RECEIVABLES S133 11.8 CONTROL OF RECEIVABLES

Make frequent aging of receivables to identify slow Make frequent aging of receivables to identify slow payers payers

and assess DOS (days of sales) performance.and assess DOS (days of sales) performance.

For external causes: visit selected customers to For external causes: visit selected customers to identifyidentify

the reasons for delay which may include: invoice the reasons for delay which may include: invoice errors, errors,

order errors, credit note claims, non-delivery, quality order errors, credit note claims, non-delivery, quality issues, incorrect documentation etc.issues, incorrect documentation etc.

S134 11.8 CONTROL OF RECEIVABLES S134 11.8 CONTROL OF RECEIVABLES (continued)(continued)

For internal causes: investigate, slow invoicing, pricing For internal causes: investigate, slow invoicing, pricing complexities and errors, credit note delays, shipment errors,complexities and errors, credit note delays, shipment errors, poor expediting, discount errors, failure to drop poor poor expediting, discount errors, failure to drop poor accounts etc.accounts etc.

Benchmark with other companies in collaboration with Benchmark with other companies in collaboration with marketing, production, quality, finance managers to marketing, production, quality, finance managers to jointly: jointly:

1. “Own” the WC problem1. “Own” the WC problem 2. Set targets, and 2. Set targets, and 3. Monitor progress. 3. Monitor progress.

S135 11.9 CONTROL OF INVENTORYS135 11.9 CONTROL OF INVENTORY

Make frequent aging of inventories to identify slow Make frequent aging of inventories to identify slow moving moving

high value items and to assess DOP (days of purchases) high value items and to assess DOP (days of purchases) and DOS (days of sales) performance.and DOS (days of sales) performance.

For external causes: visit selected suppliers to identify For external causes: visit selected suppliers to identify the reasons for high inventory which may include: the reasons for high inventory which may include:

excess excess order quantities, long delivery lead times, poor order quantities, long delivery lead times, poor standardization, lack of JIT systems etc.standardization, lack of JIT systems etc.

S136 11.9 CONTROL OF INVENTORY S136 11.9 CONTROL OF INVENTORY (continued)(continued)

For internal causes:For internal causes:

Investigate delayed usage, excess storage, poor Investigate delayed usage, excess storage, poor standardization, poor design specification, failure to control standardization, poor design specification, failure to control high value items daily, excess storage space/costs, lack of high value items daily, excess storage space/costs, lack of JIT systems, poor supplier selection etc.JIT systems, poor supplier selection etc.

Benchmark with other companies in collaboration with Benchmark with other companies in collaboration with marketing, production, quality, finance managers to marketing, production, quality, finance managers to jointly: “own” the problem, set targets and monitor jointly: “own” the problem, set targets and monitor

progress. progress.

S137 11.10 SIMPLIFIED COST OF CAPITAL, S137 11.10 SIMPLIFIED COST OF CAPITAL, EVA AND SVAEVA AND SVA

(a) In very simple terms, the Cost of Capital is the average (a) In very simple terms, the Cost of Capital is the average after-tax cost of raising long term funds for the business. after-tax cost of raising long term funds for the business.

(b) Such funds can be either from long term debt (liabilties)(b) Such funds can be either from long term debt (liabilties) or equity. Normally debt (say 8%) costs less than equityor equity. Normally debt (say 8%) costs less than equity (say 16%).(say 16%).

(c) Hence the E:D ratio set by Management (2:1 or 1:1 or (c) Hence the E:D ratio set by Management (2:1 or 1:1 or 1:2) can affect the average Cost of Captial (say 13.3% 1:2) can affect the average Cost of Captial (say 13.3% or 12% or 9.3%).or 12% or 9.3%).

S138 11.10 SIMPLIFIED COST OF S138 11.10 SIMPLIFIED COST OF CAPITAL, EVA AND SVA (continued) CAPITAL, EVA AND SVA (continued)

EVA (Economic Value Added) is produced when the net EVA (Economic Value Added) is produced when the net assets employed (A-CL) produce an OCF (Operating Cash assets employed (A-CL) produce an OCF (Operating Cash Flow) (say 11%) which is greater than the CoC (Cost of Flow) (say 11%) which is greater than the CoC (Cost of Capital) (Say 9.3%).Capital) (Say 9.3%).

EVA may be simply computed as V = OCF/(r-g), where: EVA may be simply computed as V = OCF/(r-g), where:

OCF = Operating Cash Flow (say 100)OCF = Operating Cash Flow (say 100) r = Cost of Captal (say 9.3%)r = Cost of Captal (say 9.3%) g = Growth Rate (say 5.3%)g = Growth Rate (say 5.3%) V = 100/(0.93-0.53) = 250V = 100/(0.93-0.53) = 250

S139 11.10 SIMPLIFIED COST OF S139 11.10 SIMPLIFIED COST OF CAPITAL, EVA AND SVA (continued) CAPITAL, EVA AND SVA (continued)

(e) SVA (Share Value Added) is produced when the (e) SVA (Share Value Added) is produced when the sustainable cash flows and dividends lead to sustainable cash flows and dividends lead to increased short term and long term share value.)increased short term and long term share value.)

(f) Working capital management is critical to achieving(f) Working capital management is critical to achieving EVA and SVA.EVA and SVA.

(g) And thus any INCREASE in working capital is an (g) And thus any INCREASE in working capital is an INVESTMENT that must be justified, like any other capital INVESTMENT that must be justified, like any other capital investment or acquisition, by a return, that exceeds theinvestment or acquisition, by a return, that exceeds the Cost of Capital.Cost of Capital.

S140 11.11 DIAGNOSIS AND DECISIONS140 11.11 DIAGNOSIS AND DECISION

(a)(a) Recognize that every industry and trade and Recognize that every industry and trade and country country

has a special tractional environment and has a special tractional environment and standards of standards of

financial management.financial management.

(b)(b) Knowledge, attitudes, and skills, force the Knowledge, attitudes, and skills, force the financial financial

manager to be creative.manager to be creative.

S141 11.11 DIAGNOSIS AND DECISIONS141 11.11 DIAGNOSIS AND DECISION (continued) (continued)

(c)(c) Diagnosis helps the financial manager to Diagnosis helps the financial manager to distinguishdistinguish

short term from long term problems.short term from long term problems.

(d)(d) Ensure that short term financial policies arc Ensure that short term financial policies arc consistent with long term goals.consistent with long term goals.

(e)(e) Provide for both short term and long term Provide for both short term and long term financial financial

health at appropriate risk levels. health at appropriate risk levels.

S142 11.11 DIAGNOSIS AND DECISIONS142 11.11 DIAGNOSIS AND DECISION (continued) (continued)

(f) Manage the working capital ............ or it will (f) Manage the working capital ............ or it will manage manage

itself - very badly!itself - very badly!

(g) Seek all (seven) alternatives before setting (g) Seek all (seven) alternatives before setting financial financial

policies.policies.

S143 11.11 DIAGNOSIS AND DECISION S143 11.11 DIAGNOSIS AND DECISION (continued)(continued)

NOTE: NOTE:

Past attitudes may deter new financial policies for Past attitudes may deter new financial policies for reducing reducing

assets or using increasing NEW sources of finance.assets or using increasing NEW sources of finance.

S144 11.12 LEARNING PATTERNS - S144 11.12 LEARNING PATTERNS - REVIEWREVIEW

1.1. FINANCIAL MANAGEMENTFINANCIAL MANAGEMENT S, G, F & I ........... CASH FLOW .......... EVA/SVAS, G, F & I ........... CASH FLOW .......... EVA/SVA

S145 11.12 LEARNING PATTERNS - S145 11.12 LEARNING PATTERNS - REVIEW (continued)REVIEW (continued)

2.2. COST OF CAPITAL COST OF CAPITAL

AVERAGE COST OF EQUITY AND DEBT AVERAGE COST OF EQUITY AND DEBT

(LIABILITIES)(LIABILITIES)

HURDLE RATE FOR EVAHURDLE RATE FOR EVA

S146 11.12 LEARNING PATTERNS - S146 11.12 LEARNING PATTERNS - REVIEW (continued)REVIEW (continued)

3. OPERATING CASH FLOW3. OPERATING CASH FLOW PROVIDES CASH FOR: PROVIDES CASH FOR:

WC & “NORMAL” CAPITAL WC & “NORMAL” CAPITAL INVESTMENT INVESTMENT

AND NEW PROFITABLE INVESTMENT AND NEW PROFITABLE INVESTMENT

OPPORTUNITIES FOR EVA OPPORTUNITIES FOR EVA INCREASED WC IS AN INVESTMENT!INCREASED WC IS AN INVESTMENT!

S147 11.13 INSTRUCTIONS (20 minutes)S147 11.13 INSTRUCTIONS (20 minutes)

Reassemble in SGReassemble in SG

Review the Summary Lecture for Part I in the Review the Summary Lecture for Part I in the course course

diary and discuss questions arisingdiary and discuss questions arising

To get the best out of Part II of the program, try To get the best out of Part II of the program, try to to

complete ALL of the following ... homework complete ALL of the following ... homework tonight ...tonight ...

S148 11.13 INSTRUCTIONS (continued) ... S148 11.13 INSTRUCTIONS (continued) ... homework tonight ...homework tonight ...

Read the articles on finance Read the articles on finance

In the ASS text, review the chapter summaries and the In the ASS text, review the chapter summaries and the glossaryglossary

Do the optional exercises in the course diary and check the Do the optional exercises in the course diary and check the answersanswers

Review the summary lecture for Part I in the course diaryReview the summary lecture for Part I in the course diary

Review your notes for Part I of the course and list outstanding Review your notes for Part I of the course and list outstanding questions to be resolved in Part IIquestions to be resolved in Part II

S149 11.13 INSTRUCTIONS (continued) S149 11.13 INSTRUCTIONS (continued) Final Note for Part I ... Final Note for Part I ...

Thank you for working so Thank you for working so hard today ....hard today ....

Tomorrow .... it’s downhill Tomorrow .... it’s downhill all the way ....all the way ....

s1 automated group learning (agl) agl no. 10 - financial management of working capital daily work...

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