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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
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CASH MANAGEMENT ENVIRONMENT
MANAGE FUNDS
EXCESS/SHORTFALL
DISBURSEFUNDS
COLLECTFUNDS
TRACKTRANSACTIONS
& BALANCES
CUSTOMERACCOUNT
BANKER’S PERSPECTIVE
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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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INFLOWS OUTFLOWS
INV
ES
TM
EN
TS
BO
RR
OW
ING R
EP
AY
RE
PA
YIN
VE
ST
DECELERATEACCELERATE
BO
RR
OW
WORKING CAPITALManaging Liquidity
Source: Essentials of Managing Corporate Cash
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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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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
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
anb 14
Balance SheetShort Term Items
Current assets 2011 2010
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 Work out the CCC for 2011
anb 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
From:Fundamentals of Contemporary Financial Management, 2nd ed
, by Moyer, McGuigan and Rao
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
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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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STAGES OF FLOATFunction Float Responsibility
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
Supplier
Supplier
Supplier
Buyer
Buyer/ postal service
Supplier
Banks
Banks
Banks
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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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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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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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HOW TO REDUCE/CONTROL FLOAT
Your Own Actions• Change own systems
• Educate customers
• Include costs in prices
• Negotiate with bank
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Controlling Float
Payment Methods
Payment methods are important because of
- Cost
- Risk
- Value Dating
- Finality
29
VALUE DATING
Value
The moment when funds cease to be useable to the originating party and instead become useable funds to the beneficiary in the sense of reducing
an overdraft or accruing interest
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VALUE DATING
Forward Value DatingThe 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 DatingThe 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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AVAILABILITY
The time when the beneficiary actually
has access to the funds i.e. to use to
make a payment
32
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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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 EDILook up ‘Voca’ on the internet, used to be BACSFaster pay
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CROSS-BORDER PAYMENTS
Paper-based• Foreign currency cheques• Banker’s drafts• Giros (Credit transfer)• Documentary collections• Cheque negotiations
36
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)- RTGSplus – (EAF2)
• Credit cards• Direct debits
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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?
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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
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
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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%
44
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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INVESTMENT DECISION PROCESS Monitor cash flow forecasts
annually / quarterly / monthly / weekly / daily
Determine:
Amount / currency { Now and atDuration / location { period end
Investment action
Confirmation
Recording / monitoring / reporting
Liquidation
INVESTMENTDECISION
Identify surpluses
External Factors:
Interest rates / trendsCurrency exchange ratesEconomic factorsAvailability
Internal policy covering
Investment typesRiskRatingsTime framesLiquidityPerformance objectivesFunding subsidiariesTax
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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
47
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?
48
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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THE FINANCING DECISION PROCESS Monitor cash flow forecasts
annually / quarterly / monthly / weekly / daily
Determine:Amount / currencyDuration / location
Financing action
Documentation
Recording / monitoring / reporting
Liquidation
FINANCING DECISION
Identify deficits
External Factors:
Interest rates / trendsCurrency exchange ratesEconomic factorsLiquidity of market
Internal policy covering
Borrowing internallyInstrumentsFinancing policyExisting limitsPerformance objectivesExisting facilitiesBalance sheet/ratio impactTax
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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
53
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?