Copyright Global Finance Media Inc. Feb
2003
[Headnote] |
TREASURY SPOTLIGHT |
WORKING CAPITAL MANAGEMENT |
[Headnote] |
The backroom world of cash management has suddenly
been thrust into the limelight. |
[Photograph] |
John Nicholas: The right amount of cash, in the right
currency, at the right place, at the right time
|
Cash is king.The swath of false accounting scandals
in the United States last year reinforced the strength of that dictum. As equity
analysts panicked over their ability to understand company earnings and balance
sheets, they hit on cash flow as one of the few reliable indicators of corporate
health.
At the same time, companies have also been focusing
much more on cash flows and on techniques of "working capital management" (WCM).
To some, this is a set of familiar principles dressed
up in new clothes. "WCM is, in my view, about the right amount of cash, in the
right currency, at the right place, at the right time," says John Nicholas,
senior product manager-Europe, global payments and cash management at HSBC. More
crudely, says one corporate treasury professional, "It's about leading and
lagging-getting your invoices out early and delaying your payments."
So it's not perhaps the rocket science some bankers
would have us believe. But corporates don't need telling how important the area
is."Good working capital management has always been vital," says Robin
Graham-Adriani, group treasurer at UK engineering group FKI. "It's about making
sure that cash doesn't remain unutilized!
What's been driving the new accent on WCM is the fact
that, as Olivier Brissaud, general manager of the Volkswagen treasury
coordination center in Brussels, says, "funding is getting rarer, and you have
to be very careful how you fund, because it's expensive-if it's available at
all."
Cost conscious corporates have embraced WCM in an era
of tight credit. The better their WCM practices, the less they need to borrow.
Even companies with cash surpluses have to apply WCM principles to ensure that
those surpluses are invested in ways that will help them meet internal rates of
return.
The advent of the euro has also helped in the
adoption of WCM procedures: Companies can now pool their cash across Euroland
instead of having to operate separate cash pools in each country.
Some businesses are inherently better placed than
others to collect cash up front. Insurance companies, for instance, receive
premium payments before any payouts, although they do clearly have unpredictable
outgoings as claims come in.
On the face of it, a big retail group like Tesco in
Europe or Wal-Mart in the US has little to worry about; the customer pays on the
nail pretty much every time. But it's inventories that are the potential killer.
"If retailers don't do their cash flow forecasting very rigorously, they risk
being out of business in a short space of time," says Mark Farnworth, treasury
manager at the UK's Royal & Sun Alliance.
By contrast, the timing and lumpiness of payments can
be a problem for major manufacturing companies. Manufacturers incur substantial
upfront costs for raw materials and labor before receiving payment. To make WCM
really effective, corporates need to look at their business practices at the
micro level. "WCM is really about the short term," says HSBC's Nicholas, "and
companies are placing great emphasis on supplier management to ensure that trade
terms are optimized in an effort to reduce days-sales-outstanding." This
parallels the steps companies have taken to achieve just-in-time manufacturing.
Banks can also offer invoice discounting or factoring and receivables
outsourcing to help the process.
The logic of WCM needs to reach right down into the
whole way that an enterprise is organized.As David Lock of London-based
specialist consultants REL explains, "Sales and marketing people need to realize
that their decisions on the terms for customers have an impact on the finance
department." And, says Lock, "companies need to understand that happy customers
pay, while putting invoices in the drawer and ignoring them means that suppliers
will hit back with tougher conditions or higher prices."
To optimize WCM, companies also need to ensure that
the information flow from subsidiaries and divisions is good enough. The banks
certainly see this as an opportunity for them."The key to good WCM is
information flow, and a bank that provides deeper and more data-rich information
at the right time and to the right place will add more value to a company," says
Richard Challinor, director of enterprise sales at Bank of America in London.
Some companies are happy to do it without much help
from the banks."We have an internal focus on working capital management," says
Henrik Moelgaard, cash manager at Danish pharmaceuticals company NovoNordisk.
Information from affiliates is "extremely important" to the company, and "there
is an advantage because all of them are on SAP platforms, from which the
information flows into corporate headquarters."
Because the focus of WCM is often a micro issue, some
companies-such as Dutch chemicals giant Akzo Nobel-prefer to do their WCM in the
business units, rather than at the overall corporate level.
One potentially wayward component in information flow
is a company's own ability in the black art of forecasting receipts. "There are
tools out there, and they're getting better," says Challinor, "but a company
still doesn't control the point at which a client pays its bill."
Challinor says that a group of leading treasurers
involved in the think tank Aererium, created by Bank ofAmerica, has been engaged
in a healthy debate over forecasting. "One very large, well-known European
corporate is even moving toward not forecasting cash flow at all and just
managing their position intra-day," he says.
One thing Challinor is clear about, however:
Electronic solutions are not a panacea. "'E' stands for enablement, not
efficiency," he says. Treasurers will still have to work hard to ensure that
they have the right funds in the right place at the right time.
[Sidebar] |
10 Commom Mistakes in Working Capital Management
|
[Sidebar] |
1 Waiting for a crisis before trying to improve
working capital practices |
2 Believing that working capital management problems
can be resolved by the CFO alone |
3 Waiting until debts become overdue before contacting
customers |
[Sidebar] |
4 Handling outstanding disputes in a reactive rather
than proactive manner |
[Sidebar] |
5 Extending supplier payment terms without considering
the opportunity to secure discounts for earlier payment |
6 Rewarding sales personnel on revenue booked without
considering the quality of those revenues |
7 Delaying the issue of credit notes to correct
invoicing disputes |
[Sidebar] |
8 Trying to achieve a 100% level of customer
satisfaction from inventory |
9 Equating improvement in days outstanding (DSO) with
improvement in cash flow |
10 Extending payment terms to customers to avoid
offering discounts |
Source: REL Consultancy Group
|
[Author Affiliation] |
Graham Field is a London-based contributor to Global
Finance. Email: [email protected] |