Cash Conversion Cycle
Many businesses face challenges because of cash flow problems. Traditional prudence shows that a company should have enough money to cover immediate liabilities. Some FMCG businesses claim a different approach. The FMCG Companys turnover is limited by the ability to sell goods. They can also generate money quickly. It happens because customers can pay rapidly. There are no problems in raising cash. In such companies, services and products are sold and delivered to customers before they are paid for by the company. Resources are concentrated on marketing. There is little room for raising funds by mortgaging the machinery and plant. Development in ERP, SCM and JIT implementation have businesses leaner. A firm pledges its machinery, plant or inventory so as to raise bank overdraft loan that is required to fund all operations. By realizing such limitations, most companies start to use negotiating powers over suppliers and customers to get money to fund all operations. Negative working capitals refer to the managerial efficiency sign in businesses with low accounts and inventory receivables. This sign shows that a business may be at a risk of facing serious financial trouble or bankruptcy. Research has been conducted on the field of working capital management and how it influences distinct sectors such as the liquidity, the profitability and cash conversion cycle. Optimal WCM has an effect on the profitability of the business entities. It also impacts a company through altering the technological advancements to the optimal levels. Besides, it adopts the EU directives. The managerial team can create a good impression to the shareholders by cutting the CCC to minimum and reasonable value. This study was carried on thirty firms enlisted in the London stock Exchange for a time of about 22 years (Zhou 2011).
A negative interrelation between the CCC and profitability was discovered. It developed as a result of the business entities that yielded less profit hence accumulated a longer time to clear their bills. As per this assertion, the firms have less finance to direct to the clients thus declining the accounts receivable which dictates an increase in the profits. A research in Greece evidences that most of the companies utilize the financial debt to cause a decline in the CCC and increase the profits (Pandy 2005). In most of the cases, WCM and profitability are somehow interrelated. However, there are significant differences evidenced in some industries as per the WCM measures but do not change across time limit as observed.
In FMCG Khamrui and Bagchi (2012) also showed that CCC and debts that are used by firms are associated with a firms profits so as to make improvements. The study was based in ten companies dealing with FMCG for ten years. It can be said to be biased because of ignorance of the variable that are related to the countries involved. It can be seen that different countries have different sensitivity variables while studying CCC. The study also concludes that Peninsula has low values in working capital. Concerning Days Sales Outstanding and Days Payable Outstanding, Peninsula is at the top in Italy. DPO and a low CCC are directly related. A high DIO and DSO imply a high number of days used t collect money. Iberian firms are less profitable and liquid.
This project serves the role of studying a deep way CCC and the way it differs among industries and the components that impact CCC the changes they make. Enough research has not been done about CCC. A lot of research need to be conducted on FMCG. CCC in FMCG industries is negative. Most research samples analyse big companies with a large bargaining power among the suppliers. As a result, credit is extended. The industry may explain such results.
When making observations on the 2009 and 2010, crisis period, Businesses take twenty four days for collecting money. Even though the value is usually negative, they can receive information from different clients by comparing to all deadlines they pay their suppliers. Inventory is also converted into sales. When compared to post crisis, FMCG industry is better because it unlocked its liquidity by reducing inventories and receivables in addition to extending payables. In most FMCG firms, variables decreased between 2009 and 2010 between sixteen (CCC) and seven percent (DSO and DPO). Variables also decreased in the following periods.
2.6 Enhancing Cash Conversion Cycle
After the great Recession, the economy around the world continues to show signs of recovery. Additionally, the treasury strategic value is also changing to be more efficient in regards to the management of capital in an effort to meet the expansion of equity in their companies. In spite of this, numerous companies have been accumulating record balances in cash since the previous financial meltdownthere was an increase in the corporates financial holdings of about 78% between 2008 and 2013 compared to just 27% increase between 2000 and 2008. Additionally, there is a common mandate requiring organizations to transform into more strategic partners in business. This is aimed at ensuring that liquidity and corporate free cash flows can be realized faster (Raheman & Nasr 2007).
Many American corporations are currently experiencing large cash balances in offshore sectors. As a result, there is a renewed focus on realizing strategic cash flows with the ability to give financial departments the ability to forecast without the need for a third party debt commitment. Additionally, such corporations can avoid the need to repatriate offshore cash. Repatriation of offshore cash is shunned since it has an implication on taxes that a company is obliged to pay. The management of working capital has become a major focus for CFOs as they seek to challenge the treasurys FP and A. Corporate control teams seek to reduce the management of working capital in a move to improve the nature of free cash flow.
The implication is that the capital is a representation of the liquidity that the treasurer can tap into in order to satisfy their financial obligations in the short term. These are the current assets minus the current liabilities. In other words, if the treasurers can optimize the components of the working capital, the length of the cash conversion cycle can be decreased. The effect of this would be a reduction of the time that is tied up by cash in the working capital. The cycle of the cash conversion plan has DIO (days inventory outstanding), DPO (Days Payable Outstanding) and DSO (Days Sales Outstanding). During the previous recession around the world, many American corporations had a surplus in capital, a decline in the levels of inventory, a stabilization of DSO metrics and an increase in the overall amount of global cash balances. In the recent years, the economy around the globe has been improving. The work of the treasurers has been to proactively manage working capital in the light of the expanding capital in geographies and new markets that can go a long way in lengthening the cycle of cash conversion via the extension of DIO and DSO. The treasury got a chance to work over multiple functions aimed at driving the initiatives of working capital. Holistically, this was a strategic corporate financial function. The aim of the provision was to drive the initiatives of working capital and tracking the effectiveness and the positive impact having sportive cash flow.
Prior to the initiative, it is important for one to comprehend the implications that new working capital could have on the underlying business function as well as its partners. From the perspectives of the treasury, the benefits of reducing the scope of the cash conversion cycle are apparent. In spite of this, it is important to recognize the benefits that cash conversion cycle has and factor in the manner in which capital optimization programs can impact the core of the business. Apparently, the objective is to reduce the level for DSO and DIO but increase the DPO. If the focus was the improvement of any of the metrics solely, it would be possible to realize negative implications in other areas of the business. Minimization of DIO is a fine example of the competition of priorities between sales teams and the treasury as cases of inventory management.
In order to meet demand, the sales team could work better with higher levels of inventory. If the inventory amounts are insufficient, cases of foregone sales could be rampant. However, the treasurers have a different perspective than this. A growing DIO and inventory balance have overall negative impacts on free cash flow as well as the working capital. In regards to the latter, there has been significant innovation in the past few years in the area of the accounts payable as well as the extension of the companys DPO. The account payable is thus the component of the working capital via which corporate finance has the ability to exercise the most control. Treasurers are nonetheless required to take the role of leadership in order to educate and guide their colleagues with regards to the benefits of corporate silos. They need to ensure that their colleagues pay particular attention to areas where objectives may be contrary to the whole strategic benefits of the company such as the case of excess inventory (Cebenoyan & Strahan 2004).
Through the utilization of this role of leadership, it is possible for treasurers to educate themselves on the benefits discussed here. Only then are they in a position to educate their colleagues about the benefits that an effective capital program can bring the company. These benefits include the improvement of cash flow as well as the ability to secure low cost internal funding which directly translates to an improved working capital program as well as a low cost cash source. The groups entail procurement, accounts payable, broad and legal treasury teams. From a historic perspective, managers of accounts payable were capable of delaying payments meant for suppliers a way to extend the DPO metric. This method had serious negative consequences such as stressing the relationship with the key suppliers as well as the development of volatile cash flows in the quarter.
In recent years, the use of supply chain finance and other such technologies continue being effective tools for the working capital program as means of extending the DPO. In the solution, corporations that have strong credit ratings are in a position to extend terms of payments to their suppliers via the involvement of financial institutions. Under the solution, the supplier does not necessarily receive delayed payments. Instead, of this, they receive accelerated but discounted cash receipts at low effective rates than they would if they had the ability to finance externally. The corporation can then reduce its own payable to the financial institution. This effectively improves the DPO. Under the solution, the DPO receives an extension which reduces the conversion cycle of cash. It also improves the overall cash flow and maintains good relations with the supplier.
To this respect, treasurers are the safeguards of a companys global cash as well as short term financial forecasts. The approach allows them to carry out their jobs responsibly and strategically. They do this since they are in a position to monitor the future plans for rigidity of their company. The solution allows the treasurers to use the tool to align strategic cash flow plans as well as capital vis a vis the actual performance. Supply chain finance programs and other capital working solutions are strategic toolsets for enabling a treasurer to improve the working capital proactively and reduce conversion cycle of cash. They ensure that the demands of short-term liquidity are met, satisfied and used in the achievement of quarterly cash flows.