4 Remember WC= current assets used for operations Net WC=current assets-current liabilitiesNet Operating WC=Cash + AR+ Inventory-AP-AccrualsCurrent ratioAcid test ratioWC policy; target levels and financeWC Management: setting targets, organize, lead, monitor…day to day…
5 Reduced WC creates value FCF will increase since delta WC decreases over timeEVA increases since the total operating capital decreases and thus WACC*TOCRemember EVA=NOPAT-WACC*TOCAlso ROE increases since total assets reducesRemember ROE=ROS*Sales/Total Assets*Total Assets/Equity
6 Cash conversion cycle Cash Purchase inventory Process goods Sell goods on creditCollect AR
7 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= =66 daysShorter conversion cycles create value!
8 Companies that pursue WCM actively BoeingGuessPepsiCoCiscoJohnson ControlsMac Donald’sEastman Kodak
9 WC score cardsCFO magazine calculates WC performance for main industriesCheck their website at
10 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
11 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.
12 Zero WC General Electric.. Inventory should be financed by suppliers So force payables to this levelWC=AR+ Inventory-AP these three elements are intensively managedCompanies carry on average 20 cts per USD in WCThe WC is turned over 5 times per year!
13 Cash management Reasons for holding cash: Transaction balances for day to day paymentsCompensating balances allowing banks to provide for costs of loansPrecautionSpeculation
14 Advantage of holding cash Benefit the discounts for paying promptlyMaintain good credit ratingsTake advantage of special offers/discounts on opportunity buysMeet emergencies as strikes, fires, marketing campaigns of competition, and cyclical downturns
15 The cash budget Forecast of Cash in versus cash out Per month, week, dayBased on past experience and updated with new knowledgeFocusing on a Cash target level
16 Inventory Supplies Raw materials WIP Finished goods Inventories should be available at the right timeOrdering and carrying costs of all inventory should be minimized
17 Inventory control The red line method Two bin method Computerized inventory controlJITOutsourcing
18 Accounts Receivable Quantity: DSO Quality: aging schedule Credit policy:Credit periodDiscounts for early paymentCredit standards (credit worthiness of customers)Collection policy (how to approach slow payers)
19 EOQ (Economic Order Quantity) Order Cost= D/Q*CoHolding Cost= 1/2Q*ChTotal Cost= D/Q*Co+1/2Q*Chd(Tc/Q)=0Then Q= (2DCo/Ch)0.5
20 Assignment: Working Capital Analyze the WC of your companyDetermine the cash cycle time and compare it to it’s main competitorsIf you were in charge in this company what would you do to better manage WCWhat is the implied value impact of your actions on the company’s value?