Clanak Za Treci Kolokvij

8/13/2019 Clanak Za Treci Kolokvij

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Magic of Managing theBalanceSheetWe've mentionedhe phrasemanaging he balancesheeta coupleof times n this book.Rightwant to go into greaterdetail about how to do it. The reason?Astutemanagementf theheets like financialmagic. t allowsyou o improve our company'sinancial erfbrmance

withoutboosting alesor lowering costs.Betterbalance heetmanagementakesa businessefficient at convertingnputs o outputsandultimately o cash. t speeds p the caslrconversiona concepthatwe'lI takeup later n thispart.Companieshatcangenerate orecash n lesshavegteater reedom faction; heyaren'tso dependentn outsidenvestors r lenders.Ifyou companys big enougho havea CFO anda finance epartment,heywill haveday-to-dayor managingmost of the balancesheet.They'll help you figure out how much oandon what terms,helpyou line up equity nvestmentwhen necessary, ndgenerallykeep anon the company's verall assets nd tiabilities.But any br.siness wner,,with or (especially)a financedepartment, hould ru-rderstandhe key conceptsnvolved in managinghe balanceparticular,you need o understandhe dea of managingworking capitcrl.Learn o help yourworking capital better,andyou will havea powerful eflect on bothyour company'snd tscash osition.


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THB ELEMENTS OF WORKING CAPITAL

Workingcapital is a categoryof resourceshat ncludescash, nventory, nd receivables,minushatevera companyowes in the short erm. It comesstraight rom the balancesheet,and t's oftencalculated ccordingo the ollowing ormul :workingcapital current ssets currentiabilities

Of course,his equation an be brokendown flrther. Currentassets, s we have see4 includesitemssuchas castr,eceivables, nd nventory. urrentiabilities ncludes ayables ndothershort-erm obligations. tlt thesearen't solated ine itemson the balance heet; hey epresent ifferentstages ftheproduction ycleanddiflerent brmsof workingcapital.To understandhis, maginea small manufachling ompany. veryproduction ycle beginswithasll which s the irst componentfworking capital.Thecompanyakes hecashandbuys ome awaterials. hatcreates aw-materialsnventory, second omponent f working capital.Then heaw materials re used n production, reatingwork-in-processnventoryand eventu,allyinished-oods nventory, lso part of the "inventory"component f working capital.Finally, he companysells hegoodso customers,reating eceivables, hichare he hird and astcomponentf workingapital figure25- ). In a servicebusiness,he cycle s similar but simpler.For example, ul ownompany-theBusiness iteracy nstitute-is partlya trainingbusiness.ts operating ycle nvolveshe ime equiredo go fiomthe nitial developmentf trainingmaterials,o thecompletion f traininglasses, nd inally o thecollectionof thebill. Themoreefficientwe are n finishinga projectandollowingup on collections,hehealthiel tu profitabilityandcash low will be.L.r act, hebestwaymoneyn a servicebu,sinesss to provide he servicequicklyandu.ell and hen o collectasoonas possible.Tfroughout his cycle, he orm takenby working capitalchanges.ut theamountchangeunless more cash enters the systenF-for example, liom loans or from equitynvestments.Of course, if the company buys on credit, then some of the cash remains intact-but a

payables" ine is created n the iabilities side of thebalance heet.So hatmustbeeductedrom he hreeothercomponentso getanaccurate ictLu'efthe company's orkingcapital.

FIGURE 5-]


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Workingcapitaland the productioncycleCash

Receivables Raw-materialsinventory

Finished-goodsinventory

Overall,how much .r'orkingapital s appropriateor a company? his question oesn'thaveaneasyanswer.Everycompany eeds nough ashand nventory o do its ob. The arger t is and hefaster t is gowing, the more working capital t is likely to need.But the real challenges to meworking capital effrciently. The three working capital accounts hat you and your employeescanaffectday n anddayoutareaccountseceivable,nventory, nd to a lesserextent) ccor-utsayable.We'll takeup eachone n turn.Before we do, thougll it's worth asking once again how much aft is involved in all thesecalcr.rlations.n thiscase hebestanswermightbe "some."Cash s a hardnumber, ot easilysubjectto manipulation.eceivables ndpayables rerelativelyhardas well. lnventorysn't quiteso hard.Variousaccountingechniquesndassumptionsllow a companyo value nventoryn difierentways.So a company's alculation f workingcapitalwill dependo an extenton the rules ts accountantfollows. Still, you can generallyassurnehat working capital figures aren't subject o as muchdiscretion nd udement smanvofthe numbers e learned boutearlier.


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YourBslanceSheetLeversMost companies se someof their cash o finance ustomers' urchase f products r services.That'sthe "accourts eceivable" line on the balancesheet-the amountof moneycustomers we at agivenpoint n time,based nthevalueof what heyhavepurchased efore hatdate.

The key ratio thatmeaswes ccountseceivable, swe saw in part5, is dayssalesoutstanding,rDSC -that is, the average turber of days t takes o collect on these eceivables. he onger acompany DSO, he moreworkingcapitcrls reqttireclo run the business.Cwtomers avemoreofthecompany'sash n the ormofproductsor services otyetpaid for, so thatcash sn't available obuy nventory, elivermore services, nd so on. Conversely,he shortera company's SO, he essworkingcapital s required o rr-urhebusiness.t follows that hemorepeoplewho understandSOandworkto bring t dow4 themorecash hecompany ill haveat its disposal.


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MANAGING DSO

The irst step n managing SO s to understandhat t is and n which direction t hasbeenheading.If it's higherhan t oughto be,andparticularly f it's trending pward which t nearlyalwaysseemsto be),youneed o beginasking uestions.Ask yow operationsnanager,or example,whether hereare anyproblemswith theproducts rservices hat might makecrstomers ess willing to pay their bills. Is the company ellingwhatcrtstomersantandexpect?s therea problemwith delivery?Qualityproblems nd ate deliveriesoften provoke ate payment, r,st becawe customers re not pleasedwith the products hey'rereceivingand decide that they will take their own sweet time about payment.The people inproduction ndshippinghushaveaneflecton receivables swell. In a service ompany,ouneed obe asking he samequestions f thepeoplewho are out delivering he service. f servicecustomersaren'tsatisfiedwith what hey'regetting,hey oo will take heir imeaboutpaying.Ask your customer-facingunagersand employees-those n sales and customer ervice-asimilar setof questions.re our customersinancially ealthy?What s the standardn their ndustryfor payingbills? Salespeopleypicallyhave he first contactwith a customer, o it is up to them oflag anyconcerns bout hecustomer'sinancialhealth.Once he sale s rnade, ustomer-ervce repsneed o pick up the ball and learn what's goingon. What'shappeningat the customer'sshop?Areemployees orkingovertime? s the companyayingpeopleot{? Meanwhile,salespeople eed owork with the credit fflanager ndcustomer ervice so that everybodyunderstandshe termsup frontandwill noticewhena customers late.At onecompany e workedwith, thedeliverypeopleknewthemostabout ustomers' ituations ecauseheywere at their acilitieseveryday.Theywould alertsalesandaccowrtingfthere seemedo be ssues ropping p n a customer's usiness.Chancesare you have someoneother than yowself reviewing the credit of customers ndprospectivecustomers. hatpersonneeds o askwhether he termsoflered aregoodfor the companyand whether hey it the credit historiesof the customers.He or she also needs o make udgments-mayben consultation ith you-about whetherhe companys givingcredit oo easilyor whether tis too tough n its creditpolicies.There'salwaysa trade-offbetween ncreasing aleson the onehandand ssuing redit o poorercredit isks on theother.You andyoursalesor creditmanager eedto set hepreciseerms ou'rewilling to oftbr. s net hirtydayssatisfactory-orshould ouallow netsixty?Youneed o determine trategiesuchas offeringdiscorurtsor earlypay.For example,2/10net 30" meanshat customers et a discountof 2 percent f theypay their bill in ten daysand nodiscowrt f theywait thiny-*ays.Sometimes I percent r 2 percent iscount anhelp a strugglingcompany ollect ts receivables nd herebyower its DSO-but of course, t doesso by eatingntoprofitability.We know of a smallcompanyhathasa simple,homegrown pproacho the ssueof givingcreditto customers. he companyhas dentified the traits it wants n its customers nd has evennamed tsidealcrstomerBob.Bob's qualitiesnclude he ollowing:

. He works for a large company.


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His companys known or paying ts bills ontime.He canmaintain ndunderstandheproductprovided thiscompanymakes omplexechnology-intensive roducts).He is looking br anongoingelationship.

If a newcustomer eetshese riteria, t will getcredit iom thissmallmanufactLrer.therwise,twon't.As a resultof this policy, he company asbeenable o keep ts DSO quite ow and o gowwithoutadditionalequity nvestment._ All thesedecisions reatlyaflectaccoruts eceivable nd husworking capital.Ancl he fact is ,theycanhavea hugempact.Reducing SO evenby onedaycansaveu .o-puny a lot ofmoney.Forexample, heckback o theDSOcalculationn chapter 2, and oucancalcJate hatonedayof salesin ow sample ompanys just over $24,000.Reducing SO from fifty-five days o fifo-fow in thiscompanywottld hw increase ashby $24,000.That'scash hatcan be used or other hinss n thebusiness.

aa


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MANAGING INVENTORY

Many business wners hesedaysare focusingon inventory.They work to reduce nventorywhereverpossible. They are learning concepts such as ean manufacturing, ust-in-time inventorymanagement, ndeconomicorder quantity.The reason or all this attentions exactlywhatwe'retalkingabout ere.Managingnventory tTicientlyeduces orkingcapital equirementsy freeing plarge amounts f cash.Thechallengeor inventorymanagement,fcourse, sn' t to reduce nventoryo zero,which wouldprobably eavea lot of customersrsatisfied. hechallenges to reducet to a minimumevel whilestill ensuringhatevery aw materialandeverypartwill be availablewhenneeded nd hateveryproductwill be ready or sale when a customerwants t. A manufacturereeds o be constantlyordering aw materials,makinghings, ndholding hose inished roductsbr delivery o customers.Wholesalers nd etailersneed o replenishheirstocks egularly o avoid he dreaded tockout-anitem that sn't availablewhena customerwants t. Yet every tem n inventory anbe regarded sfrozen ash,which s to saycash hat he company annot se or otherpurposes. xactlyhow muchinventorys required o satislycustomers hile minimizing hat rozen ash,well, that's hemillion-dollarquestionand he easonor all thatattention eingpaid o inventory).The techniquesor managingnventoryare beyond he scopeof this book. But we do want toemphasizehatmanydifferent eople n yourcompany ffect nventoryevels,whichmeanshatall ofthem anhavean mpacton reducingworkingcapital equirements.or example:

Salespeopleove to tell customersheycanhaveexactlywhat heywant. "Have tyour way,"as the old Br.rgerKing ingle put it.) Custom aint ob? No problem.Bells andwhistles?Noproblem.Everyvariation, owever, equires little more nventory,meaning little morecash.Obviously, ustomers wt be satisfied.But thatcofilmonsenseequirement as o be balancedagainsthe act hat nventory ostsmoney. hemore hatsalespeopleansell standard roductswith limitedvariations,he ess nventoryheircompany ill have o carry.Engineersove thosesamebells and whistles. n fact, hey'reconstantly orking o improvetheir company's roducts, eplacing ersion2.54 with version2.55 and so on.Again, his is alaudable usiness bjective,but t's one hathas o be balanced gainstnventory equirements.A proliferationof product versionsadds to frozencash and puts a burden on inventoryrnanagement.hena product ine is keptsimplewith a fbw easily nterchangeableptions, heamount f inventory eededs likely to be essand hereforeesscash s tied up.Productiondepartmentsreatlyaffect nventory.For instance,what's thepercentage f machinedowntime? requent reakdownsequire he companyo carrymorework-in-processnventoryand more finished-goods nventory. And what's the average time betvveenchangeovers?Decisions bouthow much o build of a particular arthavean enormousmpacton inventoryrequirements.ven he layoutof a plantaffects nventory:an etlciently designed roductionflow in aneltrcient lantminimizesheneed or inventory.


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Along these ines, t's worth noting hat manyU.S. plantsoperateon a principle that eatsuptremendouamounts f workingcapital.Whenbr.sinesss slow, heyneverthel.r,k .p on churningout-productwith the goal of maintainingactoryefficiency.Factoryownersand plantmanagersoc,-,ion keeping iit costsdown,oftenbecausehey earnedhatgoalearly n theircareers ndno longerquest ionr .WhenbL'sinesss good, he goalmakes erfectsense: eeping uitcostsdown s simplya way ofmanaging ll thecostsofproduction in anefficientmanner.itrl s is the old approachof focusingonlyon the ncome tatement,'hich s fineas far as t goes.)Whendemands sl'ow,however,heowneror plantmanager wt consider hecompany'surliu, well as ts Lurit osts.A plant hatcontinuesournoutproductn these ircumstancess ust creatingmore nventoryhatwill ,it on u shelftaking pspaceandcash.Coming o work and eading bookmightbe bettei hanbuildingproduct hat s noteady o be sold.How muchcana companysavethrougl-rstute nventorymanagement?ook againat our samplecuttingust one day out of theDII number-reclucing t from seventy-fotrclayso seventy-

increase ashby nearly$19,000.Any companywith inventorycan savesignificantof money,and thereby reduce r.vorkingcapitai requirements,rxt by making modestn its inventorymanagement.


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HomingIn on CashConversion[n thischapter e'll takeup thecashconversion ycle,which measuresow effectively companycollects ts cash.But there's one little wrinkle we have o consider irst-how fast a companydecides o pay hemoneyt owes ts vendors.Accorurtspayable s a tough number o get right. It's an area where flnance meetsphiiosophy.Financial considerations lone wor-rldencourage miness owners to maximize days payableoutstandingDPO), husconservingheir company's ash.A changen this ratio is as powerfulas achangen the other ratios we've beendiscussing. or instance,n the imaginary onrpany e'velookedat in many hapters ow, f managersncreased PO byjust one day, heywould add about$19,000o thecompany's ashbalance.But hereareotherconsiderations,s we mentionedn chapter 2. Wl:r;r ind of a relationship oyou want with you vendors?What l


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THE CASH CONVERSIONCYCLE

Anotherway to tnderstandworking capital s to study he cashconversion ycle. t's essentiallytimeline relating he stagesof production the operating ycle) to the company'snvestmentnworkingcapital.The imelinehasmultiple evels,andyoucanseehow the evelsare inked n igue27-L Understandinghese evelsand heir measr.resrovidesa powerfulway of ur.rderstandingourbusinessndshould elpyoumake inanciallyntelligent ecisions.Starting t the eft, hecompany wchasesaw materials. hatbegins heaccourts ayable eriodand the inventoryperiod. In the next phase, he companyhas to pay for those raw materials.Thatbegins hecash onversion ycle tself-that is, thecashhasnow beenpaid out,, nd he ob is to seehow fast t cancomeback.Yet he companys still in its inventory eriod; t hasn'tactually oldanyfinished oods et.

FIGURE 7-]


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Theoperatingcycle

RawmaterialspurchasedPaymentfor awmaterials

Sale ffinishedgoodsCashcollectedon sales

Eventually,he company oessell its finishedgoods,ending he nventoryperiod.But it is justnteringhe accowttseceivable eriod; t still hasn't eceivedany cash.Finally, t doescollect heashon ts sales'whichendsboth heaccoutsreceivable eriodand hecash onversion ycle.Why is this important?Becausewith it, we can determine ow manydays he cycle takesand hennderstand ow manydays a company'scash s tied up. That's an imporlant number or companywners o know. Armed with the number,entrepreneurs ay be able to find ways to "save" lots ofash or their company. o ligure it out,use he following formula:cash onversion ycle DSO+ Dll - DPO

In otherwords, take dayssalesoutstanding,dd days n inventory,and subtract henumberofdaysoutstanding. hat tells yoq in days,how fast your company ecovers its cash,from thet pays ts payableso themomentt collects ts receivables.Thecashconversion ycle also givesyou a way of calculating ow muchcash t takes o financebusiness:oujLrstakesalesper dayandmultiply t by thenunrber fdays in thecash onversionycle.Hereare hecalculationsor our sample ompany:

lnventory eriod Accounts


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54days+ 74days 55 days= 73days73days $24,136sa esld y= $1 767,928

Thisbminess equiresworkingcapitalof around$1.8million r"st o f-rnancets operations. hatisn't urusual or a gowing company. vensmallcompaniesequirea lot of workingcapital elativeto theirsalesftheir cash onversion ycle s as ongas sixtydays.Companiesof any size can get themselves nto trouble on this score. Tyco International-mentionedearlier in this book-was famor.sor acquiringsix hr.rndredompanies n two years.Allthoseacquisitions ntailed lot ofchallenges, ut one seriow challengenvolvedhuge ncreasesnthe cash onversionycle.The reason? ycooftenwasacquiring ompaniesn thesamendutry, andcompeting roductswere added o its product ist. With several cry similarproductsn inventory,the company ouldn't move l.rat nventoryas fastas it oncehad. nventorydaysbegan o spiral outofcontrol, increasingn someparts of the businessby more than en days. n a multinationalcompanywith more han$30 billion in revenue,ncreasesn that scalecan deplete ashby several udredmillion dollars. (This is an issue hat Tyco has addressedn recentyearsby closing down theacquisition ipelineand ocusing n theoperations fthe business.)Thecash onversion yclecanbe shortenedy all the echniquesiscussedn thispart:decreasingDSO,decreasingnventory, nd ncreasing PO.Figureoutwhatyourcompany's ycle s andwhichdirection it's heading n. You may want to discrss it with your managers.That might start aconversationhatwill result n a fastercashconversion ycle, ower workingcapital equirements,andmorecash. hatwill benefiteverybodyn thebuiness.

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Clanak Za Treci Kolokvij