WORKING CAPITAL

MANAGEMENT
 AGENDA

 Working Capital, Definition

 Float and Value Dating
 Payment and Collection Instruments
 Short-Term Investing
 Short-Term Borrowing

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 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.

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 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

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 CASH MANAGEMENT
ENVIRONMENT
BANKER’S PERSPECTIVE

COLLECT DISBURSE
FUNDS FUNDS

CUSTOMER
ACCOUNT

MANAGE
TRACK FUNDS
TRANSACTIONS EXCESS/
& BALANCES SHORTFALL

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 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
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 BENEFITS OF GOOD CASH
MANAGEMENT

 Control of financial risk

 Opportunity for profit
 Strengthened balance sheet
 Increased customer, supplier, and
shareholder confidence

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 WORKING CAPITAL
Managing Liquidity

Source: Essentials of Managing Corporate Cash 8

 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

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

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THE CASH GENERATOR / ABSORBER

£40
Stock
£20
Purchases

£80

Sales
£20
PROFIT?
CASH BALANCE?

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 Operating Cycle
Purchase Resources Pay Sell on Credit Receive Cash
Inventory Conversion Receivables Conversion

Payables Period Cash Conversion Cycle

Operating Cycle

From:Fundamentals of Contemporary Financial Management, 2nd ed

, by Moyer, McGuigan and Rao

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 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

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 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

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 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

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 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

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 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?

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 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

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WHY DOES FLOAT OCCUR?

 Deliberately
 Inefficiency
 Logistical situations
 Compensation mechanism

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 STAGES OF FLOAT
Function Float Responsibility

1. Order received Production float Supplier

2. Goods dispatched System float Supplier

3. Invoice issued Credit period Supplier

4. Payment due Customer float Buyer

5. Payment made Postal float Buyer/ postal service

6. Payment received System float Supplier

7. Payment banked Bank float Banks

8. Funds available Concentration float Banks

9. Funds to correct account Information float Banks

10. Advice of availability

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 Controlling Float
 We need to look at controlling /
influencing float in three areas
 * Ourselves
 * Our Customers
 * Our Banks

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 HOW TO
REDUCE/CONTROL FLOAT
 Your Own Actions
• Change own systems

• Educate customers

• Include costs in prices

• Negotiate with bank

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 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

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 RECEIVABLES IMPACT
Important because of costs arising from
 Float

 Bad debts

 Management time

 Legal fees

And
 Impact on analysts and creditors

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 RECEIVABLES MANAGEMENT 1
 Clear instructions

 Method of payment

 Documentation

 Account structures

 Terms of Trade

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

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 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
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 RECEIVABLES MANAGEMENT 2

 Penalties
 Post dated cheques
 Legal process
 Internal process
 Stop supply

But do not forget Relationship

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 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 customer’s account and the
item being valued on a date prior to the date of
the transaction

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 FINALITY

The time after which a payment is

considered to become irrevocable and
cannot be returned without the
permission of beneficiary account
holder.

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 DOMESTIC PAYMENT
INSTRUMENTS
 Paper-based
• Cash
• Cheques

• Bank transfers or giros

• Postal giros

• Bills of exchange

• Promissory notes

• Banker’s drafts

Search for ‘APACS’ on the internet

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Method of Payment
Cheque Clearing, UK

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 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

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 CROSS-BORDER PAYMENTS

 Paper-based
• Foreign currency cheques
• Banker’s drafts
• Giros (Credit transfer)
• Documentary collections
• Cheque negotiations

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 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

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Clearing House Automated Transfer
System

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 Controlling Float
 Bank Services
• Lockbox
• Intervention accounts
• Remote disbursement
• Controlled disbursement
• Direct collections
• Efficient collections structure

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 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?

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 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

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 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?

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 INVESTMENT GUIDELINES

 What are the company’s policies

regarding:
• Currency exposure and hedging
• Banks used and limits
• Investment instruments and limits
• Use of automated sweep accounts
• Bank / investment ratings

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 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

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 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%

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 SHORT-TERM INVESTMENTS

 Commercial paper (CP)

 Banker’s acceptances (BAs)
 Repurchase agreements
 Certificates of deposit (CDs)
 Money market funds
 Treasury instruments (bills, notes,
bonds)

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 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?

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 FACTORS AFFECTING
BORROWING

 These factors affect both amount

available and cost
• Financial strength of the company
• Key covenants
• Industry
• Available guarantee or security
• Company’s ability to repay on time from
bank’s perspective

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 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

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 FACTORS IN CHOOSING
FUNDING INSTRUMENTS

 All-in borrowing cost

 Security required
 Terms & conditions
 Tax & balance sheet aspects

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 INVESTMENT DECISION PROCESS
Monitor cash flow forecasts
annually / quarterly / monthly / weekly / daily

Identify surpluses

Determine:
Amount / currency { Now and at
Duration / location { period end

Internal policy covering

Investment types External Factors:

Risk
Ratings INVESTMENT Interest rates / trends
Time frames DECISION Currency exchange rates
Liquidity Economic factors
Performance objectives Availability
Funding subsidiaries
Tax

Investment action

Confirmation

Recording / monitoring / reporting

Liquidation

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 THE FINANCING DECISION
PROCESS
Monitor cash flow forecasts
annually / quarterly / monthly / weekly / daily

Identify deficits

Determine:
Amount / currency
Duration / location

Internal policy covering

Borrowing internally External Factors:

Instruments
Financing policy Interest rates / trends
Existing limits FINANCING DECISION Currency exchange rates
Performance objectives Economic factors
Existing facilities Liquidity of market
Balance sheet/ratio impact
Tax

Financing action

Documentation

Recording / monitoring / reporting

Liquidation
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U.S. SHORT-TERM INVESTMENTS

 Commercial paper (CP)

 Banker’s acceptances (BAs)
 Repurchase agreements
 Certificates of deposit (CDs)
 US Treasury instruments (bills, notes,
bonds & STRIPS)

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 INTERNATIONAL SHORT-TERM
INVESTMENTS

 Banker’s Acceptances
 Commercial paper
• Euro
• GBP
 Treasury bills
 Certificates of deposit
• GBP
• Eurodollar

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 BILLS OF EXCHANGE

 Foreign currency
 Commercial
 GBP
• Eligible
• Ineligible
• Trade bills

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 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?

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 OTHER SOURCES OF
FUNDING

 Factoring
 Invoice discounting
 Trade bills
 Acceptance credits

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