Author: Willem van Barneveld Student number: 1475657
Thesis supervisors: C.P.A. Heijes W. Westerman Company supervisors: E. de Kroon
improvement. If you cannot measure something, you cannot understand it. If you
cannot understand it, you cannot control it. If you cannot control it, you cannot
improve it."
E
XECUTIVE SUMMARY
The goal of this research is improving the current view on working capital analysis of the management accounting department of CSM, a listed mid cap company at the NYSE Euronext Amsterdam.
In order to come to recommendations academic literature, practitioner journals, company interviews, and documents on current working capital reports were analyzed. The starting point was constructing a theoretical framework for analyzing the drivers of working capital which could be controlled by CSM. Secondly, analyzing the working capital reporting gave a view of existing working capital management. Finally, current and alternative performance indicators were evaluated against generally accepted criteria.
The recommendations of this research are focused on improving the quality of working capital management by supplying more detailed, but relevant, information, complementing current efficiency measures with effectiveness measures to put performance in a wider perspective, and introducing the latest performance measures used in the field of working capital management. According to the components of working capital the findings and recommendations will be summarized below.
D
EFINITIONDuring the research on working capital management within CSM multiple interviewees were dissatisfied with the current definition and performance evaluation. The main causes of this were the biasing factors in the measurements due to intercompany sales and management fees. Therefore the first recommendation is to simplify the definition of working capital to evaluate “real” working capital performance. Excluding the latter will evaluate performance that impacts CSM as a group.
Q
UANTITATIVE WORKING CAPITAL ANALYSISA
CCOUNT RECEIVABLEThe most significant account receivable drivers that are under control of CSM are sales terms and collection process. Currently CSM measures/monitors performance by Days Sales Outstanding (DSO) which assesses the efficiency of the combined performance of these drivers. Additional insights would be given if these drivers were monitored separately. Therefore it is recommended to include the measures Best Possible Days Sales Outstanding (BPDSO) and Average Days Delinquencies (ADD) to the periodic reporting.
Moreover, to complement the efficiency measure on the collection process the Collection Effectiveness Index (CEI) is recommended for implementation. This measure captures the quality of collections more accurately than bad-debt-to-sales and communicates performance by a single number.
I
NVENTORYInventory cannot be considered as a whole since levels of raw materials, work-in-progress, and finished goods are influence by different drivers.
Finished goods inventory drivers are customer service levels and forecast accuracy since they determine the level of safety stock and variety of SKU’s being held. Cost trade-offs can increase the level of inventory further. Work-in-progress level is determined by the design of production and is therefore difficult to influence. Only a fraction of total inventory can be accounted to work-in-progress therefore it is considered less relevant. Finally, raw materials inventory levels. The level is influenced by production, through finished goods, and supplier’s performance. The current DIO takes into account the aggregated efficiency which does not provide much information on each inventory component. It is therefore recommended that Days Raw Materials (DRW), Days Work-In-Progress (DWIP), and Days Finished Goods (DFG) are introduced.
The effectiveness of inventory management is determined by which part of inventory is to be used in the nearby future. To monitor the effectiveness and give a representation of the quality of inventory it is recommended to introduce the Inventory Quality Ratio (IQR).
A
CCOUNT PAYABLEBetter analysis would be derived when these drivers were monitored on a individual basis and therefore it is recommended to introduce Best Possible Days Payable Outstanding (BPDPO) and Average Days over Terms (ADT)
Q
UALITATIVE WORKING CAPITAL ANALYSISThe recently implemented qualitative working capital analysis (narrative) has hitherto not proven to be of additional value to working capital analysis and improvements. Currently the quantitative analysis is put in a textual form and submitted focusing on drivers out of CSM’s reach, as for example commodity price risings or seasonality.
P
REFACE
For the completion of my Masters it was always my ambition to write my thesis on a business case as an addition to the years of theoretical education. This desire was realized by doing an internship for four months at the management accounting department of CSM, Diemen. Focusing my research on working capital management, specifically on the analysis and reporting of accounts receivable, inventory, and accounts payable. Within these four months I have gained valuable experience in the field of working capital management and in the field of management accounting. These insights were especially valuable considering my upcoming employment as a Business Analyst.
First of all I like to thank Erik de Kroon, my supervisor at CSM, for all the effort and time he dedicated to me and this research. The frequent reflections led me to a research that can contribute to working capital management at CSM, as well having academic relevance concerning the field of working capital. Furthermore I like to thank Bratislav Zivadinovic for his critical view, on everything. Moreover, I like to thank all the people at CSM, with an emphasis on management accounting, supporting this research and reserved time for me to come to them with questions.
Secondly, I would like to thank Coen Heijes for helping me structuring my ideas, and guiding me toward this final result. Every time I came back from our meetings it was clear to me what to do to overcome the difficulties that I faced during this research.
T
ABLE OF CONTENT
Executive summary...2 Preface ...5 Table of content...6 List of Figures ...8 List of tables ...8 List of Abbreviations...9 Chapter 1. Introduction ...10 1.1. CSM ...10 1.2. Relevance ...12Chapter 2. Aims and objectives ...14
2.1. Aim...14 2.2. Objectives...14 2.3. Research question ...14 2.4. Contribution...14 2.5. Thesis structure...15 Chapter 3. Methodology ...17 3.1. Type of research...17 3.2. Data collection...17
3.3. Conditions of the research ...18
3.4. Planning of the research ...19
3.5. Quality of the research...19
Chapter 4. Conceptual Framework...21
Chapter 5. Theory and Literature review ...22
5.1. Current state of working capital research and literature...22
5.2. Working capital...24
5.3. Account receivable ...28
5.4. Inventory...30
5.5. Account payable ...31
5.6. Conclusion...32
Chapter 6. CSM’s working capital performance ...33
6.1. Data and measurement ...33
6.3. DSO...34
6.4. DIO ...35
6.5. DPO ...35
6.6. Conclusion...36
Chapter 7. Drivers of working capital...37
7.1. Working capital...37
7.2. Account receivable ...38
7.3. Inventory...40
7.4. Account payable ...43
7.5. Conclusion...44
Chapter 8. Working capital reporting at CSM...45
8.1. Definition...45
8.2. Reporting...46
8.3. Measurement...48
8.4. Interviews ...49
8.5. Conclusion...53
Chapter 9. Performance measurement alternatives...55
9.1. Performance measurement criteria...55
9.2. Measurement alternatives ...58
9.3. Conclusion...70
Chapter 10. Recommendations...76
10.1. Definition...76
10.2. Quantitative performance measurement...76
10.3. Qualitative performance measurement...79
Chapter 11. Conclusion...80
11.1. Limitations...81
11.2. Further research ...82
References ...84
Appendix I Interview characteristics...90
Appendix II Peer group benchmark data...91
Appendix III CSM’s working capital analysis ...93
L
IST OF
F
IGURES
Figure 1: Stylized representation of organizational structure CSM...11
Figure 2: Conceptual framework...21
Figure 3: Checkley's real business model ...24
Figure 4: Working capital definition Preve & Sarria-Allende...27
Figure 5: Accounts receivable process...29
Figure 6: Supply chain process...31
Figure 7: Account payable process...32
Figure 8: Cash conversion cycle...34
Figure 9: Days sales outstanding...35
Figure 10: Days inventory outstanding ...35
Figure 11: Days payables outstanding ...36
Figure 12: Impact of seasonality and growth on working capital ...38
Figure 13: Diagnostic control elements...55
Figure 14: Classification scheme IQR...66
Figure 15: CSM's 2010 CCC rank...91
Figure 16: CSM's 2010 DSO rank...91
Figure 17: CSM's 2010 DIO rank...92
Figure 18: CSM's 2010 DPO rank...92
Figure 19: Graphical display working capital trend analysis ...93
Figure 20: Example of corporate reporting ...94
L
IST OF TABLES
Table 1: Process and output criteria of performance measures ...57Table 2: Selected performance measurement criteria ...58
Table 3: Comparison Lewellen (1973), Stone (1976) and Aging schedule...64
Table 4: Account receivable performance indicators score on criteria...71
Table 5: Inventory performance indicators score on criteria ...73
Table 6: Account payable performance indicators score on criteria...74
Table 7: Interview characteristics...90
L
IST OF
A
BBREVIATIONS
ADD Average days delinquency ADT Average days over terms
AP Account payable
AR Account receivable
B2B Business to business
BPDPO Best possible days payables outstanding BPDSO Best possible days sales outstanding BSEU Bakery supplies Europe
BSNA Bakery supplies North America
CCC Cash conversion cycle
CEI Collection effectiveness index CFO Chief financial officer
CP Credit period
CSM Centrale Suiker Maatschappij (Central Sugar Organization)
d Discount percentage
DFG Days finished goods
DIO Days inventory outstanding DPO Days payable outstanding
DP Discount period
DRM ` Days raw materials DSO Days sales outstanding DWIP Days work-in-progress
EBITDA Earnings before interest, tax, depreciation, and amortization ERP Enterprise resource planning
FNO Funds needed for operating
INV Inventory
NV Naamloze vennootschap (Limited liability company) NYSE New York Stock Exchange
SKU Stock keeping units
WACC Weighted average cost of capital
Chapter 1. I
NTRODUCTION
1.1.
CSM
1.1.1.
CSM’
S BACKGROUNDThe “Centrale Suiker Maatschappij” (CSM) was born from a consolidation within the sugar industry within The Nederlands in the 1920’s after the abolishment of subsidies on refined sugar by the Dutch government. After the consolidation only two competing sugar producers were left in the Dutch market. Within the ‘20’s CSM expanded internationally, to Belgium, the UK, and Eastern Europe. However, the economic crisis in 1929 and the collapse of the sugar market abruptly reduced the amount of plants to six, mainly operating in the Netherlands and Belgium. After the war CSM started diversifying with by setting up a sugar R&D division. However, due to the acceptation of European Community regulation in 1968 the future outlook for the sugar market diminished further. Therefore it merged its biochemical division with a key producer of lactic acids to diversify its business in a faster pace.
In the 80’s CSM diversified into the food industry acquiring KSH, the owner of the Honig brand. From this time on CSM regularly added smaller Dutch based companies as Royal De Ruiter, Venz, and HAK to its portfolio. However, the diversification into the food industry positioned CSM as a direct competitor of global players Nestlé and Kraft foods, forcing CSM to reassess their strategy. This reassessment resulted in the acquisition of confectionary brands making sweets, chocolates and peppermints.
In 1991 only two of the Sugar producing facilities were left after decades of divestments. CSM refocused its strategy, divested a part of the confectionary division, and acquired Arizona Bakery Sales in 1994 and changed its focus to bakery products. By buying Unilever’s Bakery division in 2000 and adding more bakery companies from North America and Europe to its organization CSM became the largest bakery supplies manufacturer in Europe and the second largest in North America.
Today CSM is a global manufacturer of bakery supplies and lactic acids after divesting the confectionary and sugar producing businesses. Currently CSM can be divided into two segments, bakery supplies and biochemical lactic acid business.
supermarkets, takeaways, caterers and coffee chains. Revenue of the bakery branch accounts for 87 % of CSM’s revenue.1
The lactic acid business is formed by Purac, which is a leading player in the field of food preservation, green chemicals and bio plastics components produced from lactic acid, lactic acid derivatives and other fermentation-based products. Purac is active in preservation, mineral fortification and green chemicals for the food, health care, chemical and polymer industries. CSM operates worldwide and generates annual sales of nearly € 3 billion and has a workforce of around 9,700 employees in 28 countries. CSM is a limited liability company, listed on NYSE Euronext Amsterdam.
1.1.2.
CSM’
SO
RGANIZATIONALS
TRUCTUREWith presence in several geographic locations CSM uses a divisional structure which consists of Bakery Supply North America, Bakery Supply Europe, CSM International, and Purac. Each division has operating companies categorized by geographical location. Within the divisions a matrix structure ensures that there is a customer focus throughout the company. The board of directors and the main finance functions as tax, treasury, internal audit, financial accounting, together with procurement, HR and IT are centrally coordinated from the Netherlands to ensure common effort toward the goal of value creation. A stylized organizational chart is displayed below in Figure 1.
Figure 1: Stylized representation of organizational structure CSM
1.1.3.
T
HE MISSIONThe mission of CSM is to make customers successful by creating unique experiences through the best products, technologies and services. Combining products and services to provide effective solutions based on knowledge of customer requirements. This means going beyond understanding customers’ needs, by also understanding the consumers’ needs.
1.1.4.
C
URRENT TRENDSCurrent trends that affects CSM‘s business are that end users are being more aware of the impact food has and try to maintain a more healthy diet. Therefore the demand for sweet products is diminishing and consumers are looking for healthier alternatives. Secondly, there is an ongoing volume decline due to lower end user consumption of bread and bread related products in the United States and Europe.2 The third trend affecting CSM’s business is the rise of commodity
prices. Within recent years commodity prices have risen significantly.3 (Bok, 2011; De Kroon,
2011) Due to this price rise the margins of CSM’s product are under pressure. Higher prices are not only affecting CSM’s margins but also demand more working capital to finance short term operations.
1.2.
R
ELEVANCEThe relevance of this thesis is illustrated by the next newspaper article headline. “Het Financieele Dagblad” stated after the, second consecutive, profit warning “CSM’s CEO Gerard Hoetmer has lost control over its company”. (Bartjens, 2011) The author of the column calculated that CSM is closing in on its critical debt level of 3.5 times EBITDA. Crossing this ratio would violate bank covenants and put the company into default. At year end 2010, the net debt ratio was 2.6 EBITDA, however, due to a large increase in working capital of € 97 million and diminishing profit margins in the first half of 2011, third quarter ratio was up to a critical 3.0 times EBITDA. (CSM NV, 2011c)
In case of CSM exceeding the ratio of 3.5 EBITDA it would violate its bank covenants and would be therefore in default. The consequence of being in (technical) default could be a higher interest on the loan, or even worse, a call of the loan.
Working capital plays a crucial role in this debt problem, since the amount of working capital used influences the net debt position of the company. Using working capital more efficiently reduces the need for capital and improves the debt ratio. Therefore working capital
Chapter 2. A
IMS AND OBJECTIVES
This thesis is written at the corporate management accounting department at CSM during a period in which the company is concerned with working capital. The objective of this thesis is not to resolve the working capital problem by giving an optimal level of working capital. Instead it will contribute by analyzing drivers of working capital and complementary performance indicators to improve reporting and analysis.
2.1.
A
IMThe aim of this thesis is to give corporate management accounting insights in the drivers of working capital and possibilities to monitor them with the focus of improving reporting and analysis. Thereby improving control over working capital.
2.2.
O
BJECTIVESThe objectives of this thesis are:
To identify the drivers of working capital.
To determine which drivers are suitable for being included into the periodic reporting. To compare current working capital reporting with derived drivers from theory. To develop possible complementary measures based on working capital drivers.
2.3.
R
ESEARCH QUESTIONThe above research objectives lead to the following research question:
What are the drivers of working capital that can be measured and can improve the periodic reporting and analysis of CSM’s corporate management accounting department?
2.4.
C
ONTRIBUTIONSecondly, the current academic literature on working capital drivers is only limited.4Most of the
information on drivers of working capital comes from practitioner´s publications and books. In this thesis we define practitioner articles as articles from professional periodicals and articles published by consultants, treasurers, and credit and procurement managers on working capital, account receivable, account payable and inventory management. An exemption has to be made to inventory management since this is the field of operations research and supply chain management where much academic research has been published.
The contribution of this thesis will be assessing which working capital drivers play a significant role in working capital management compared to those that are described in the current academic literature. Furthermore it will use the outcomes of the case study to update on the current practice of working capital management.
2.5.
T
HESIS STRUCTUREThe thesis started with a short introduction of CSM. Hereafter the aim, objectives and research question were introduced to guide the reader towards the final goal of this thesis.
Chapter three will discuss the methodological approach to the research that ensures a high quality research. Chapter four discusses the combined conceptual/research framework and gives a graphical representation of the research.
Chapter five continues with the discussion on the current state of working capital. Furthermore it explains the working capital concept, the definitions and its components.
Chapter six attends to the current and historic performance on working capital management at CSM by benchmarking it against an internally selected peer group. The underlying drivers of this performance are discussed in chapter seven based on the theory and interviews held with key employees within CSM.
After determining the drivers of working capital performance the current monitoring and analysis of working capital is evaluated in chapter eight.
In order to supply CSM with alternative performance indicators chapter nine discusses these alternatives and the criteria by which they are evaluated to qualify for inclusion into the periodic working capital reporting and analysis.
Chapter ten combines the analyses of drivers, current reporting and alternatives and recommends on possibilities for improving working capital analysis and reporting.
Chapter 3. M
ETHODOLOGY
This chapter presents the methodology which is the basis of a research. Methodology is concerned with the effective, verifiable, professionally credible and efficiently approach of research to ensure quality of the outcome (De Leeuw, 2005). Firstly, the type of research is established. The subsequent paragraph is concerned with the data collection. Thereafter the conditions of the research are discussed. The last paragraph deals with generalisability and reliability to define the quality of the research.
3.1.
T
YPE OF RESEARCHDe Leeuw (2005) classifies research according to their product type. In the classification there exist five types of research. Although this research can be classified as policy supporting, which is a form of practical research, it can also be classified as a case study on current working capital practice. The main difference between scientific- and practical research is the type of knowledge generated. Scientific research focuses on an expansion of the general knowledge, whereby practical research provides knowledge to specific management problems. De Leeuw (2005) defines policy supporting research as research with a focus on generating specific knowledge that is applicable in a specific situation for the customer, thereby satisfying a pre-specified part of the knowledge requirement. For this research knowledge is generated for CSM on the topic of working capital analysis. However, as a case study it also contributes to the general knowledge on working capital management verifying or opposing current paradigms.
3.2.
D
ATA COLLECTIONThe data is collected by several methods and from different sources to verify the validity of the information. Triangulation was done by means of different methods described by De Leeuw (2005) as:
3.2.1.
D
ESK RESEARCH3.2.2.
I
NTERVIEWSThere is a variety of interview methods ranging from highly structured to open and from a single interviewee to group interviews. Interviews can, compared to a survey, acquire more in-depth knowledge about a topic. By using an open form of interviewing the researcher can come to new insights because the interviewee is given room to put forward new insights. (De Leeuw, 2005) Data was collected through a semi structured one-on-one interview with employees concerned with working capital aspects and management accounting of several layers within the organization. Not only financial staff was invited for interviews, also sub company- and divisional staff that are confronted with the working capital reporting were interviewed. Furthermore, planning and logistics employees were involved in the research to give a complete picture of working capital processes and reporting within CSM. However, the focus of the interviews was on the three sub topics of working capital, accounts receivable, payable and inventory. For these interviews working capital champions5from within the organisation were
approached. The topics of the interviews concerned the drivers of working capital, the current working capital reporting, the day to day management of working capital accounts, and possible improvements to the monitoring and analysis. An overview of the interviewees is presented in Appendix I. Summaries of the interviews are included in Appendix IV.
3.2.3.
P
ARTICIPATING RESEARCHBeing on the work floor and accumulating information through conversations and discussions can be classified as participating research when this leads to knowledge accumulation on the research topic. (De Leeuw, 2005) Within the four months of research at CSM, valuable information was gathered by being in the presence of employees working on working capital analysis. Overhearing problems and considerations provided extra input for the solution of the working capital analysis problem. Being in the proximity of the discussions on working capital by employees and discussing with them about the best way of measuring and monitoring working capital resulted in a more complete understanding of the problem. Taking the contingencies into account to match the needs of CSM.
3.3.
C
ONDITIONS OF THE RESEARCHThe research is subjected to a priori conditions. Conditions concerned with the end product for CSM and the process. For this thesis the conditions are:
The research will be conducted for CSM’s corporate management accounting department. Employees of CSM support the researcher in his research.
The report focuses on improvements on working capital reporting and analysis.
The thesis is written in accordance to the academic standards. The thesis is completed within six months.
3.4.
P
LANNING OF THE RESEARCHThe research period totaled six months in which the following phases are identified: September: Introduction to the company, literature review. October: Literature review, design of research.
November/December: Design of the research, collecting data, and interview employees. January/February: Thesis writing.
3.5.
Q
UALITY OF THE RESEARCH3.5.1.
G
ENERALISABILITYThis research can be classified as a policy supporting research. However, it has also the characteristics of a single case research. Both these classifications limit the generalisability of the research to certain extend to a wider population. Moreover, collecting data by semi-structured interviews with an exploratory character limits the generalisability further. Although these restrictions arise, Yin (2003) states that case studies can be used for generalization whenever the case is part of a class, which is defined by theoretical constructs or empery.
3.5.2.
R
ELIABILITYDe Leeuw (2005) labels a research as being reliable when outcomes are similar when the research is reproduced and similar findings are presented while all other variables remain constant. This definition is not attainable for a case study within a dynamic environment as with CSM.
To ensure that reliability of the research is optimized, literature on working capital-, short term capital-, and cash management was studied thoroughly before the research started. Furthermore, multiple professional periodicals were included to ensure the most recent knowledge was gathered by the researcher. Because of the internship at the company multiple points of view were collected from employees being in the field of working capital for over 10 years. These insights contributed to the understanding and knowledge of working capital, to ensure a reliable outcome of the research.
Chapter 4. C
ONCEPTUAL
F
RAMEWORK
The conceptual/ research framework in Figure 2 gives a graphical overview of the research.
Figure 2: Conceptual framework
The conceptual/research framework outlines the research in the figure above. The first step in the research was to evaluate the current literature on working capital and interview employees of CSM to determine the drivers of working capital.
The second phase is the evaluation of the performance indicators that monitor working capital performance. The first step in this phase is to exclude the drivers that are exogenous to the company. Thereafter performance measurement alternatives were generated internally from the interviews but also from practitioner´s and academic literature.
Chapter 5. T
HEORY AND
L
ITERATURE REVIEW
Chapter five evaluates the current literature on working capital, introduces the concepts and definitions of working capital together with its components, and describes the processes of which working capital is the result.
5.1.
C
URRENT STATE OF WORKING CAPITAL RESEARCH AND LITERATUREIn this paragraph the available literature is discussed and evaluated for its relevance to the thesis. The selection of literature used for the review on the definition and measurement of working capital and its components comes from books which focus on working capital management (Preve & Sarria-Allende, 2010; Scherr, 1989), short term financial management (Checkley, 1994; N. C. Hill & Sartoris, 1995; Maness & Zietlow, 2002) and operations management (Lysons & Farrington, 2006; Slack, Chambers, & Johnston, 2004; Wisner, Leong, & Tan, 2005).
From the above selection of books on working capital, short-term financial management and operations management a first indication can be derived as to what extend researchers are attributing their time to or what new findings are done in each field. It can be seen that the time between reoccurrence of a book on working capital is twenty year. For short term financial management this is approximately five years, and the reoccurrence of a new book on operations management is every year.
The slow progress of working capital knowledge is illustrated by the bibliometric research of Viskari et al (Viskari, Lukkari, & Kärri, 2011). According to Viskari et al. (2011) articles from academic literature on working capital occur only sporadic with 23 publications in the last two decades. Moreover, the above mentioned author concludes that there are only two streams of research that produce the majority of the research. The first stream of researchers are concerned with the working capital practices in different contexts and determinants of these working capital practices. The second stream considers the impact working capital has on risk taking and profitability.
Besides the above research fields Viskari et al. (2011) found article deviating from the mainstream topics. One of these researches is conducted by Chen et al (2009) developing a tool for cash management especially for construction companies.
understand the benefit-cost tradeoffs in working capital management (Reilly & Reilly, 2002), management of operational working capital and releasing cash from the company’s processes (Kaiser & Young, 2009), and the importance of working capital in loan negotiations(Kaiser & Young, 2009; Strischek, 2002).
In the above review only working capital papers were considered to give an indication of the current status of this field of research. The same can be concluded for the individual accounts of working capital except for inventory management since this has been the domain of operations and logistics management where multiple publications exist.
The inventory/supply chain aspect has been researched quite well and published in academic journals as ‘Annals of Operations Research’, ‘International Journal of Operations and Production Management’, ‘Journal of Operations Management’, and ‘Operations Research’. Although the field of operations is relatively well researched, only recently the attention for the financial aspect of supply chain management has originated (Protopappa-Sieke & Seifert, 2010).
Apart from the information gathered from the books on working capital management, short term management, and supply chain management academic articles, as described by Viskari et al. (2011), for working capital as a total, are relatively nonexistent. Knowledge on this topic had to be derived from practitioner´s papers.
For accounts payable and receivable management the main sources of papers came from `Managing Accounts Payable`, ‘Financial magazine’, ‘Global treasurer magazine’. Furthermore, papers and insights were collected via the portals of `Global treasurer`, `CFO magazine`, `Association for Financial professionals`, `Credit Research Foundation` , and `Institute of Credit Management` to support the theory with up to date findings based on surveys or case studies by experts.
Next to practitioner literature, internally available consultancy literature from CSM was included. This literature was available from prior working capital projects done at CSM when the company experienced similar problems with rising commodity price affecting working capital and profitability. From this literature (Bank of America Merrill Lynch, 2011; Just One Consultancy, 2008) insights into working capital management were distilled.
5.2.
W
ORKING CAPITALWithin a company there are two aspects of financing; long term and short term financing. Long term financing entails guarding and controlling the solvability and capital structure of the company whereas the short term is focused on the liquidity and alignment of cash inflows and outflows, considering the stage of the company. Scherr (1989) divides financial management in three function:
Long term asset management; capital budgeting
Long term capital management; capital structure management
Short term asset and liability management; working capital management
Working capital management is coping with the uncertainty and timing differences related to the business cycle of a company. In Figure 3 the business cycle of a manufacturing firm is described according to Checkley (Checkley, 1994).
Figure 3: Checkley's real business model
receivable will eventually convert in cash. Due to the timing difference between distribution and receiving cash working capital has to be maintained to finance operations during this period.
5.2.1.
O
BJECTIVEThe working capital problem of illiquidity arises due to the non-instantaneous and unsynchronised nature of three activities, production, sales, and collection of funds, discussed above (Richards & Laughlin, 1980). Working capital is held to cope with uncertainty regarding demand, prices, quality and availability of its own products and of its suppliers. Moreover there are limitations to production and technology which can be applied, and information asymmetry causes substantial uncertainty. To tackle these problems the firm possesses many strategies however strategies that utilize investment or financing with working capital has significant advantage over others (Scherr, 1989).
Contradicting to the objective of coping with uncertainty by using working capital strategies is the financial objective of a firm. The main objective from a financial perspective is to maximize value for shareholders, which is realized through a high share price. Working capital influences the amount of capital needed to realize a profit and by attaining the same profit with less capital invested, share prices should increase. In practice this translates to maximizing the present value (PV) of operating cash inflows –operating cash outflows (Maness & Zietlow, 2002).
Endless maximization however, is constrained by legal and ethical motives, by the need to provide adequate liquidity, and by the need to keep customer and supplier service on an acceptable level (N. C. Hill & Sartoris, 1995). To realize an optimum tradeoffs have to be made between operational and financial aspects of the business. A discussion on the tradeoffs within working capital management will be held for each component of working capital in paragraph 7.2, 7.3, and 7.4.
5.2.2.
I
MPORTANCETraditionally the contribution of working capital management to value creation has gained lesser attention in research than long-term financing although a large amount of the financial manager’s time and attention is spend on short term financing (Weston & Brigham, 1979). Not only manager’s time and attention are taken up by working capital. Funds included in current assets are around 25% of total assets therefore affecting profitability significantly (Deloof, 2003). Moreover Checkley (1994) demonstrates that working capital changes have a larger impact on profit than sales does.
effectively. Deloof (2003) complements this with the fact that there is a positive relationship between efficient working capital management and profitability in Belgium firms. These findings were supported by similar research for different regions and industries (Baños-Caballero, García-Teruel, & Martínez-Solano, 2010; Dong & Su, 2010; Jose, Lancaster, & Stevens, 1996; Lazaridis & Tryfonidis, 2006; Porwal & Agarwal, 2011; Raheman, Afza, Qayyum, & Bodla, 2010). The importance of working capital is that effective working capital management reduces cost and short term financing needs, gives a better view of the organisation’s processes, builds better supplier relationships and improves the shareholders relationship (Kieft, 2011).
The importance of working capital can also be illustrated from practice. A research among 355 senior finance executive concluded that releasing cash in times of a recession by a strong discipline in working capital did not only improve liquidity, it also caused a strong discipline in operations which resulted in significant improvement in productivity (Driscoll, 2012). However, working capital efficiency is not a driver of improvements; it is merely a measure of improvements that the drivers create (Richman, 1995).
5.2.3.
D
EFINITIONWorking capital is frequently described as the lifeblood of a company. However, the definition of working capital differs between authors. Scherr (1989) defines working capital management, from a financial perspective, as the management of the top half of the balance sheet, thereby defining working capital as current assets minus current liabilities. This static definition is supported by Checkley (Checkley, 1994).
seen, part of working capital. However, most articles and books refer to net working capital as working capital, thereby netting excess cash positions against debt.
Figure 4: Working capital definition Preve & Sarria-Allende
As can be seen above, the distinction between long- and short term character of financing is made and FNO reflects what the other authors define as working capital.
Reilly and Reilly (2002) define working capital in a contradicting way, different than currently done in the finance literature where it is considered as a static concept. From a financial point of view an acceptable definition of working capital has a balance sheet focus, which is the domain of financial specialists. However, according to Reilly and Reilly (2002) working capital should be defined as the net investment required carrying out business activities in an environment where the purchasing, production, sales and distribution processes of the firm are non-instantaneous, unsynchronized and uncertain.
5.2.4.
C
ONCLUSIONWorking capital has a variety of definitions which vary from static to dynamic and from narrow to wide. The most common, and most feasible, approach to working capital is the narrow dynamic one. This reflects the nature of working capital and provides a workable bases since not all cost of operating can be extracted from financial statements. Furthermore, the importance of working capital was outlined, and it can be concluded that an improvement in working capital has significant effect on the profitability of a firm. However, the level of working capital is affected by purchase and sales prices, and volume changes which can be caused by growth or seasonality.
The workable dynamic approach of working capital has accounts receivable, payable and Inventory as the main operational accounts. Therefore they will be discussed in detail in the next paragraphs to provide an accurate and detailed representation of the working capital elements by discussing separately their definition, their function, and the processes from which the accounts originate. In Chapter 7 the underlying drivers of these accounts will be discussed more thoroughly.
5.3.
A
CCOUNT RECEIVABLEAccount receivable is defined as money owed by customers, individuals or corporations, to another entity in exchange for goods or services that have been delivered or used, but not yet paid for. Hill and Sartoris (1995) define account receivable as an accounting recognition that sales have been made but cash flows have to be realized. Receivables usually come in the form of operating lines of credit and are typically due within a relatively short time period, ranging from a few days to a year. On a public company's balance sheet, accounts receivable is recorded as an asset because this represents a legal obligation for customers to remit cash for its short-term debts.
5.3.1.
FUNCTIONCredit sales is the universally practice in Business-to-Business (B2B) practice. (N. C. Hill & Sartoris, 1995) The occurrence of credit sales comes according to Maness and Zietlow (2002) and Ng (1999) from four motives:
Operating motive: Setting favorable terms to cope with demand fluctuations instead of installing extra capacity.
Contracting motive: customers can assess the quality of product and service and can withhold payment if agreements are not met. Moreover the separation of collection and delivery will enhance efficiency due to specialization of labor which results in lower contracting costs.
Pricing motive: increase sales by setting favorable terms instead of lowering sales price. Thereby pricing discrimination can be used to enhance sales
From the above motives the contracting motive is strongly supported by research. Convincing results for the other motives is not provided by the research field although there is limited support for the pricing motive to sell products on credit. There is however, no support for the operating motive to influence products sold by setting favorable terms in times of diminishing demand (Maness & Zietlow, 2002; Ng et al., 1999).
Hill and Sartoris (1995) state that prices and credit terms are interchangeable. Introducing more liberate credit terms is equivalent to a price decrease and can have affect on the sales volume. Therefore making it a marketing instrument used by sales to position the company’s products.
5.3.2.
P
ROCESSThe process of collecting accounts receivable is handled by the AR department. Although the AR department faces the responsibility of collection, other departments have influence on the size of the collectables in phases prior to the collection. To understand this we will discuss the sales and collection process briefly in Figure 5.
Figure 5: Accounts receivable process
The order handling phase is done by supply chain and isn’t the responsibility of the collection department but has an impact on collection process as we will discuss in Chapter 7.
The process for the collection department starts with invoicing and continues until the cash is collected. The length of this process is determined by the agreements made and the effectiveness of collection procedures. With invoices exceeding the period agreed upon overdues arise and these could, when not attained, transform in non collectables and bad debts, deteriorating the firm’s profitability.
5.3.3.
E
VALUATIONThe evaluation of account receivable is most frequently done by a financial turnover measure that expresses the amount of days funds are tied up in AR as Days sales Outstanding (DSO). For now this measure is used for evaluation. A further discussion of the performance measures is included in paragraph 9.2.
5.4.
I
NVENTORYInventory is defined by the Institute of Logistics and Transportation (1998) as goods and materials held by the organization in the supply chain or in a segment of the supply chain used internally or for sale which is expressed in quantities, locations or other values.
5.4.1.
F
UNCTIONThe function of working capital discussed above can be directly translated to the function of inventory. The main function of inventory is that it protects the company from uncertainty. Inventory separates demand from supply to ensure a steady and efficient manufacturing process. Therefore it is used as a buffer to be independent from lead time uncertainty and can smooth seasonal demand. Furthermore, it can be used to take advantage of favourable prices or can hedge against shortage and a price increase. (Lysons & Farrington, 2006; Slack et al., 2004)
5.4.2.
P
ROCESSdemand. In order to supply continuously, these levels have to be established and supplemented from production which drives the level of raw materials needed (Lysons & Farrington, 2006; Slack et al., 2004).
Figure 6: Supply chain process
5.4.3.
E
VALUATIONComparable to account receivable, Days Inventory Outstanding (DIO) evaluates the efficiency as a turnover and expresses it in a number of days. Evaluation of other measures will be in paragraph 9.2.
5.5.
A
CCOUNT PAYABLEAccount payable is the amount owed, from the purchase of goods or services, to the supplier. Accounts payable is presented in the liability section of the balance sheet. A/P is a form of credit that suppliers offer to their customers by allowing them to pay for a product or service after it has already been received (Schaeffer, 2007).
Payables, together with accruals, are a spontaneous source of financing for the firm’s investment in working capital generated by the operations of the firm (N. C. Hill & Sartoris, 1995; Maness & Zietlow, 2002). However, we will not go into the monitoring of accruals.
5.5.1.
F
UNCTIONThe function of account payable is similar to that of account receivable discussed prior only not the perspective is the other way around. Account payable provides the company time to ensure that the ordered goods are delivered in full and are received on time. Furthermore the quality of the goods can be assessed and payment can be withheld whenever it lacks.
5.5.2.
P
ROCESSThe process that leads to accounts payable is the purchase process. The process consist of several steps, the first step in this process is the selection of and negotiation with suppliers. After agreement on the quantity, price, and other conditions, the purchase contract is signed by buyer and supplier. Secondly, a purchase order is drafted by the buyer and send to the supplier containing the quantity and type of goods. After the submission of the purchase order by the buyer, goods will be received from the supplier. The received goods will be handled by warehousing, the invoice by the AP department who reconcile it with the quantity ordered and the price stated in the purchase contract.
Figure 7: Account payable process
5.5.3.
E
VALUATIONComplementing the evaluation of AR and inventory, Days Payable Outstanding (DPO) measures the efficiency of AP as a turnover expressed in days.
5.6.
C
ONCLUSIONChapter 6. CSM’
S WORKING CAPITAL PERFORMANCE
6.1.
D
ATA AND MEASUREMENTTo assess prior and current performance of working capital management from a financial perspective a peer group was formulated internally to benchmark CSM. Moreover Ek and Guerin (2011) argue that this is a method of assessing “the size of the price”, meaning the financial benefits that can be gained with working capital improvements.
The performance measurement uses the cash conversion cycle (CCC), since this measure is a rough indication of the efficiency by which working capital is managed. Furthermore the information is easily attainable from public statements, and the normalizing character of the measure makes it suitable for comparison (P. D. Hutchison et al., 2007; Richman, 1995).
The data covers annual year end data for the period 2006-2010. It is gathered from annual reports when available. Data of limited companies were retrieved from Deloitte’s industry benchmark (Deloitte, 2011). Year end data is used due to its availability among peer group companies. Furthermore sales are used to normalize CCC because it is easily retrieved and reduces comparison complications concerning profit margins.
The peer group is composed of thirteen companies in the food sector which have, to some extent, related bakery activities. Moreover, the peer group is selected from companies that operate in similar geographic regions. Compared to the peer group CSM has an average size based on 2010 sales. Sales of the peer group ranges from 500 million to 15 billion USD annually.6
For the comparison of working capital the widest definition of working capital is used within the limitation of the data. Firstly, net accounts receivable is used and is specified as total receivables, which includes trade and other receivables minus provisions for bad debt that are due within one year. Secondly, inventory is defined as raw materials, work in progress, finished products, and other inventory held for trade. Last, accounts payable includes trade and other payable which are due in one year.
The widest definition is used to approximate the total concept of working capital as discussed by Reilly and Reilly (2002), as they define working capital as the net investment required to continue business in an uncertain environment.
From Figure 8 the comparison between CSM and the peer group is made on a CCC level. The peer group is divided in a top tier, average, and bottom tier. The top and bottom tier group is constructed from average of the three best and worst performing companies.
6.2.
CCC
On a total CCC level CSM is performing below average of the peer group over the whole benchmark period. It can be seen that there was a drop in CSM’s efficiency of working capital management in the period 2006-2007 and from 2009-2010, although the latter drop was less severe it is more alarming since the peer group shows an upward trend in working capital performance (a drop in CCC) with a reduction of nine days for the top tier and the average reducing cash outstanding by four days.
Figure 8: Cash conversion cycle
6.3.
DSO
Figure 9: Days sales outstanding
6.4.
DIO
The days inventory outstanding (DIO) in Figure 10 presents a different image compared to the prior account of the CCC. CSM’s inventory has been increasing since 2009, which is remarkably since the average and the top companies are reducing their DIO. When the data in Figure 17 in Appendix II is analyzed it can be concluded that CSM has the worst performance compared to the food peer group since Novozymes is similar to CSM’s Purac, which is the chemical non-food division.
Figure 10: Days inventory outstanding
6.5.
DPO
Figure 11: Days payables outstanding
6.6.
C
ONCLUSIONOverall the performance of CSM is behind industry peers. The most improvement can be realized by a reduction in the capital invested in inventory and an improved position for accounts payable. Bakery supplies Europe’s (BSEU) finance director agrees on this and mentions inventory as an account where improvements can be made and notes: “Due to different kinds of IT systems such as planning and logistics inventory levels are too high on a local level”(Bok, 2011). A one day reduction in the DIO would result in a € 7,8 million reduction in working capital required on an annual basis. A DPO reduction of one day would have an effect on working capital of € 6,1 million.7
Chapter 7. D
RIVERS OF WORKING CAPITAL
After the discussion on the definition and the process that lead to working capital in Chapter 5 and the performance of CSM evaluated in Chapter 6, Chapter 7 will focus on the underlying drivers. In this chapter theoretical insights will be combined with the findings of the interviews.
7.1.
W
ORKING CAPITALAs defined above working capital is constructed from accounts payable, receivable and inventory. Each of these accounts has specific drivers that influence the level of capital invested in them. However, there are also generic drivers that apply to working capital. The generic drivers of working capital will be discusses below, and specific drivers of each account will be discussed in their specific paragraph.
There are four generic drivers of working capital; sales, prices, growth, and seasonality. These drivers can be best explained by the definition of working capital by Preve & Sarri-Allende (2010) which describe working capital (FNO) as account receivable + inventory – account payable. Where these accounts are a function of factors that can be formally noted as:
Account receivable = f ( Sales volume, sales price, days credit to customers) Inventory = f( Sales volume, cost of goods sold, days in inventory)
Account payable = f( Purchase volume, purchase price, days of credit from suppliers)
With a change in sales or price the above accounts will change influencing working capital needs (Scherr, 1989). Mr. Bok, BSEU finance director, notes on these changes that: “although the AR volumes are lowered, the increase in commodity prices diminish this effort, pushing AR to a higher level “(Bok, 2011).
Figure 12: Impact of seasonality and growth on working capital
“Seasonality and growth do influence working capital” says Mr. Theeuwes, finance director for CSM Germany, “we can do a good job in reducing working capital, but these factors influence it no matter what we do” (Theeuwes, 2011).
7.2.
A
CCOUNT RECEIVABLEThe two main drivers of account receivable are the credit terms and the credit collection process (Callahan, accessed 2011; N. C. Hill & Sartoris, 1995; Leone, 2006; Lewellen & Johnson, 1972; Maness & Zietlow, 2002; Smith, 2003). Whereby the sales phase of setting the credit terms contributes significantly to the investment made in account receivable (Stuart, 2011). The two drivers are influenced by multiple other factors other than the generic price and volume changes (seasonality and growth).
The credit term includes next to the price of the product, the line of credit a customer can use before being put to a delivery stop. Secondly, the payment term sets the deadline for payment. Longer payment terms and a higher line of credit result in a higher investment in AR and can be considered as a discount to the customer. Thirdly, the discount percentage and the discount period influence the investment in account payable. The discount is an incentive for customers to settle the account on a shorter term with the effect that lower investments have to be made in working capital. The drawback however is the reduced profit margin, which demonstrates that margin and invested capital are two sides of the return-on-invested-capital coin (Preve & Sarria-Allende, 2010).
terms. The equation to be solved is derived from Maness and Zietlow (2002) who represent this choice as:
ܹ ܣܥܥ >1 − ݀ ∗݀ ܥܲ − ܦܲ365 With
WACC = Weighted average cost of capital CP = Credit period in days
DP = Discount period in days d = Discount as percentage
The finance director Germany agrees on this tradeoff but puts it in perspective. “At the initial negotiations there is a tradeoff between price and sales terms. However, when agreements are made this tradeoff is less rigid and prices can be somewhat changed in the following months”. “Therefore I would give some more discount to lower the sales terms that justified by the cost of capital” (Theeuwes, 2011).
The way of payment, agreed on in the sales term, is another factor that influences AR. (Theeuwes, 2011) “Payment with checks differs significantly from wire transfers, especially at the end of the year” Says Theeuwes (2011). “With all the seasonal mailing the clearance of the check can last until half of January. With wire transfer the money is in our account within a day.” This payment float can increase the process of collection by several days. (Maness & Zietlow, 2002)
The way the credit terms can be set depends on the relative supplier/buyer power the company has to negotiate. Determinants of this are the relative size and strategic importance of the customer. (Just One Consultancy, 2008)
Former finance manager of bakery supplies North America (BSNA) Mr. Brons confirms that size and cost of capital play a significant role: “We are currently researching the cost of capital of our suppliers, which is inter alia related to size, in order to create possibilities for negotiating favorable discounts”(Brons, 2011).
the root problems should come from the dispute management systems since every complaint is registered (Just One Consultancy, 2008).
7.3.
I
NVENTORYThe drivers price and volume, and the derivatives seasonality and growth, are already discussed in the paragraph covering working capital as a whole. However, inventory is influenced by multiple other drivers in the process from raw materials to finished goods. Since the function of inventory is to ensure sufficient products to customers the drivers are based on volume and less on value. Price functions as multiplier and can therefore have a significant effect on the value of inventory that resides within the production process.
From the strategy of a company certain value propositions arise to sell the product to customers such as price and quality. However, to retain the customers attracted by the value proposition other drivers than price and quality have significant influence on the level of inventory held (Lysons & Farrington, 2006; Slack et al., 2004; Wisner et al., 2005).(Lysons & Farrington, 2006; Slack et al., 2004)
The three main drivers of inventory and the design of a production chain, are customer service, supply chain management cost, and forecast accuracy. The influence and trade-offs within and between these three will be discussed below.
Firstly, customer service is a driver of inventory levels because it entails providing the agreed upon product at the pre-specified time and under the right conditions. For inventory this has the consequence of keeping more finished goods at stock when a company strives for better service. More finished goods means not only a higher volume of products but also a greater variety (Lysons & Farrington, 2006; Slack et al., 2004). Shen (2005) determines that, based on the researches of eight consultancy firms, customer service has the most effect on the financial performance of all the supply chain drivers.
Another effect on the value of inventory is the number of stock keeping units (SKU) which measures the variety of products kept in inventory. For this driver the same argument applies as the above since higher customer service rates lead to holding a greater variety of products to fulfill the order at any moment and preserve customer service (Cleton & Vervoort, 2011; Hofman, 2004; Lysons & Farrington, 2006).
These above two effects, level and variety of safety stock, are significantly influenced by the forecasting accuracy of sales, making forecasting an important driver of inventory. “The sales forecast determines our safety stock, which is the input for production.” Says CSM Purac’s supply chain controller (Smit, 2011). By having an accurate demand forecast, volumes are known, which results in less uncertainty. Inventory’s function is to cope with uncertain customer demand and when this is reduced the required levels can drop (Checkley, 1994; Lysons & Farrington, 2006; Maness & Zietlow, 2002; Slack et al., 2004; Wisner et al., 2005).
The forecast is constructed by sales and provided to planning. Planning has the objective of minimizing inventory levels. Minimization is contradicting to the interest of sales, who are rewarded for customer service and turnover. The more inventories readily available the better customer service and the easier ad-hoc sales can be made. Therefore high forecast accuracy/ low inventory is not in the best interest for Sales. “In order to improve forecast accuracy we address sales representatives when they fall below a certain threshold” (Smit, 2011).
Although inventory levels are under scrutiny and forecasting can be a solution, the accuracy remains low due to a lack of sophisticated models and promotional sales. This is illustrated by BSNA’s finance director mentioning: “Promotional actions and our current forecasting tool do not enable us to predict demand accurately in the US. In our planning cycle of nearly a month planning can change up to ten times “ (Brons, 2011).
model that calculated, based on a certain weeks of coverage, our safety stock in order to reduce inventory” (Waechter, 2011).
At best, poor forecasting abilities force companies to make trade-offs between service and cost. At worst, both customer service and cost suffer from inaccurate demand forecasting (Hofman, 2004).
The third significant driver of the level of inventory held is the supply chain management cost (Hofman, 2004; Lysons & Farrington, 2006; Slack et al., 2004; Wisner et al., 2005). These cost can be summarized as purchasing, manufacturing, transportation, warehousing, inventory holding and customers service cost (Hofman, 2004; Wisner et al., 2005). Within every decision in the supply chain a cost trade-off arises which also affects the level of inventory. Purac’s supply chain controller puts forward the example of Purac buying inventory for the rest of the year because the price of sugar is so low during the harvesting period the inventory costs are offset by the future production cost (Smit, 2011).
Cleton & Vervoort (2011) mention production flexibility, which is actually a solution for uncertain demand forecasting and a minimum customer service rate, as an example of a cost trade-off; a flexible production process will lead to lower inventory levels since the company can respond earlier to demand changes. However, this gain will be offset by a higher production cost since more changeovers are needed to fulfill demand which will result in lower plant utilization. Within such a trade-off all supply chain management cost are affected.
The above discussed drivers have interlinked trade-offs that influence the level of inventory held. These drivers originate from decisions made by sales and affect the level of finished goods held. Based on the finished goods inventory requirements the production and purchase of raw materials is determined (Smit, 2011). However, to assure a smooth production process raw material inventory depends also on supplier’s performance.
He concludes that management of raw material involves a considerable amount of risk management (Smit, 2011).
7.3.1.
I
NVENTORY SUMMARYThe above drivers show that the level of inventory held is determined by the strategic choices made by sales and procurement in the way they sell and buy products, and by the way the supply chain is designed. The drivers of inventory are not stand alone drivers but are interlinked with and are in a trade-off with multiple other sales and purchase drivers which demonstrates that these drivers should be considered in a holistic way.
7.4.
A
CCOUNT PAYABLEThe account payable process is similar to the account receivables in the way that it is also driven by two factors; the purchase terms and the payment process (Checkley, 1994; Maness & Zietlow, 2002; Scherr, 1989). Finance director Brons at BSNA confirms this by stating:” When monitoring AP I look at the procurement process, explicitly the purchase terms, and the payment process. Those are the two key factors influencing AP” (Brons, 2011).
The purchase terms depend on the relative bargaining power the company has compared to its suppliers. When a supplier is crucial to the company’s process and not substitutes exist the bargaining power is only small and the terms of purchase have to be accepted (Just One Consultancy, 2008). The purchase terms relevant for accounts payable are the price, payment term, discount, and discount term. Other purchase terms could be relevant for inventory management, lead time and frequency of delivery, or production, which considers the quality of the product.
The consideration between fast payment discount and longer payment terms depends on the discount period, the discount offered, the credit period and the cost of capital of the company. Maness and Zietlow (2002) represent this choice as:
ܹ ܣܥܥ <1 − ݀ ∗݀ ܥܲ − ܦܲ365 With
WACC = Weighted average cost of capital CP = Credit period
DP = Discount period
This implies that whenever the implicit interest rate of the discount is greater than the weighted average cost of capital the discount should be taken and payment should be done within the discount period.
The second driver of accounts payable is the payment process. In order to maximize the benefits of the payment terms payments should be withhold up until the payment date. This process can be disrupted by early payment due to priority payment, wrong payment terms in the system or wrong target setting for employees (Just One Consultancy, 2008). These are only the most mentioned causes of an ill functioning payable process.
Within the payment process the frequency of payment also affects the level of payables. This is accomplished by paying for example on the end of the month; letting the cash inflows finance the cash outflow at the end of the month. By reducing the frequency of payment working capital acquires a onetime boost since cash outflows do not have to be financed with borrowings (Just One Consultancy, 2008). “CSM follows a strict payment policy to improve working capital. Paying only once a week and three times a month, thereby moving up the last payment to the next month to finance it cash outflows” Says Finance director Brons (2011).
7.5.
C
ONCLUSIONThe above discussion on the drivers of working capital and its components illustrate that it is a complex domain with much interrelations within and between the component’s processes. The interviews confirm the drivers of working capital as described in the literature revealing no new drivers. Based on these sources the most significant drivers of account receivable and account payable are the collection/payment process together with the agreements made on sale/purchase terms. These drivers are influenced by underlying interrelated factors which are out of the scope of this thesis.
Chapter 8. W
ORKING CAPITAL REPORTING AT
CSM
After having discussed the drivers of working capital, chapter eight examines the current working capital reporting and analysis at CSM. Firstly, the definition used by CSM is considered. Secondly, the reporting and the measurements of working capital, as retrieved from company documentation, are evaluated. Additionally to the formal documents and data, the results of the interviews will be discussed to give an insight in the current monitoring and analysis on a periodic basis.
8.1.
D
EFINITIONWithin CSM the definition of working capital is in line with Reilly and Reilly´s (2002) net investment to carry out all business activities in an environment where the purchasing, production, sales and distribution processes of the firm are non-instantaneous, unsynchronized and uncertain. The main accounts of CSM’s definition are elaborated on in the next three subparagraphs.
8.1.1.
A
CCOUNT RECEIVABLE AND ACCOUNT PAYABLEThe receivable account is split up in three subaccounts; trade receivables, other receivables, and derivatives and prepayments plus accrued income. Within trade and other receivables accounts are categorized by third parties, intercompany and related parties.
The same structure is used for account payable, splitting the account between trade, other, and derivatives and accruals.
8.1.2.
I
NVENTORYThe inventory is defined by six accounts which include all products used by CSM. The accounts most commonly used are raw material and packaging, work in progress, and finished goods. Other accounts are products for resale, paid in advance on inventory and supplies.
8.1.3.
F
ROM WORKING CAPITAL GROSS TO NET8.2.
R
EPORTING8.2.1.
P
ROCESSWithin CSM the stream of information that reaches the management team differs in frequency. Sales is reported by a weekly sales flash, a rough estimate, for each operating company, income and balance sheet statements on a monthly basis together with the working capital analysis. All these reports are realized according to the same internal process, involving operating company, division and corporate controllers and financial/management accountants.
Within CSM there exist multiple IT platforms from which information is gathered for the periodic reporting. On a local level subsidiaries have their own ERP system, as do the divisions. On the corporate level an overarching system, finance world, in which every subsidiary and division has to upload the required data.
The reporting process starts with the operating companies uploading the required data to the division’s controller before a pre-specified date so that the data of the division can be consolidated. In their turn divisions have a deadline for submitting the working capital data to corporate management accountants, which report to the CFO. Since CSM’s CFO has to report on its performance to shareholders there on a quarterly basis there is significant pressure on management accounting to deliver the correct story behind the performance on a timely basis, classifying which changes can be attributed to business related or industry/market factors (E. de Kroon, 2011).
8.2.2.
F
ORMATAnalyzing the reporting formats determines what information is provided, what is highlighted and what information is assumed less relevant for working capital management at CSM. This assessment is based on the management reports of June (2011d), July (2011e), and August (2011f).
8.2.3.
QUANTITATIVE ANALYSISThere are multiple quantitative working capital analyses within CSM. The vast majority of these quantitative analyses are constructed by a graphical display of the working capital trend for each of the working capital components (red. Account receivable, inventory, and account payable) and the total working capital level per month.
