Confidential. Optimizing your cash flow during the downturn Alan Miltz Founding Director Inmatrix

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Optimizing your cash flow during the downturn

Alan MiltzFounding Director Inmatrix

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Objectives

• How to conduct a financial health check

• How the banks would review your performance

• Techniques used by the best global companies to measure financial performance

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Who am I?

12 years ago I co-founded Inmatrix. We developed Optimist as a standard communication between Accountants, Banks & Companies.

Optimist

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BC

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22 Countries+1500 Accountants

Optimist

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BC‘000s of Companies +200 Banks

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Gary’s Furniture

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• Gary’s Furniture was founded in 2001

• Gary is a furniture importer and manufacturer and distributes to 500 stores including majors and independents

• Gary believes he is doing fantastically

We are going to use a case study based on a company Gary’s Furniture.

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Gary’s Furniture

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Gary’s Furniture

• On a scale of 1 to 10 how would you rate Gary's Furniture’s financial performance?

• On a Scale of 1 to 10 how do you think the Bank rates Gary's Furniture’s financial performance?

• What is Gary's cash flow for 2009?

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The funnel analogy

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Your company’s strategy

• Does your strategy give you a sustainable competitive advantage? (SCA)

• Your SCA should be a filtering mechanism when considering new opportunities. ( i.e. Will the new opportunity add value to your SCA?)

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How does finance measure your SCA?

• Profit?

• Revenue Growth?

• Cash Flow?

• Market Share?

• Return?

• Dividends?

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How does finance measure your SCA?

• Profit

• Revenue Growth

• Cash Flow

• Market Share

• Return

• Dividends

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How do your accounts enable you to calculate these measures?

• Profit

• Revenue Growth

• Cash Flow

• Market Share

• Return

• Dividends

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The accounting equation – the balance sheet

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The management accounting equation – the balance sheet

All funding is moved to the left hand side of the equation

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The balance sheet

Funding (E +ND)

OperationsNOA

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The balance sheet

Rearrange the accounts of Gary’s Furniture.

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Gary’s Furniture

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Gary’s Furniture

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Why go into business?

Return On Capital Employed (ROCE)

OR

Return On Net Assets (RONA)

ROCE = RONA(The Dupont Theory of Financial Analysis)

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Financial analysis – the theory

Return on Capital Employed or Return on Net Assets or

XEBIT

Revenue

Revenue

Net OperatingAssets

OR

ROCE = EBIT/Net Operating Assets

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The ROCE equation

As management it is mission critical that over time we ensure that our EBIT is growing at a faster rate than our investment in our Net Operating Assets.

EBIT

NOA

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KEY POINTS

Clear understanding of what the business is doing

Which quadrant is the business in now, where is it heading and why?

What are the opportunities for the business?

What will the outcomes be for the business

There are options and the answer is ‘it depends’

This provides a powerful partnership tool

Optimizing Growth

8m

7m

6m

5m

4m

3m

2m

1m

24m 25m 26m 27m 28m 29m

EB

IT

A

B

C

D

E

NET ASSETS

Corporate stress?

Fast growth?

Declining Growth?

Re-engineering Working Investment?

Optimising growth?

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Business Positioning

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What return should we be getting?

• D + E = NOA

• What is the cost of debt = after tax cost of borrowing

• What is the cost of equity = Rf + (Beta x Mp)

• What is the weighted average cost of capital (WACC)

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Equity is the most expensive source of funding

• Have you ever tried to get equity funding?

• Approx 2 to 5% of companies are successful in attaining equity finance

• What does an investor look for?

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Obtaining Equity Finance

A Prospective Investor will look at:

ManagementOpportunitiesValuation Exit StrategyROI

Is your Company a MOVER?

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How do I understand my SCA?

• Marketing

• Operations

• Innovation

• HR

• Finance

What are the 3 critical success factors for each of the above?

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Does your business have an SCA?

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Take my business I founded 11 years ago

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Plotting your Critical Success Factors

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Techniques to improve your ROCE and Cash Flow

• Marketing

• Operations

• Innovation

• HR

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Marketing – understanding your customers

Most companies operate under the 80/20 rule – 80% of their customers account for 20% of the revenue.

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Who do we want to work with?

1 2

3 4

We want a relationship

We don’t want a relationship

They want a relationship

They don’t want a relationship

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Blind spot?

Common Knowledge Private

Blind spot ?

Known to you

Unknown to you

Known byothers

Unknownby others

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What do we do with the 3 and 4s?

1 2We want a relationship




Increase priceEnforce strict terms

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What do we do with the 1 and 2s?

The goal is to identify your blind spots with your 1 and 2 clients and lock them into your business.

Ask these key clients for a wish list (i.e. what do we need to do to at least be equal with your best supplier?)

Provide these clients with your wish list (i.e. what we want from them)

Document a supply chain agreement.

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Operations – where are your overheads?

1 2

3 4

We want a relationship




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Who creates innovation?

Once a week each staff member should provide one idea in writing on how to improve the business.

This is called the 5:15 report.

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The role of Finance

Finance’s role is to measure your company from a business and banking perspective.

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The Financial Health Check

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The quality of your cash flow

Cash FlowFunding

Fixed Assets

Working Capital

Profit

Next PeriodWeaknessStrengths

impact on cash flow

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For each measure let’s look at…

Profitability Ideal Profile G A B

Sales 100

GM% 30 >30 28 – 30 <28

OH% 20 < 20 20 – 22 <22

EBIT% 10 >10 8 – 10 <8

Working Capital

AR Days 60 <60 60 – 70 >70

Inv/WIP Days 90 <90 90 – 100 >100

AP Days 60 45 – 60 60 – 70 <45 >70

Working Capital % 22 <22 22 – 25 >25

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Gary’s numbers

Profitability Ideal Profile G A B

Sales 100

GM% 30 31

OH% 20 20

EBIT% 10 11

Working Capital

AR Days 60 75

Inv/WIP Days 90 180

AP Days 60 (70)

Working Capital% 22 41

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The Power of One

It is essential to know the cash flow sensitivities of a 1% or 1 day change in: • Price %

• Volume %

• COGS %

• AR

• INV/WIP

• AP

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The Power of One

Why does an increase in sales volume reduce cash flow?

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The Power of One - sensitivity

Change Effect on Net Cash Flow

COGS % - 1% 406,000

Price % +1% 187,000

AR days -1 118,000

INV/WIP days -1 81,000

AP days +1 81,000

Volume % +1% -123,000

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Revenue Growth %

GM %

Overheads %

EBIT %

Chapter 1 - Profitability

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Chapter 2 – Working Capital

Accounts Receivable

Inventory/WIP

Accounts Payable

Working Capital %

} Days

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Growth in Net Non Current Assets

Asset Turnover

Chapter 3 – Net Non Current Assets

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Net Cash Flow

Borrowed Funds

Cash After Operations

GM% - WC%

ROCE%

Chapter 4 – Cash Flow and Returns

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Interest Cover

Debt Service Coverage

Leverage

Debt Payback

Bank Measures

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Why is cash flow important?

• What is profit – an opinion or a fact?

• What is a balance sheet – an opinion or a fact?

• What is cash flow – an opinion or a fact?

• Cash flow is the only fact in the accounts

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Cash flow

The term ‘cash flow’ is used in so many different forms, that it means something different to each of you.

A consistent, meaningful, standardized definition of cash flow would be very helpful.

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Net cash flow

On the 1st of January 2008 I have $160 in the bank.

On the 31st of December 2008 I have $60 in the bank.

What is my net cash flow?

100 outflow

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Net cash flow

Why can’t we apply this logic to the company?

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Gary’s net cash flow

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Net cash flow

Remember, as the providers of your finance, the bank always knows your cash flow.

Ask yourself: is the bank providing funds to grow or to fund wastage?

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Net cash flow

We know that the Net cash flow for Gary's Furniture was -$3,260,073

Is that a good or bad?

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Net cash flow

We need to know what the money was spent on….

The 4 chapters approach to analysing cash flow will assist…...

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The 4 chapters of cash flow

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Marginal cash flow

The additional cash that will be generated or used up if we sell $1 more of our product or services.

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Marginal cash flow

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Marginal cash flow for the next $1 of sales

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What does this tell us?

For each additional $1 of sales the business will require 10.34c of funding

If the existing relationships stay the same

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Why is marginal cash flow important?

Many businesses do not understand why

as Sales increase Cash Flow deteriorates

Solicitor

Sales $ 100Direct Costs $ 30

Gross Margin $ 70Working Capital $ 80

Marginal Cash Flow $ -10

The Balance Sheet in effect steals from the Income Statement

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Profit vs cash flow

High Margin

Poor Balance Sheet Management

= possibility of poor Cash Flow

Low Margin

Good Balance Sheet Management

= possibility of good Cash Flow

Solicitor

Construction CompanyObtains payments in advance, deposits, bills work in progress frequently, pays creditors slowly

Many companies do not understand the relationship between profit and cash flow.

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Marginal cash flow

• Products

• Product groups

• Customers

• Distributors

• State offices

• Business units

Marginal cash flow can be very powerful to analyze components of a business:

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A bank’s view of cash flow

The cash flow methodology used by banks is not even the same as the ones used by you!!!!

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A bank’s view of cash flow

So what is a banker’s cash flow?

All major Australian banks and most banks around the world use subtle variations of the same report.

Many call it the UCA Cash Flow.

No one seems to know what UCA stands for!!!

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Banker’s cash flow

Focuses on the 7 key items of cash flow:

1. Gross cash profit

2. Cash after operations

3. Net cash after operations

4. Net cash income

5. Cash after debt amortization

6. Net cash after investing

7. Financing surplus/(requirements)

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Gross cash profit

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Gross cash profit

Gross cash profit is in turn made up of cash from customers & cash paid to suppliers.

Gross cash profit is equivalent to the cash flow from gross margin.

Note: COGS would exclude depreciation.

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Cash after operations

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Cash after operations

Cash after operations is gross cash profits less Overheads and changes to balance sheet items relating to overheads such as provisions, accruals & prepayments.

Cash after operations is equivalent to the cash flow from EBITDA

Note: Overheads would exclude depreciation and amortization.

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Net cash after operations

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Net cash after operations is cash after operations less changes in sundry assets & liabilities and income taxes paid.

Income tax paid is not the tax charge per the profit & loss, but is the actual tax paid.

Net cash after operations is the operating cash flow from which the providers of funding are paid.

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If you were the banker of Gary's Furniture what does a net cash after operations of negative $895,442 tell you?

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Net cash income

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Net cash income

Net cash income is net cash after operations less interest and dividends paid.

Interest and dividends paid are not the charge per the profit & loss, but the actual amounts paid.

Net cash income is the cash flow from which the business must pay back debt.

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Net cash income

Gary's Furniture has a net cash income of negative $2,258m.

As their banker how do you feel now?

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Cash after debt amortization

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Cash after debt amortization is net cash income less commitment to retire debt.

The most interesting aspect of cash after debt amortization is to look at what items are yet to be taken into account.

Cada is BEFORE the purchase of fixed assets & investments. Is there enough cash flow generated after paying tax, interest, dividends & retiring debt to buy fixed assets or investments?

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Gary's Furniture has a cash after debt amortization of negative $2,258m

As the banker to Gary's Furniture, how comfortable are you with their 2009 cash flow at this stage?

Where is the company going to find the money to purchase the new coffee roaster?

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Net cash after investing

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Net cash after investing

Net cash after investing is cash after debt amortization less net purchases of fixed assets and investments.

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Financing / surplus (requirement)

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Financing surplus is net cash after investing less extraordinary items.

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Is equal to the Net Cash Flow that we calculated already.

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How was the $3,260,073 financing requirement funded?

$2,260,073 by short term borrowings

$1,000,000 by long term debt

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Banker’s cash flow

A banker’s cash flow treats cash flow as a process rather than a number.

The cash flow shows the flow of cash in and out of the business.

As we have seen, the banker’s cash flow is a very good way of understanding the flow of money through our business.

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Your Credit Officer

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Your Credit Officer

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Your Credit Officer

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Your Credit Officer

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A big picture for credit management

Understanding the customer

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Key Measures

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Profitability

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Assets

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Working Capital

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Cash Wastage

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Strategy

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RONA %

Documents

Confidential. Optimizing your cash flow during the downturn Alan Miltz Founding Director Inmatrix