1. WORKING CAPITAL MANAGEMENT

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

3. 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. 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. 5 CASH MANAGEMENT ENVIRONMENT BANKERS PERSPECTIVE

6. 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. 7 BENEFITS OF GOOD CASH MANAGEMENT Control of financial risk Opportunity for profit Strengthened balance sheet Increased customer, supplier, and shareholder confidence

8. 8 WORKING CAPITAL Managing Liquidity Source: Essentials of Managing Corporate Cash

9. 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. 10 NEED FOR LIQUIDITY Day to day transactions Precautionary balances Compensating balances Obtaining discounts Acid tests Favourable opportunities Overall avoiding bankruptcy!

11. 11 THE CASH GENERATOR / ABSORBER PROFIT? CASH BALANCE? Stock Purchases Sales £20 £40 £80

12. 12 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, 2 nd ed, by Moyer, McGuigan and Rao

13. 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. 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. 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. 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. 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. 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. 19 WHY DOES FLOAT OCCUR? Deliberately Inefficiency Logistical situations Compensation mechanism

20. 20 STAGES OF FLOAT FunctionFloatResponsibility 1. Order received Production float 2. Goods dispatchedSystem float 3. Invoice issuedCredit period 4. Payment dueCustomer float 5. Payment madePostal float 6. Payment receivedSystem float 7. Payment bankedBank float 8. Funds availableConcentration float 9. Funds to correct accountInformation float 10. Advice of availability Supplier Buyer Buyer/ postal service Supplier Banks

21. 21 Controlling Float We need to look at controlling / influencing float in three areas * Ourselves * Our Customers * Our Banks

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

23. 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. 24 RECEIVABLES IMPACT Important because of costs arising from Float Bad debts Management time Legal fees And Impact on analysts and creditors

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

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

27. 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. 28 RECEIVABLES MANAGEMENT 2 Penalties Post dated cheques Legal process Internal process Stop supply But do not forget Relationship

29. 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. 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. 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. 32 Method of Payment Cheque Clearing, UK

33. 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. 34 CROSS-BORDER PAYMENTS Paper-based Foreign currency cheques Bankers drafts Giros (Credit transfer) Documentary collections Cheque negotiations

35. 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. 36 Clearing House Automated Transfer System

37. 37 Controlling Float Bank Services Lockbox Intervention accounts Remote disbursement Controlled disbursement Direct collections Efficient collections structure

38. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 48 FACTORS IN CHOOSING FUNDING INSTRUMENTS All-in borrowing cost Security required Terms & conditions Tax & balance sheet aspects

49. 49 INVESTMENT DECISION PROCESS

50. 50 THE FINANCING DECISION PROCESS Monitor cash flow forecasts annually / quarterly / monthly / weekly / daily Determine: Amount / currency Duration / location Financing action Documentation Recording / monitoring / reporting Liquidation FINANCING DECISION Identify deficits External Factors: Interest rates / trends Currency exchange rates Economic factors Liquidity of market Internal policy covering Borrowing internally Instruments Financing policy Existing limits Performance objectives Existing facilities Balance sheet/ratio impact Tax

51. 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. 52 INTERNATIONAL SHORT-TERM INVESTMENTS Bankers Acceptances Commercial paper Euro GBP Treasury bills Certificates of deposit GBP Eurodollar

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

54. 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. 55 OTHER SOURCES OF FUNDING Factoring Invoice discounting Trade bills Acceptance credits