1. Optimizing your cash flow during the downturn
Alan Miltz
Founding Director Inmatrix

2. Objectives
How to conduct a financial health check
How the banks would review your performance
Techniques used by the best global companies to measure financial performance

3. Who am I?
12 years ago I co-founded Inmatrix. We developed Optimist as a standard communication between Accountants, Banks & Companies.
Optimist A C B 3

4. A C B Optimist 22 Countries +1500 Accountants ‘000s of Companies
+200 Banks

5. Gary’s Furniture
We are going to use a case study based on a company Gary’s Furniture.
Gary’s Furniture was founded in 2001
Gary is a furniture importer and manufacturer and distributes to 500 stores including majors and independents
Gary believes he is doing fantastically
B-91

6. Gary’s Furniture

7. Gary’s Furniture
On a scale of 1 to 10 how would you rate Gary's Furniture’s financial performance?
On a Scale of 1 to 10 how do you think the Bank rates Gary's Furniture’s financial performance?
What is Gary's cash flow for 2009?

8. The funnel analogy

9. Your company’s strategy
Does your strategy give you a sustainable competitive advantage? (SCA)
Your SCA should be a filtering mechanism when considering new opportunities. ( i.e. Will the new opportunity add value to your SCA?)

10. How does finance measure your SCA?
Profit?
Revenue Growth?
Cash Flow?
Market Share?
Return?
Dividends?

11. How does finance measure your SCA?
Profit
Revenue Growth
Cash Flow
Market Share
Return
Dividends

12. How do your accounts enable you to calculate these measures?
Profit
Revenue Growth
Cash Flow
Market Share
Return
Dividends

13. The accounting equation – the balance sheet

14. The management accounting equation – the balance sheet
All funding is moved to the left hand side of the equation

15. The management accounting equation – the balance sheet

16. The balance sheet
Funding
(E +ND)
Operations
NOA

17. The balance sheet
Rearrange the accounts of Gary’s Furniture.

18. Gary’s Furniture

19. Gary’s Furniture

20. The management accounting equation – the balance sheet

21. (The Dupont Theory of Financial Analysis)
Why go into business?
R eturn On Capital Employed (ROCE) OR
Return On Net Assets (RONA)
ROCE = RONA
(The Dupont Theory of Financial Analysis)

22. Financial analysis – the theory
Return on Capital Employed or
Return on Net Assets or
ROCE = EBIT/Net Operating Assets OR X
EBIT
Revenue
Net Operating Assets

23. EBIT NOA The ROCE equation
As management it is mission critical that over time we ensure that our EBIT is growing at a faster rate than our investment in our Net Operating Assets.
EBIT
NOA

24. Optimizing Growth B C A D EBIT E NET ASSETS KEY POINTS
Clear understanding of what the business is doing
Which quadrant is the business in now, where is it heading and why?
What are the opportunities for the business?
What will the outcomes be for the business
There are options and the answer is ‘it depends’
This provides a powerful partnership tool B
Optimising growth? C
Fast growth? A
Declining Growth? D
EBIT E
Corporate stress?
Re-engineering
Working Investment?
24m m m m m m
NET ASSETS

25. Business Positioning

26. What return should we be getting?
D + E = NOA
What is the cost of debt = after tax cost of borrowing
What is the cost of equity = Rf + (Beta x Mp)
What is the weighted average cost of capital (WACC)

27. Equity is the most expensive source of funding
Have you ever tried to get equity funding?
Approx 2 to 5% of companies are successful in attaining equity finance
What does an investor look for?

28. Obtaining Equity Finance
A Prospective Investor will look at:
Management
Opportunities
Valuation
Exit Strategy
ROI
Is your Company a MOVER?

29. How do I understand my SCA?
Marketing
Operations
Innovation HR
Finance
What are the 3 critical success factors for each of the above?

30. Does your business have an SCA?

31. Take my business I founded 11 years ago

32. Plotting your Critical Success Factors

33. Plotting your Critical Success Factors

34. Plotting your Critical Success Factors

35. Techniques to improve your ROCE and Cash Flow
Marketing
Operations
Innovation HR

36. Marketing – understanding your customers
Most companies operate under the 80/20 rule –
80% of their customers account for 20% of the revenue.

37. Who do we want to work with?
They want a relationship
They don’t want a relationship 1 2 3 4
We want a relationship
We don’t want
a relationship

38. Blind spot? Known by others Unknown by others Common Knowledge Private
Known to you
Unknown to you

39. What do we do with the 3 and 4s?
They want a relationship
They don’t want a relationship 1 2
We want a relationship
Increase price
Enforce strict terms
We don’t want
a relationship

40. What do we do with the 1 and 2s?
The goal is to identify your blind spots with your 1 and 2 clients and lock them into your business.
Ask these key clients for a wish list (i.e. what do we need to do to at least be equal with your best supplier?)
Provide these clients with your wish list (i.e. what we want from them)
Document a supply chain agreement.

41. Operations – where are your overheads?
They want a relationship
They don’t want a relationship 1 2 3 4
We want a relationship
We don’t want
a relationship

42. Who creates innovation?
Once a week each staff member should provide one idea in writing on how to improve the business.
This is called the 5:15 report.

43. The role of Finance
Finance’s role is to measure your company from a business and banking perspective.

44. The Financial Health Check

45. The quality of your cash flow
Cash Flow Funding
Fixed Assets
Working Capital
Profit
Next Period
Weakness
Strengths
impact on cash flow

46. For each measure let’s look at…
Profitability
Ideal Profile G A B
Sales
100
GM% 30
>30
28 – 30
<28
OH% 20
< 20
20 – 22
<22
EBIT% 10
>10
8 – 10
<8
Working Capital
AR Days 60
<60
60 – 70
>70
Inv/WIP Days 90
<90
90 – 100
>100
AP Days
45 – 60
<45 >70
Working Capital % 22
22 – 25
>25

47. Gary’s numbers Profitability Ideal Profile G A B Sales 100 GM% 30 31
OH% 20
EBIT% 10 11
Working Capital
AR Days 60 75
Inv/WIP Days 90
180
AP Days
(70)
Working Capital% 22 41

48. The Power of One
It is essential to know the cash flow sensitivities of a 1% or 1 day change in:
Price %
Volume %
COGS % AR
INV/WIP AP

49. The Power of One
Why does an increase in sales volume reduce cash flow?

50. The Power of One - sensitivity
Change
Effect on Net Cash Flow
COGS %
- 1%
406,000
Price %
+1%
187,000
AR days -1
118,000
INV/WIP days
81,000
AP days +1
Volume %
-123,000

51. Chapter 1 - Profitability
Revenue Growth %
GM %
Overheads %
EBIT %

52. } Chapter 2 – Working Capital Accounts Receivable Inventory/WIP
Accounts Payable
Working Capital % }
Days

53. Chapter 3 – Net Non Current Assets
Growth in Net Non Current Assets
Asset Turnover

54. Chapter 4 – Cash Flow and Returns
Net Cash Flow
Borrowed Funds
Cash After Operations
GM% - WC%
ROCE%

55. Bank Measures
Interest Cover
Debt Service Coverage
Leverage
Debt Payback

56. Why is cash flow important?
What is profit – an opinion or a fact?
What is a balance sheet – an opinion or a fact?
What is cash flow – an opinion or a fact?
Cash flow is the only fact in the accounts

57. Cash flow
The term ‘cash flow’ is used in so many different forms, that it means something different to each of you.
A consistent, meaningful, standardized definition of cash flow would be very helpful.

58. Net cash flow On the 1st of January 2008 I have $160 in the bank.
On the 31st of December 2008 I have $60 in the bank.
What is my net cash flow?
100 outflow

59. Why can’t we apply this logic to the company?
Net cash flow
Why can’t we apply this logic to the company?

60. Gary’s net cash flow

61. Net cash flow
Remember, as the providers of your finance, the bank always knows your cash flow.
Ask yourself: is the bank providing funds to grow or to fund wastage?

62. Net cash flow
We know that the Net cash flow for Gary's Furniture was -$3,260,073
Is that a good or bad?

63. Net cash flow We need to know what the money was spent on….
The 4 chapters approach to analysing cash flow will assist…...

64. The 4 chapters of cash flow

65. Marginal cash flow
The additional cash that will be generated or used up if we sell $1 more of our product or services.

66. Marginal cash flow

67. Marginal cash flow for the next $1 of sales

68. Marginal cash flow for the next $1 of sales

69. Marginal cash flow for the next $1 of sales
What does this tell us?
For each additional $1 of sales the business will require 10.34c of funding
If the existing relationships stay the same

70. Why is marginal cash flow important?
Many businesses do not understand why
as Sales increase
Cash Flow deteriorates
Solicitor
Sales $ 100
Direct Costs $ 30
Gross Margin $ 70
Working Capital $ 80
Marginal Cash Flow $ -10
The Balance Sheet in effect steals from the Income Statement

71. Profit vs cash flow
Many companies do not understand the relationship between profit and cash flow.
High Margin
Poor Balance Sheet Management
= possibility of poor Cash Flow
Solicitor
Low Margin
Good Balance Sheet Management
= possibility of good Cash Flow
Construction Company
Obtains payments in advance, deposits, bills work in progress frequently, pays creditors slowly

72. Marginal cash flow
Marginal cash flow can be very powerful to analyze components of a business:
Products
Product groups
Customers
Distributors
State offices
Business units

73. A bank’s view of cash flow
The cash flow methodology used by banks is not even the same as the ones used by you!!!!

74. A bank’s view of cash flow
So what is a banker’s cash flow?
All major Australian banks and most banks around the world use subtle variations of the same report.
Many call it the UCA Cash Flow.
No one seems to know what UCA stands for!!!

75. Banker’s cash flow Focuses on the 7 key items of cash flow:
Gross cash profit
Cash after operations
Net cash after operations
Net cash income
Cash after debt amortization
Net cash after investing
Financing surplus/(requirements)

76. Gross cash profit

77. Gross cash profit
Gross cash profit is in turn made up of cash from customers & cash paid to suppliers.
Gross cash profit is equivalent to the cash flow from gross margin.
Note: COGS would exclude depreciation.

78. Cash after operations

79. Cash after operations
Cash after operations is gross cash profits less Overheads and changes to balance sheet items relating to overheads such as provisions, accruals & prepayments.
Cash after operations is equivalent to the cash flow from EBITDA
Note: Overheads would exclude depreciation and amortization.

80. Net cash after operations

81. Net cash after operations
Net cash after operations is cash after operations less changes in sundry assets & liabilities and income taxes paid.
Income tax paid is not the tax charge per the profit & loss, but is the actual tax paid.
Net cash after operations is the operating cash flow from which the providers of funding are paid.

82. Net cash after operations
If you were the banker of Gary's Furniture what does a net cash after operations of negative $895,442 tell you?

83. Net cash income

84. Net cash income
Net cash income is net cash after operations less interest and dividends paid.
Interest and dividends paid are not the charge per the profit & loss, but the actual amounts paid.
Net cash income is the cash flow from which the business must pay back debt.

85. Net cash income
Gary's Furniture has a net cash income of negative $2,258m.
As their banker how do you feel now?

86. Cash after debt amortization

87. Cash after debt amortization
Cash after debt amortization is net cash income less commitment to retire debt.
The most interesting aspect of cash after debt amortization is to look at what items are yet to be taken into account.
Cada is BEFORE the purchase of fixed assets & investments. Is there enough cash flow generated after paying tax, interest, dividends & retiring debt to buy fixed assets or investments?

88. Cash after debt amortization
Gary's Furniture has a cash after debt amortization of negative $2,258m
As the banker to Gary's Furniture, how comfortable are you with their 2009 cash flow at this stage?
Where is the company going to find the money to purchase the new coffee roaster?

89. Net cash after investing

90. Net cash after investing
Net cash after investing is cash after debt amortization less net purchases of fixed assets and investments.

91. Financing / surplus (requirement)

92. Financing / surplus (requirement)
Financing surplus is net cash after investing less extraordinary items.

93. Financing / surplus (requirement)
Is equal to the Net Cash Flow that we calculated already.

94. How was the $3,260,073 financing requirement funded?
$2,260,073 by short term borrowings
$1,000,000 by long term debt

95. Banker’s cash flow
A banker’s cash flow treats cash flow as a process rather than a number.
The cash flow shows the flow of cash in and out of the business.
As we have seen, the banker’s cash flow is a very good way of understanding the flow of money through our business.

96. Your Credit Officer

97. Your Credit Officer

98. Your Credit Officer

99. Your Credit Officer

100. Understanding the customer
A big picture for credit management
Understanding the customer

101. Key Measures

102. Profitability

103. Assets

104. Working Capital

105. Cash Wastage

106. Strategy

107. RONA %