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WORKING CAPITAL MANAGEMENT

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Irrevocable documentary letter of credit. Unconfirmed. Confirmed. Advance payment. 28 ... is considered to become irrevocable and cannot be returned without ... – PowerPoint PPT presentation

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Title: WORKING CAPITAL MANAGEMENT


1
WORKING CAPITAL MANAGEMENT

2
AGENDA
  • Working Capital, Definition
  • Float and Value Dating
  • Payment and Collection Instruments
  • Short-Term Investing
  • Short-Term Borrowing

3
Working Capital
  • Working Capital All the items in the short term
    part of the balance sheet
  • e.g. cash, short term debt, investments,
    inventory, debtors (receivables), payables
    (creditors) etc
  • Net Working Capital is the difference between
    Current Assets and Current Liabilities
  • Cash Management, Liquidity Management
  • Interconnected terms.

4
CORPORATE DEFINITION OF CASH MANAGEMENT
  • The effective planning, monitoring and management
    of liquid / near liquid resources including
  • Day-to-day cash control
  • Money at the bank
  • Receipts
  • Payments
  • S-T investments and borrowings

5
CASH MANAGEMENT ENVIRONMENT
BANKERS PERSPECTIVE
6
BANK DEFINITION OF CASH MANAGEMENT
  • The effective planning, monitoring and management
    of liquid / near liquid resources including
  • Provision of bank accounts
  • Deposit / withdrawal facilities
  • Provision of information regarding bank accounts
    and positions
  • Money transfers and collection services
  • Investment facilities
  • Financing facilities
  • Pooling and netting

7
BENEFITS OF GOOD CASH MANAGEMENT
  • Control of financial risk
  • Opportunity for profit
  • Strengthened balance sheet
  • Increased customer, supplier, and shareholder
    confidence

8
WORKING CAPITAL
Managing Liquidity
Source Essentials of Managing Corporate Cash
9
DEFINITION OF LIQUIDITY
  • Having sufficient funds available to meet all
    foreseen and unforeseen obligations
  • Liquidity has costs
  • Cash is unproductive
  • Spread between borrowing and deposit rates and
    between long and short term rates

10
NEED FOR LIQUIDITY
  • Day to day transactions
  • Precautionary balances
  • Compensating balances
  • Obtaining discounts
  • Acid tests
  • Favourable opportunities
  • Overall avoiding bankruptcy!

11
THE CASH GENERATOR / ABSORBER

40
Stock
20
80
Purchases
Sales

20
PROFIT?
CASH BALANCE?
12
Operating Cycle
  • Purchase Resources Pay
    Sell on Credit Receive Cash
  • Inventory Conversion
    Receivables Conversion
  • Payables Period
    Cash Conversion Cycle

  • Operating Cycle
  • FromFundamentals of Contemporary Financial
    Management, 2nd ed
  • , by Moyer, McGuigan and Rao

13
The Various Cycles
  • Inventory Conversion
  • Inventory x 365
  • Cost of Goods Sold
  • Payables Conversion
  • Payables/Creditors x 365
  • Cost of Goods Sold
  • Receivables Conversion
  • Receivables/Debtors x 365
  • Turnover

14
Balance Sheet Short Term Items
  • Current assets
  • Inventories
    1,910 1,903
  • Trade and other receivables
    1,713 1,625
  • Current tax assets
    13 -
  • Other financial assets
    43 78
  • Cash and short term assets
    733 917

  • 4,412 4,523
  • Current liabilities
  • Short term borrowings
    355 555
  • Trade and other payables
    1,690 1,735
  • Current tax liabilities
    121 44
  • Other financial liabilities
    119 13
  • Short term provisions
    82 130

  • 1,367 2,477
  • Turnover 9,577
  • Cost of goods sold 8,943

15
Operating Cycle
  • Purchase Resources Pay
    Sell on Credit Receive Cash
  • Inventory Conversion 78 days
    Receivables Conversion


  • 65 days
  • Payables Period
    Cash Conversion Cycle
  • 69 days
    74 days

  • Operating Cycle

  • 143

16
Cash Conversion
  • We need to consider control in all areas of
    working capital to maximise return, reduce cost.
  • Some areas are not controlled by the Finance
    Function Stock/inventory
  • Some areas have shared control payables and
    receivables
  • Some areas are controlled by the Finance
    Function short term borrowing and investment

17
Float
  • Any delay in the process of converting materials
    and labour to receipt of payment involves cost,
    float cost.
  • Similarly, any delay in making payments will also
    give rise to float but this time to our advantage
  • What is float?

18
FLOAT
  • Definition of bank float
  • The time lost between a payor making a payment
    and a beneficiary receiving value
  • Cost of Float
  • principle amount due x no of days x cost of funds
  • 360 or 365

19
WHY DOES FLOAT OCCUR?
  • Deliberately
  • Inefficiency
  • Logistical situations
  • Compensation mechanism

20
STAGES OF FLOAT
1. Order received
Production float
2. Goods dispatched
System float
3. Invoice issued
Credit period
4. Payment due
Customer float
5. Payment made
Postal float
6. Payment received
System float
7. Payment banked
Bank float
8. Funds available
Concentration float
9. Funds to correct account
Information float
10. Advice of availability
 
21
Controlling Float
  • We need to look at controlling / influencing
    float in three areas
  • Ourselves
  • Our Customers
  • Our Banks

22
HOW TO REDUCE/CONTROL FLOAT
  • Your Own Actions
  • Change own systems
  • Educate customers
  • Include costs in prices
  • Negotiate with bank

23
RECEIVABLES AND PAYABLES MANAGEMENT
  • Good receivables and payables management aids in
  • Cash flow forecasting
  • Long-term funding and investment decisions
  • Reduced risk of bad debts
  • Stronger liquidity
  • Stronger balance sheet ratios

24
RECEIVABLES IMPACT
  • Important because of costs arising from
  • Float
  • Bad debts
  • Management time
  • Legal fees
  • And
  • Impact on analysts and creditors

25
RECEIVABLES MANAGEMENT 1
  • Clear instructions
  • Method of payment
  • Documentation
  • Account structures
  • Terms of Trade

26
Controlling Float
  • Payment Methods
  • Payment methods are important because of
  • - Cost
  • - Risk
  • - Value Dating
  • - Finality

27
INTERNATIONAL TRADE PAYMENTS
  • Terms of trade
  • Settlement
  • Open account
  • Clean collection
  • Documentary collection
  • Against payment
  • Against acceptance
  • Revocable documentary letter of credit
  • Irrevocable documentary letter of credit
  • Unconfirmed
  • Confirmed
  • Advance payment

28
RECEIVABLES MANAGEMENT 2
  • Penalties
  • Post dated cheques
  • Legal process
  • Internal process
  • Stop supply
  • But do not forget Relationship

29
VALUE DATING
  • Forward Value Dating
  • The time between a bank being notified of a
    transaction in favor of a customer and the
    customer receiving future value for the item
  • Back Value Dating
  • The time between a bank being notified of a
    transaction to the customers account and the
    item being valued on a date prior to the date of
    the transaction

30
FINALITY
  • The time after which a payment is considered to
    become irrevocable and cannot be returned without
    the permission of beneficiary account holder.

31
DOMESTIC PAYMENT INSTRUMENTS
  • Paper-based
  • Cash
  • Cheques
  • Bank transfers or giros
  • Postal giros
  • Bills of exchange
  • Promissory notes
  • Bankers drafts
  • Search for APACS on the internet

32
Method of Payment Cheque Clearing, UK
33
DOMESTIC PAYMENT INSTRUMENTS
  • Electronic
  • Funds transfer
  • Urgent wires
  • Standard EFT
  • Automated clearing house payments
  • Standing order
  • Direct Debit
  • Electronic bills of exchange
  • Plastic (credit, charge, cheque guarantee, cash
    dispenser, debit)
  • Financial EDI
  • Look up Voca on the internet, used to be BACS

34
CROSS-BORDER PAYMENTS
  • Paper-based
  • Foreign currency cheques
  • Bankers drafts
  • Giros (Credit transfer)
  • Documentary collections
  • Cheque negotiations

35
CROSS-BORDER PAYMENTS
  • Electronic
  • Using correspondent banks
  • Using a global or pan-regional bank
  • Cross-border systems
  • TARGET
  • EBA EURO 1
  • EBA Step 1
  • CHAPS euro (NewCHAPS)
  • Credit cards
  • Direct debits

36
Clearing House Automated Transfer System
37
Controlling Float
  • Bank Services
  • Lockbox
  • Intervention accounts
  • Remote disbursement
  • Controlled disbursement
  • Direct collections
  • Efficient collections structure

38
PAYABLES
  • Critical questions
  • What is due?
  • When is it due?
  • Where should the payment be sent?
  • How should the payment be sent?
  • Are there funds to cover the payment?
  • Is the payment properly authorized?

39
PAYABLES MANAGEMENT
  • The flip side of the coin
  • So
  • Hang on to it
  • Consider float versus control
  • Account structures
  • Discounts
  • But do not forget Relationship

40
SHORT-TERM INVESTING
  • The Decision Process
  • How much do I have to invest per currency?
  • How long do I have to invest it?
  • Where are the funds located?
  • What is my appetite for risk?

41
INVESTMENT GUIDELINES
  • What are the companys policies regarding
  • Currency exposure and hedging
  • Banks used and limits
  • Investment instruments and limits
  • Use of automated sweep accounts
  • Bank / investment ratings

42
FACTORS IN CHOOSING INVESTMENTS
  • The need to make an adequate return
  • The need to take into account areas of risk
  • Credit risk
  • Interest rate risk
  • Capital risk
  • Market risk
  • The need to consider liquidity

43
HOW RATES ARE QUOTED
  • At a discount Instrument issued at less than
    100
  • Coupon Specific interest payments made at
    specific times
  • Yield to redemption Interest payments over the
    lifetime of the instrument and principal repaid
    may be greater or less than 100

44
SHORT-TERM INVESTMENTS
  • Commercial paper (CP)
  • Bankers acceptances (BAs)
  • Repurchase agreements
  • Certificates of deposit (CDs)
  • Money market funds
  • Treasury instruments (bills, notes, bonds)

45
SHORT-TERM BORROWING
  • The Decision Process
  • How much needs to be financed and in what
    currency?
  • How long does the deficit need to be financed?
  • Where does it need it be financed?
  • What is the maximum level of funding needed?

46
FACTORS AFFECTING BORROWING
  • These factors affect both amount available and
    cost
  • Financial strength of the company
  • Key covenants
  • Industry
  • Available guarantee or security
  • Companys ability to repay on time from banks
    perspective

47
SHORT-TERM FUNDING INSTRUMENTS
  • Internal short-term funding
  • Least expensive source of funding
  • Cross-border and cross-currency intra-group
    financing can be difficult
  • External short-term funding
  • Can act as a built-in hedge if sourced in the
    same currency
  • Can be inexpensive to borrow local currency in
    the currency center

48
FACTORS IN CHOOSING FUNDING INSTRUMENTS
  • All-in borrowing cost
  • Security required
  • Terms conditions
  • Tax balance sheet aspects

49
INVESTMENT DECISION PROCESS
50
THE FINANCING DECISION PROCESS
Monitor cash flow forecasts
annually / quarterly / monthly / weekly / daily
Identify deficits
Determine
Amount / currency
Duration / location
FINANCING DECISION
Financing action
Documentation
Recording / monitoring / reporting
Liquidation
51
U.S. SHORT-TERM INVESTMENTS
  • Commercial paper (CP)
  • Bankers acceptances (BAs)
  • Repurchase agreements
  • Certificates of deposit (CDs)
  • US Treasury instruments (bills, notes, bonds
    STRIPS)

52
INTERNATIONAL SHORT-TERM INVESTMENTS
  • Bankers Acceptances
  • Commercial paper
  • Euro
  • GBP
  • Treasury bills
  • Certificates of deposit
  • GBP
  • Eurodollar

53
BILLS OF EXCHANGE
  • Foreign currency
  • Commercial
  • GBP
  • Eligible
  • Ineligible
  • Trade bills

54
FACTORS IN CHOOSING FUNDING
  • Are all-in borrowing costs being offered?
  • Does the bank require security?
  • What are the terms and conditions?
  • Is interest able to be offset on tax returns?

55
OTHER SOURCES OF FUNDING
  • Factoring
  • Invoice discounting
  • Trade bills
  • Acceptance credits
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