Welcome back, my friends.
Let's get back again to the importance of Working Capital Management.
Let's have not a real example,
but a little bit more complicated example.
Let's suppose you have a gas station.
I mean, let's suppose you were given
a small gas station company for you to work. What's going to happen?
Initially, net fixed asset is exactly equal to net worth.
So we're going to have fixed assets,
1000 and net worth, 1000.
Assets equal to liabilities. No problem at all.
The company, let's also assume that a company generates sales of just $1,000,000 a day,
just for the sake of simplicity.
Let's all assume that it's necessary to keep seven days worth sales as of inventory.
So, given the fact that a company sells $1,000,000 a day,
the company needs seven days worth sales of inventory.
So inventory is going to be seven million, right?
Let's also assume the average collection period is 21 days,
what does that mean 21 days?
It means that, despite the fact that you sell $1,000,000 a day,
receivables is going to be $21,000,000.
One million times 21 days, $21,000,000.
And, let's also suppose that the average payment supplier period is just one day.
Do you understand the difference here?
You will receive in 21 days,
but you have to pay to your supplier in one day.
I might be wrong.
But I do believe,
this company is going to not generate enough cash.
But let's see what's going to happen.
Assuming that you do not have access to own resource,
for example you cannot rely on third party loans.
You cannot ask the owner of the company to allocate more money.
We understand that the company will need to get funds
from banks at the amount of $27,000,000.
Guys, this is absolutely important.
For example, do you remember that we discussed that eventually a company will use
an assumption to establish a strategy euphoric asset used,
euphoric cost of goods sold,
you end up with a gross profit,
but if you do not manage your working capital,
you end up with an increasing bank loan of $27,000,000.
This $27,000,000, obviously, will end up with a much higher financial expense
that your originally profitable company is
no longer going to be profitable because you have to pay financial expense,
because you do not manage your working capital.
Let's check all the time.
Let's have another example.
Let's suppose now a supermarket.
You were given a supermarket.
Initially fixed asset is exactly equal to net worth.
Let's use just $50,000,000,
$50,000 whatever it is $50,000,000 just to get simple.
Again, assets, liabilities, asset,
net fixed asset $50,000,000,
net worth $50,000,000, asset equal to liabilities, balance sheet.
The company, assumed generate sales of $1,000,000 a day,
no profit, let's think just that.
Also, let's assume that it's necessary to keep seven days worth sales as of inventory.
So inventory, again, is going to be $7,000,000.
So your inventory $7,000,000.
The average collection period,
check difference from the previous month.
The previous month average collection period was 21 days.
Now the average collection period is just one day.
You have to pay everything.
I mean, you're going to have to receive everything in one day.
The average payment period supplier is now 30 days.
Do you understand the difference?
You buy raw materials,
you purchase something and you have 30 days to pay.
You sell something and you're going to receive tomorrow.
I might be wrong,
but I think in these example we are going to generate excess of cash,
because of our working capital management.
The company obviously does not need additional work capital.
In fact, as the supermarkets sell with the average collection period of just one day,
and purchase with an average payment period of 21 days.
The mismatch between payment period and collection period
leads to an excess of cash of $22,000,000.
So if your company was profitable,
now it's going to be more profitable,
because this excess of cash due to
your correct management of working capital will generate financial revenues.
Financial revenues add up to operating cash profit,
you end up with a much higher net profit.
I know, not just all the time but that's why I'm here,
just to you to say that budget is important,
strategy is important, but never never never forget your working capital.
It's important for cash flow what matters,
we will speak later on, is the change in working capital between one year and another.
We will check. Relax. We will check later on.
Let's assume in the previous example,
that the average period decreased to 14 days.
Do remember the average period at that time was just 30 days?
Now the average period,
the payment period is 14 days.
If the company has enough cash,
do remember that the company was generating enough cash.
But now for some particular reason,
your suppliers say I'm not going to give it 30 days tenure.
I'm not going to give you 30 days credit.
I'm not going to give it 30 days tenure for you to pay what you buy.
I'm just going to give you 14 days.
So, given the fact that you had generate
cash and now the average payment period decrease from 20,
30, to 14 days,
the company has enough cash to invest in working capital.
There is no need yet to get funds from banks offer all the assets.
So suppliers, will move from $30,000,000 to $14,000,000 and your cash,
that was $22,000,000 before,
now it's going to end up with six million dollars.
Why? Because you manage your working capital appropriately.
So now let's assume the average payment period decreased to 14 days.
Do you remember, that average payment period at that time,
I mean the previous example was 30 days.
So what's going to happen with my supplier?
My account suppliers?
Supply is going to decrease from $30,000,000 to $14,000,000. What does that mean?
The supplier that used to give a 30 days to pay for your acquisition,
now your supplier is going to give you just 14 days.
So you provide credit to your supplier.
Given the fact that you had enough cash of $22,000,000 in the previous example,
given the fact that now you given less tenure to your supplier,
you need to consume,
use this excess of cash.
Initially was $22,000,000, now you end up with just six million dollars, why?
22, 30 minus 14,
we end up with less cash.
The company, fortunately has enough cash to invest in working capital.
Therefore, there is no need to get funds from banks,
or other sources to make matters much better.
With this excess of cash like the previous example,
you can get financial revenues by investing
this excess of cash in some certificate of the depositor,
or hedge funds, whatever it is.
Financial needs, we have discussed ad nauseam about working capital.
What do you understand about financial needs?
Is the need of financing consider all source.
Now we are just go see the operating cash flow,
but a cash, or a cash flow for a company,
we need to consider all source not just to operating activity.
I know, I know it just gets a little bit more difficult,
but lets go step by step. We will understand.
The need of financing considering all source not just the operating cash flow,
all source and use the fund,
is different from working capital.
As the later consider only the operational or operating account.
Now we're going to check all source of funds and also use of funds.
It's just the basic concept is pretty much the same,
but it's going to use what really impacts all cash flow of a company,
and not just operating activity.
For example, we have an example here,
we see that in this company, what we see?
The company is performing a much better,
much better result in terms of evident margin and operating margin.
Can you see that in terms of operating margin it's getting better,
but less than one year the company went bust.
What happened with that company?
How come you just showed to your boss,
you just did a budget analysis,
you just use old microcosm driver to forecast sales, cost,
and you believe that,
that company is going to end up with a profit,
and that was a profit as well.
As you can see, margin, operating margin improved.
But why on earth that company went down,
went bust later on, why?
Check in the balance sheet.
Look what happened to the balance sheet.
The tenure of supply,
and the tenure of tradeables, for example receivables,
we give more average collection period,
obviously you sell more,
because you provide credit to your buyers,
to your client, all the way around.
You sell more, but you have to pay at the much lower tenure to your supplier.
So what did kill this company?
Despite the fact that their operating margin got better.
Working capital.
I know, again and again and again we can't just going to check and I promise one day,
maybe I will stop talking about working capital,
but I don't think it's going to stop in this lesson.
For example, just to end up financial management.
Is absolutely crucial for your business as we have discussed already.
Always consider your budget under a cash basis perspective.
It does not matter how well the budget incorporates your sales and cost forecast.
If you fail to manage the working capital,
the leverage of your company certainly will deteriorate your business perspective.
I promise, I will revert with that concept again,
but in a much higher complication.
See you in a couple of minutes. Stay tuned.
Alberto Sansiviero Jr.MBA
Samantha MazzeroMSc, MBA, BS Math
Nelson YoshidaPh.D., MBA, B.Eng.
Roberto Dumas DamasM.Sc., CFA
Fernando FleuryPh.D.
