working capital management advanced corporate finance spring 2014 shanghai- week7 finc 5880 happ¥...
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Working Capital Management
Advanced Corporate Finance
Spring 2014 Shanghai- week7
FINC 5880
HAPP¥ N€W ¥€AR !
Look at the past success of Dell BTO strategy..
WC Dell
Remember WC= current assets used for
operations Net WC=current assets-current
liabilities Net Operating WC=Cash + AR+
Inventory-AP-Accruals Current ratio Acid test ratio WC policy; target levels and
finance WC Management: setting targets,
organize, lead, monitor…day to day…
Reduced WC creates value FCF will increase since delta WC
decreases over time EVA increases since the total
operating capital decreases and thus WACC*TOC
Remember EVA=NOPAT-WACC*TOC
Also ROE increases since total assets reduces
Remember ROE=ROS*Sales/Total Assets*Total Assets/Equity
Cash conversion cycle
Cash Purchase inventory Process goods Sell goods on credit Collect AR Cash
Conversion calculated Inventory Conversion:
Inventory/Sales per day (say 72 days)
Receivables Conversion: (also DSO) Receivables/Sales per day (say 24 days)
Payables Conversion: Payables/Purchases per day (note at COGS) (say 30 days)
Conversion cycle=72+24-30=66 days
Shorter conversion cycles create value!
Companies that pursue WCM actively
Boeing Guess PepsiCo Cisco Johnson Controls Mac Donald’s Eastman Kodak
WC score cards CFO magazine
calculates WC performance for main industries
Check their website at www.cfo.com
Barely Working: The 2003 Working Capital Survey Maybe they were preoccupied with governance
issues. But whatever the reason, U.S. companies blew some good chances last year to generate extra cash via working capital improvements. That's the primary conclusion of CFO's annual CFO's annual working capital survey, conducted by REL Consultancy Group.
The survey, which examines the 1,000 largest U.S. companies, showed the average company improved its days working capital (DWC) by a meager 2.1 percent. That's a poor showing compared with previous years — for 2001 the improvement was 9 percent. It's also just a fraction of the 7.6 percent improvement recorded by European companies
WC Performance… U.S. Versus Europe
A comparison of the top 1,000 companies (by sales, in $billions, for all figures) here and in Europe show European firms narrowing the gap.
Despite deterioration in DPO, they improved their average DWC by 7.6 percent. Their U.S. counterparts displayed an unimpressive 2.1 percent improvement in DWC in 2002.
Zero WC General Electric.. Inventory should be
financed by suppliers So force payables to this
level WC=AR+ Inventory-AP
these three elements are intensively managed
Companies carry on average 20 cts per USD in WC
The WC is turned over 5 times per year!
Cash management Reasons for holding cash: Transaction balances for
day to day payments Compensating balances
allowing banks to provide for costs of loans
Precaution Speculation
Advantage of holding cash Benefit the discounts for
paying promptly Maintain good credit ratings Take advantage of special
offers/discounts on opportunity buys
Meet emergencies as strikes, fires, marketing campaigns of competition, and cyclical downturns
The cash budget Forecast of Cash in
versus cash out Per month, week,
day Based on past
experience and updated with new knowledge
Focusing on a Cash target level
Inventory Supplies Raw materials WIP Finished goods
Inventories should be available at the right time
Ordering and carrying costs of all inventory should be minimized
Inventory control
The red line method Two bin method Computerized inventory control JIT Outsourcing
Accounts Receivable
Quantity: DSO Quality: aging schedule
Credit policy: Credit period Discounts for early payment Credit standards (credit worthiness of
customers) Collection policy (how to approach slow
payers)
EOQ (Economic Order Quantity)
Order Cost= D/Q*Co Holding Cost= 1/2Q*Ch Total Cost= D/Q*Co+1/2Q*Ch d(Tc/Q)=0 Then Q= (2DCo/Ch)0.5
Assignment: Working Capital Analyze the WC of your company Determine the cash cycle time and compare it
to it’s main competitors If you were in charge in this company what
would you do to better manage WC What is the implied value impact of your
actions on the company’s value?