Building strategies for optimizing Cash Management decisions.

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Let’s manage cash better.

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L ET ’ S MANAGE CASH BETTER .

Building strategies for optimizing Cash Management decisions.

THE AUTHOR IS REPONSIBLE FOR THE CONTENT OF THIS PAPER. THE COPYRIGHTS OF THIS PAPER ARE FOUNDED ON THE AUTHOR.

AUTHOR: HENDRIK BLENKEN BLIJDENSTEIN

S^TUDENTN^UMBER: 0992542

PROFESSORS: DR. W. WESTERMAN, PROF. DR. IR .F. KUIJPERS

COACHES PHILIPS: SIMON BRAAKSMA, PAULI BRUGMAN

AMSTERDAM, MARCH 15TH 2004

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Preface

PREFACE

The last stage of the study Management and Organisation includes a research of six months within a company and writing a finalizing thesis about this that meets the scientific requirements of the faculty. In my case it needed to be an interesting financial subject within an environment where I would like to start working permanently after finishing my study. Philips Corporate Treasury turned out to be the perfect location to combine these two conditions. By having finalized this thesis, my feeling is quite ambiguous. On one hand I am aware that a period of more than six fabulous years is over, but on the other hand a new start within Philips in Hamburg is appearing, to which I am really looking forward. For eight months I lived in Amsterdam, to visit Philips headquarters on a daily basis. Within the Corporate Treasury department I studied Philips’ global Cash Management Structure and built a strategy to improve this structure. This thesis is the result of my research.

This thesis had never come about without the assistance, coaching and critical feedback of numerous people. I would like to thank Philips’ local treasury delegates in 58 countries that provided me with the input for my study. Besides them I would like to thank the Corporate Treasury department in Amsterdam and Hamburg, who spend much time in introducing me into the subject and always being available for questions and discussions. Outside Philips I would like to thank my two professors Dr. W. Westerman and Prof Dr. Ir. F.P.J. Kuijpers, who gave me the right critical feedback to ensure that this thesis contains its scientific body and my relatives and friends, who always supported me during this period.

There are two persons I owe special thanks. Pauli Brugman and Simon Braaksma of the Cash Management department of Philips supported and coached me enormously during my internship and tried their very best to get me enlightened in this subject. All vague thesis concepts and ideas were grammatically and substantive reviewed intensively, with a founded feedback as a result.

I really enjoyed the internship within Philips, the research and the production of my thesis. It was a perfect learning experience to find out what is expected on a professional level.

I hope you will enjoy reading this paper.

Hendrik Blenken Blijdenstein Amsterdam, March 5^th 2004.

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Executive Summary

EXECUTIVE SUMMARY

This thesis has been prepared to complete the requirements for the Master of Science ’Financial Value Management’ at the faculty of Management and Organization in Groningen (The Netherlands). This research and the resulting thesis took nine months, and the main input is provided via a survey completed by local treasury delegates of 60 National Organisations in the countries where Philips executes its business activities.

In the past fifty years many environmental changes towards centralisation can be notified, which cause that cash within multinational companies can be managed more centralized.

In this research five scenarios are created to classify the Cash Management Structures of multinationals in order of centralization. The objectives of these scenarios are cost saving, upstream cash as quickly as possible and shortening of the balance sheet.

To get there the most advanced centralized cash management instruments are discussed for the following cash management areas:

• Third party accounts payable: The Payment Factory to centralize all payments via a web based tool. Corporate Treasury is paying on behalf of all entities.

• Third party accounts receivable: The Currency Centre Principle, where all amounts are received in the home country of the concerning currency.

• Intercompany transfers: The In House Bank, connected to the web based Payment Factory to administer and settle intercompany transfers, avoiding external payments.

• Liquidity management: The Global Overlay Structure, where all local idle cash balances are zero balanced towards one account per currency on a daily basis.

All these instruments are connected to two Global Cash Management Banks, as it results in a better contribution towards the objectives of the designed Cash Management Structure. This situation would be very desirable, but three real-life factors have taken into account resulting in some deviations in the centralized Cash Management Structure.

• The influence of country restrictions results in the fact that many countries aren’t allowed to implement centralized Cash management instruments.

Legal, fiscal and regulatory issues are discussed. Alternative structures are developed, to mitigate this influence.

• The influence of bank relationships results in the fact that in some countries bank instruments are used that are not supported by the Global Cash Management Bank. Therefore the Local Cash Management Bank must be used instead. It can also be that the local bank outperforms the global bank on its services, expertise, credit rating etc.

• The influence of internal considerations results in the fact that for economical, strategic or organizational reasons, the cost saving objective is met by reducing efforts to centralize the Cash Management Structure in these countries.

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Executive Summary

Studying these three real-life factors result in several alternative structures, which are combined into the five scenarios. Given the demands of these three real-life factors the countries are classified in these scenarios. Every scenario has a solution for all the four parts of the Cash Management Structure, which is best in class.

The actual Cash Management Structure is compared to the designed Cash Management Structure, resulting in improvement areas per country.

Conclusions:

Philips’ Cash Management Structure is quite advanced, but almost in almost every country, improvements are still possible. Many improvements can be realized by abandoning old structures, which are still active next to the centralized solutions.

In most of the concerning countries:

• There are hardly any country restrictions that have impact on the Cash Management Structure.

• Global Cash Management Banks have a good infrastructure.

• From an internal point of view it is valuable to centralize the Cash Management Structure

In the remaining countries there are many alternatives available to meet the objectives as much as possible, but basically:

• Almost everywhere it is possible to use the Payment Factory to simplify the third party payments process within Philips. Paying on behalf is the restriction in this respect.

• Almost everywhere it is possible to open foreign currency accounts, so that currency conversions with local banks can be avoided.

• Almost everywhere it is possible to implement the In House Bank to settle intercompany payments

• Local Zero Balancing or Notional Pooling is allowed almost everywhere to centralize idle cash balances on a country level.

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Table of contents

TABLE OF CONTENTS

PREFACE 2

EXECUTIVE SUMMARY 3 TABLE OF CONTENTS 5 INTRODUCTION 9 1 PHILIPS AND CASH MANAGEMENT 11

1.1 HISTORY 11

1.2 PROFILE 12

1.3 CORPORATE TREASURY 12

1.3.1 CORPORATE FINANCE 13 1.3.2 FINANCIAL RISK SERVICES 13 1.3.3 OPERATIONAL HUB 13 1.3.4 CASH MANAGEMENT 14

1.4 CASH MANAGEMENT STRUCTURE 15

2 CONCEPTUAL RESEARCH DESIGN 17

2.1 TYPE OF RESEARCH 17

2.2 PROBLEM DEFINITION 17

2.2.1 RESEARCH OBJECTIVE 17 2.2.2 RESEARCH QUESTION 18 2.2.3 ESSENTIAL PRECONDITIONS 18

2.3 CONCEPTUAL FRAMEWORK 19

2.3.1 CORNERSTONES OF THE CURRENT CASH MANAGEMENT STRUCTURE OF PHILIPS 19 2.3.2 COUNTRY RESTRICTIONS 19 2.3.2 BANK RELATIONSHIP 19 2.3.4 INTERNAL RESTRICTIONS 20 2.3.5 RECOMMENDED CASH MANAGEMENT STRUCTURE OF PHILIPS 20 2.3.6 RESEARCH OBJECTIVES 20

2.4 SUB QUESTIONS 20

2.4.1 ADDITIONAL EXPLANATION OF THE SUB QUESTIONS 21 3 TECHNICAL RESEARCH DESIGN 23

3.1 RESEARCH PLANNING 23

3.1.1 STAGE 1: DIAGNOSIS 23 3.1.2 STAGE 2: DESIGN 23 3.1.3 STAGE 3: TESTING 24 3.1.4 STAGE 4: REDESIGN 24

3.2 RESEARCH METHODS 24

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Table of contents

4 THE CASH MANAGEMENT STRUCTURE 26

4.1 A BEST IN CLASS DESIGN 26

4.1.1 Y- AXIS 26 4.1.2 X- AXIS 27 4.1.3 CENTRALIZATION 28 4.1.4 INSTRUMENTS 29

4.2 THIRD PARTY PAYMENTS PROCESS 30

4.2.1 DEFINITIONS 30 4.2.2 PHILIPS 31 4.2.3 DESIGN 32

4.3 THIRD PARTY RECEIVABLES PROCESS 33

4.4 INTER-COMPANY TRANSFERS 35

4.5 LIQUIDITY MANAGEMENT 36

4.5.1 DEFINITIONS 36 4.5.2 PHILIPS 37 4.5.3 DESIGN 38 4.6 CONCLUSIONS 39 4.6.1 CONTRIBUTION TO THE CRITERIA 40 4.6.2 THE MATRIX 40 4.6.2 THE MATRIX 41 5 COUNTRY RESTRICTIONS 42

5.1 RESTRICTIONS 42

5.1.1 LEGAL RESTRICTIONS 42 5.1.2 TAX 42 5.1.3 REGULATORY ISSUES 43 5.1.4 THE IMPACT ON THE CMS 44 5.2 INFLUENCE ON THE THIRD PARTY PAYMENTS PROCESS 44 5.2.1 THE QUESTIONS 44 5.2.2 ALTERNATIVE STRUCTURES 45 5.3 INFLUENCE ON THE THIRD PARTY RECEIVABLES PROCESS 45 5.3.1 THE QUESTIONS 45 5.3.2 ALTERNATIVE STRUCTURES 46 5.4 INFLUENCE ON THE INTERCOMPANY TRANSFER PROCESS 46 5.4.1 THE QUESTIONS 46 5.4.2 ALTERNATIVE STRUCTURES 47 5.5 INFLUENCE ON THE LIQUIDITY MANAGEMENT PROCESS 48 5.5.1 THE QUESTIONS 48 5.5.2 ALTERNATIVE STRUCTURES 48

5.6 CONCLUSIONS 49

5.6.1 THE MATRIX 49

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Table of contents

6 BANK RELATIONSHIPS 52

6.1 BANK RELATIONSHIPS 52

6.1.1 THE DISCUSSION 52 6.1.2 PERFORMANCE CRITERIA 53

6.2 INFLUENCE ON THE CMS 53

6.2.1 THIRD PARTY ACCOUNTS PAYABLE PROCESS 54 6.2.2 THIRD PARTY ACCOUNTS RECEIVABLE PROCESS 54 6.2.3 INTERCOMPANY TRANSFER PROCESS 54 6.2.4 LIQUIDITY MANAGEMENT PROCESS 54 6.3 THE CHOICE BETWEEN A GCMB AND A LCMB 55 6.3.1 THE NECESSITY FOR A CERTAIN BANK RELATIONSHIP 55 6.3.2 THE DESIRABILITY FOR A CERTAIN BANK RELATIONSHIP 55 6.3.2 THE DESIRABILITY FOR A CERTAIN BANK RELATIONSHIP 56

6.4.1 THE MATRIX 58 7 INTERNAL CONSIDERATIONS 60

7.1 INTERNAL CONSIDERATIONS 60

7.2 INFLUENCE ON THE CMS 61

7.2.1 INFLUENCE ON THE THIRD PARTY PAYMENTS PROCESS 62 7.2.2 INFLUENCE ON THE THIRD PARTY RECEIVABLES PROCESS 62 7.2.3 INFLUENCE ON THE INTER-COMPANY TRANSFERS PROCESS 63 7.2.4 INFLUENCE ON LIQUIDITY MANAGEMENT PROCESS 63

7.3.1 THE MATRIX 64 8 A SCENARIO APPROACH 66

8.1 GLOBAL SCENARIO 66

8.2 RESTRICTED GLOBAL SCENARIO 67

8.3 LOCAL SCENARIO 67

8.4 RESTRICTED LOCAL SCENARIO 68

8.5 INTERNAL CONSIDERED SCENARIO 68

8.6 CONTRIBUTION TO THE OBJECTIVES 69

9 THE ACTUAL CMS OF PHILIPS 71

9.1 THE ACTUAL THIRD PARTY PAYMENTS PROCESS OF PHILIPS 71 9.2 THE ACTUAL THIRD PARTY RECEIVABLES PROCESS OF PHILIPS 72 9.3 THE ACTUAL INTERCOMPANY TRANSFERS PROCESS OF PHILIPS 73 9.4 THE ACTUAL LIQUIDITY MANAGEMENT PROCESS OF PHILIPS 73

9.5 THE MATRIX 74

9.6 COMPARISON OF THE MATRICES 75

9.6 COMPARISON OF THE MATRICES 76

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Table of contents

CONCLUSIONS AND RECOMMENDATIONS 79 REFERENCES 85 APPENDICES

APPENDIX 1: ORGANISATIONAL CHART CORPORATE TREASURY 87

APPENDIX 2: SURVEY LOCAL TREASURY DELEGATES (51 QUESTIONS) 88

APPENDIX 3: ANSWERS SURVEY REGARDING CHAPTER 5 91

APPENDIX 5: RESULTS OF THE COMPARISON BETWEEN THE LCMBS AND THE GCMBS 93

FIGURES

FIGURE 1.2: PHILIPS’ PRODUCT DIVISIONS 12

FIGURE 1.3: BALANCE SHEET PHILIPS 14

FIGURE 1.4: FOREIGN BANKING PRESENCE, BY HOST COUNTRY 15

FIGURE 2.3: CONCEPTUAL FRAMEWORK 19

FIGURE 3.1: RESEARCH STAGES 23

FIGURE 4.1.1: REGIONAL FINANCE CENTRES WITH SELECTED GCMB 27

FIGURE 4.1.2: THE COMPLETE REAL BUSINESS MODEL 27

FIGURE 4.2: PAYMENT FACTORY PROCESS 32

FIGURE 4.6.1: PRO´S AND CONS CENTRALIZATION 40

FIGURE 4.6.2: MATRIX CHAPTER 4 41

FIGURE 5.6: MATRIX CHAPTER 5 51

FIGURE 6.3.1: LCMB´S VS. GCMB´S PERFORMANCE INDICATOR 55

FIGURE 6.3.2: REGIONAL CONTRIBUTION TO LCMB´S PERFORMANCE 56

FIGURE 6.3.3: REGIONAL CONTRIBUTION TO GCMB´S PERFORMANCE 56

FIGURE 8.6: CONTRIBUTION TO THE RESEARCH OBJECTIVES 69

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Chapter 1 Introduction

INTRODUCTION

Turnover is vanity, profit is sanity, but Cash is king.

You can be turning over millions, but still losing money. If there is no cash in the bank, you are dead meat [Hodge, 1999]¹.

Companies that are producing and selling their products all over the world also need to be expert in the financial markets in those countries. The cost of capital, local bank fees, the bank float, the country restrictions, the risks, etc. are all issues that have to be taken care off. The Corporate Treasury department within Philips manages this process for the whole Philips group. The product line Cash Management, where this study finds its origin is responsible for the management of the worldwide cash position. Every supplier that is paid, or every customer that has paid, has its effect for the cash position of Philips. The timing and management of this process is the main task of the product line Cash Management.

Cash managements mission is to create shareholder value by structuring and implementing best in class value-adding solutions to cash management related topics (payments, collections and liquidity management) for their clients (product divisions and board of management). To fulfil this mission, cash management uses several complex tools to shape the so-called Cash Management Structure.

The necessity for a global managed Cash Management Structure has become higher, because of rapid environmental changes in the financial markets and the development of the Philips organization that create large opportunities. The research will deal with these issues to improve Philips’ current CMS.

The Cash Management Structure will be divided in four parts, of which the best in class solution will be studied for all countries where Philips exploits business activities. This Paper is divided in nine chapters. In the first three chapters the framework for the research is explained, which will be elaborated in the chapters 4-8. In chapter nine the results of the research will be discussed. In the remainder of this introduction the subjects of the nine chapters will be discussed in more detail.

• Chapter 1:

A brief description will be given about the field where the research will take place and the reason for this research.

• Chapter 2:

A structured research design is divided in two sets of activities, namely a conceptual- and a technical research design [Doorewaard en Verschuren, 1999]. The discussion of the conceptual research design providing a logical flow within the research thought-process. In this chapter the conceptual research design is structured as a policy supportive research [Leeuw de, 2001]. The general research question will be posed of which a conceptual framework will be derived. In the conceptual framework the variables that have influence on the Cash Management Structure of Philips are explained.

These influences can be translated in several sub-questions. These sub-

1 http://www.guardian.co.uk/Archive/Article/0,4273,3860564,00.html

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Chapter 1 Introduction

questions will take care of answering the research question in a structured way, to maintain the relevance and validation.

• Chapter 3:

The technical research design is discussed in this chapter dealing with the methodological issues. The sub-questions are divided into four stages:

diagnosis, design, testing, and redesign, to structure and plan the research. An overview is given of the fieldwork timeline of this study; i.e.

from June 2003 till January 2004. Finally it shows the research methods that will be used.

• Chapter 4:

The first sub-question will be answered in this chapter. A theoretical best in class design will be developed taking into account Philips current approach and a literary approach.

• Chapter 5-7:

After the theoretical design three real-life factors will be discussed in chapter 5-7. After the elaboration of these real-life factors the Cash Management Structure can be utilized in the concerning countries.

• Chapter 8:

The final designed matrix of the Cash Management Structure is analysed resulting in five scenarios. All concerning countries can be classified into these scenarios in order of their contribution to the objectives. Feedback is given on the literature and the research design by explaining in what level a contribution to the objectives is realised by the five scenarios.

• Chapter 9:

The actual situation of Philips is reviewed and grouped in the alternatives provided by the designed Cash Management Structure.

When these steps are taken, the general research question can be answered in the conclusions. This will be taken care of in this final part of the thesis. After having answered this question and evaluating the research objective, some final thought is given, related to this research. This evaluation results in several recommendations to make the implementation of the outcomes successful.

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Chapter 1 Philips and Cash Management

1 PHILIPS AND CASH MANAGEMENT 1.1 History²

In 1891 Gerard Philips established a company in Eindhoven, the Netherlands, to 'manufacture incandescent lamps and other electrical products'. Further developments in new lighting technologies supported a steady program of expansion, and, in 1914, Philips established a research laboratory to study physical and chemical phenomena, so as to stimulate product innovation.

Philips began to protect its innovations with patents, for areas taking in X-ray radiation and radio reception at this time. This marked the beginning of the diversification of its product range. Having introduced a medical X-ray tube in 1918, Philips then became involved in the first experiments in television in 1925.

It began producing radios in 1927 and had sold one million by 1932. One year later, it produced its 100-millionth radio valve, and also started production of medical X-ray equipment in the United States.

In 1939 Philips' first electric shaver was launched. At that time the Company employed 45,000 people worldwide and had sales of 152 million guilders. Science and technology underwent tremendous development in the 1940s and 1950s, with Philips Research inventing the rotary heads, which led to the development of the Philishave electric shaver, and laying down the basis for later groundbreaking work on transistors and integrated circuits. In the 1960s, this resulted in important discoveries such as CCD’s (charge-coupled devices) and LOCOS (local oxidation of silicon).

Major contributions in the development of the recording, transmission, and reproduction of television pictures are made by Philips. In 1963, it introduced the Compact Audio Cassette and produced its first integrated circuits (chips) in 1965.

Throughout the 1970s, the flow of new products and ideas continued: research in lighting contributed to the new PL and SL energy-saving lamps; other key breakthroughs came in the processing, storage and transmission of images, sound and data where Philips Research made key breakthroughs, resulting in the inventions of the Laser Vision optical disc, the Compact Disc and optical telecommunication systems.

Philips established PolyGram in 1972, and acquired Magnavox (1974) and Signetics (1975) in the United States. Acquisitions in the 1980s included the television business of GTE Sylvania (1981) and the lamps business of Westinghouse (1983). The Compact Disc was launched in 1983, while other landmarks were the production of Philips' 100-millionth TV set in 1984 and 300- millionth Philishave electric shaver in 1995.

A significant change for Philips was made in the 1990s. The company carried out a major restructuring program (centurion) to return it to a healthy footing. And more recently it has been concentrating on its core activities.

2 http://www.philips.com/InformationCenter/Global/FArticleSummary.asp, 2003

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1.2 Profile

Royal Philips Electronics is the parent company of the Philips Group. The statutory seat of the company is Eindhoven, the Netherlands. In the remainder of this thesis Royal Philips Electronics will be called ‘Philips’. Sales of EUR 29 billion in 2003 make Philips one of the world’s biggest electronics companies and Europe’s largest. It is a global leader in color television sets, lighting, electric shavers, medical diagnostic imaging and patient monitoring, and one-chip TV products. Its 164,500 employees in more than 60 countries are active in the areas of lighting, consumer electronics, domestic appliances, semiconductors, and medical systems. Philips is quoted on the NYSE (symbol: PHG), London, Frankfurt, Amsterdam, and several others. The company was organized along country structures in the past, but with the centurion restructuring, this model changed.

Today the activities of the Philips Group are organized in five product divisions, which are responsible for the worldwide policy. Philips has more than 150 production sites in over 25 countries and sales and service outlets in some 150 countries. It delivers products, systems, and services in the fields of lighting, consumer electronics and communications, domestic appliances and personal care, components, semiconductors, medical systems, business electronics and information technology. Several global leading examples are colour television sets, lighting, electric shavers, medical diagnostic imaging and patient monitoring, and one-chip TV products.

The companies’ activities are grouped in five main sectors³.

1.3 Corporate Treasury

To create more efficiency gains and maintain control, large companies as Philips have all kinds of corporate staff departments. These staffs vary from branding to strategy, to real estate to treasury, with treasury being the department, where I have been doing this research.

The core business of Corporate Treasury is to provide the most cost efficient and secure way of handling the Group’s internal and external payments; support an optimal management of its short term liquidity; minimise the net financing costs to Philips, and to identify, measure and reduce in a cost efficient way the financial

3http://www.philips.com/InformationCenter/Global/FArticleSummary.asp?lNodeId=308&channel=308

&channelId=N308A869, 2004

Medical systems

Domestic Appliances & Personal Care

ROYAL PHILIPS ELECTRONICS

Consumer Electronics

Semiconductors

Lighting

Figure 1.2

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and operational risk exposures that furthermore threaten the shareholder value of Philips. The Corporate Treasury department is a cost center.

Corporate Treasury consists of six product lines⁴, namely:

• Corporate finance

• Financial risk services

• Operational hub

• Cash management

• Insurance

• Treasury control

The product lines that are relevant for this research are discussed in more detail in the remainder of this section.

1.3.1 Corporate Finance

The general aim of corporate finance is to enhance shareholder value creation of Philips. Therefore, a minimisation of the net financing costs of Philips is key. This product line is involved in building all kinds of financial constructions in order to manage the financial structure in an optimal manner.

1.3.2 Financial Risk Services

Financial risk services (consisting of financial risk consulting and risk management) identifies and measures the financial risk exposures. Therefore, it is necessary to have updated, clear and concise standard global policies for the Group with regards to exposures of foreign exchange, interest rates, country, credit and commodity risks. The financial risk services group therefore ensures that business and/or country specific requirements are properly defined.

Moreover, financial risk service provides concrete and systematic risk consulting to confirm or correct the initial risks identified. Establishing a secure automated web link with approved external counterparties for standard foreign exchange, commodity, and money market transactions is one of the tasks of this sub department.

1.3.3 Operational Hub

The operational hub is the processing centre for treasury transactions. They provide a seamless, automated and secure payment process for Philips. In close co-operation with all the other Corporate Treasury areas, the manual intervention to the approval of the payment and the change of static data is reduced. In this way, Philips has a fully automated and bank independent reconciliation process.

The operational hub consists of four parties:

• Payment Factory: acts as a worldwide-shared service provider to cover all outgoing payments. Both inter-company and third party, domestic as well as cross-border payments.

• In-house bank: supports all inter-company cash flows for more than 900 entities, each having in principle one IHB-account in its functional currency. The cross-currency payments need special attention, because foreign exchange risk is created.

4 The organizational chart is included as appendix 1

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• Middle office: covers all treasury payments and receipts for Royal Philips Electronics and reconciles these. The Dealing Room and cash management cover the created positions in the market and the resulting payments have to be executed by the Middle office.

• Back office: is the administrative part of this process. They are responsible for accounting, reporting the IHB-balances, and controlling static data that go into treasury systems.

Risk consulting, corporate finance, and front Office make important inputs for the operational hub. Risk Consulting processes all FX, Options, and metal deal requests from businesses, while Corporate Finance processes money market requests. The Front Office, or dealing room, is the interface between financial markets and Philips. All the risks brought into Corporate Treasury by Philips organizations via Corporate Finance and Risk Consulting are transferred to the Front Office, and they manage the risks.

1.3.4 Cash Management

This is the product line where this research finds its origin. Cash management can be considered as a stand-alone topic within the management of short-term assets and the question is addressed how much cash is needed in comparison to other liquid assets. It is the main approach in textbooks on short-term financial management [Eije von, Westerman, 2002]. The mission of cash management is to create shareholder value by structuring and implementing best in class, value- adding solutions to cash management related topics (payments, collections and liquidity management) for their clients (Product Divisions and Board of Management). ⁵ The general objective of this product line is to support an optimal management of Philips short-term liquidity and to provide the most cost efficient and secure ways of handling the Group’s internal and external payments. More about this product line will be explained in the next section.

Finally, the different responsibilities within Corporate Treasury will be clarified by looking at this department from a balance sheet perspective. The responsibilities of the described product lines can briefly be seen as represented in below stated figure 1.3.

5 http://pww.treasury.corp.philips.com/apps/c_dir/e1107801.nsf, 2003

Fixed assets PD

Liquid assets CM

Equity CF

Long term debt CF

Short term debt RM/CM Balance Sheet Royal Philips Electronics

PD = Product Division CM = Cash Management CF = Corporate Finance RM = Risk Management Figure 1.3

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Corporate Treasury has got nothing to do with the business decision about where to invest, what to buy or sell, how much to produce, etc. That is the reason why the product divisions (PD’s) manage all the fixed assets. All the money to do the investment, pay the suppliers, and receive the revenues is managed by Corporate Treasury. Corporate finance decides if all business related aspects mentioned for the whole company, should be financed with debt or with equity, and is therefore responsible for the Weighted Average Cost of Capital, the solvability, and the debt Equity ratio of Philips. In these hard times there is a focus on the liquid assets, as a better management of these create money to repay long-term debt. The purpose for shortening the balances is to keep the recover the A-credit-rating, which improves the ratios mentioned. Risk Management takes care of all short- term loans and deposits for the whole group, because they have the knowledge and efficiency gains to perform better on the financial markets. Finally cash management is responsible for the cash at bank position and the locally held cash position of the group.

1.4 Cash Management Structure

Getting introduced in the specialty of a professional treasury environment like Philips is difficult. The terminology and complexity of the Cash Management Structure needs a lot of studying and analyzing. This in order to get enlightened in the processes of the Corporate Treasury department and the role of cash management in it.

There are various reasons in the development of the global financial markets that cause that Philips Corporate Treasury needs to continuously review all these global payments and receipts. Fifty years ago it was not possible to have a grip on the global capital markets [Smith, Walter 1999] for the reason that international commercial banking simply did not exist. This hampered transferring generated funds. Global integration of financial markets is being driven by the worldwide search on the part of investors and issuers for more favorable returns and lower costs of funds. Meeting these objectives has been facilitated by

Figure 1.4

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improved communications, the erosion of barriers to capital flows, the modernization of key national financial systems, and the gradual liberalization of international trade in services. The effect of globalization is to give participants in financial markets a wide range of viable alternatives. Centered in London, Tokyo and New York, action in the global market is continuous. In the figure 1.4 is shown how foreign banking developed in the period between 1970 and 1985. This movement has been accelerated by the realization of the euro-zone.

By anticipating on these environmental changes, large efficiency gains can be realized by concentrating cash formerly available on local balances. This process stands or falls with a good functioning Cash Management Structure (CMS). If there is not a tool to concentrate the cash generated in a proper manner, there is no possibility to manage the cash that efficient. That is the reason why cash management is dealing with the development and implementation of the CMS of regions and countries where new opportunities arise and actual issues need to be solved. Today it is possible to transfer money with same day value all over the world. It is also possible to predict and follow the majority of cash flows on a daily basis, thanks to the implementation of Enterprise Resource Planning systems like SAP, e-mail, Internet, and other fast communication devices.

This results in the shortening of the cash conversion cycle, (the length of time between the purchase of raw materials and the collection of receivables generated in the sale of the final product)⁶. This does not mean that on a local or regional basis nothing has to be done to optimize cash flows, but Corporate Treasury is in control of more than 1100 reporting entities in about 60 different currencies. Firstly, all these entities have multiple external bank accounts, used for external supplier payments, customer receipts, salary payments etc., on a daily basis. The total revenues are EUR 30 billion per annum and in the current economic climate the margins are under pressure. Beside these external cash flows, internal cash flows arise because of inter-company price setting. This means that separate entities invoice their semi-manufactured products and services to entities following in the production process within Philips. This results in another EUR 60 billion of cash flows going through Philips.

Within this topic this research will elaborate the current CSM of Philips. It is desirable for the cash management department of Philips to review their CMS, but there are influences that make this CMS various. Experience during the pre research learned that a best in class Cash Management Structure is subject to various country restrictions, the relationship with the different banks and internal considerations that are economically advantageous. This research will design a CMS taken into account these variables, with the expectation that it will create value to Philips. In the next chapter these experiences will be structured in order to develop the research design.

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Chapter 2 Conceptual research design

2 CONCEPTUAL RESEARCH DESIGN

This chapter will answer the following questions “Who wants to know what and for what reason?” and “ What essential preconditions are in force in this matter?” The first question will be answered by defining the research objective and the research question. The answers to the second question are divided into product and procedural essential preconditions. With this information a conceptual framework will be explained. This framework will function as a guideline in the research from which the sub-questions will be derived. In answering the sub- questions I hope to design a CMS that will meet the objectives.

2.1 Type of research

This research can be categorized as a policy supporting research. Policy is the package of objectives and measures on behalf of the management. The goal of policy supporting research is to deliver usable knowledge to rationalize this policy [Leeuw de, 2001]. The policy of cash management can be summarized as:

concentrate all cash flows daily, in an automated, secure, and cost-efficient fashion. This research envisages delivering a framework that will be supportive to future policy decisions and that will assist to improve the current CMS of Philips.

2.2 Problem definition

The problem definition contains three components [Leeuw de, 2001]:

• Research objective (2.2.1)

• Research question (2.2.2)

• Essential preconditions (2.2.3)

2.2.1 Research objective My research objective is:

To evaluate the current global Cash Management Structure of Philips and show Philips their improvement areas for future Cash Management Structure decisions.”

The model needs to result in:

• Cost savings

• Quicker up streaming of cash

• Shortening of the balance sheet

These quality demands are elaborated on further in the explanation of the conceptual model in section 2.3.6

Although this research is completely focused on the Cash Management Structure of Philips, it should also be seen as a template for other large multinationals, dealing with complex global cash flows. Companies can share a lot with each other in this matter. Although it is a very important issue these days in a world where deregulation, liberalization and globalization making great improvements, literature is hardly available. In many professional publications is stated [Wood

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2002, Gupte 2003], and by all global banks is recognized, that Philips is dealing in a progressive way with cash management issues. The results should are able to contribute to the knowledge on this subject, which makes this research relevant for Philips and the understanding of global cash management in general.

2.2.2 Research question

The following research questions can be posed:

‘How can the current Cash Management Structure of Philips be improved to become best in class, if the influences of the country restrictions, bank relationships and internal considerations are applied to this structure?’

2.2.3 Essential preconditions

This research is subject to multiple preconditions Product essential preconditions

• The choice to create a model suitable to the local situation of every single country but to categorize by the factors that will cause a deviating structure is due to the fact that the CMS is complex.

• In this research, no attention will be paid to processes and working methods within Philips. Only the CMS as such will be designed.

Procedural essential preconditions

• This research is performed by order of the Corporate Treasury department of Philips to build a renewed strategy for their Cash Management Structure decisions and therefore meeting their requirements.

• This research is also conducted to be the researcher’s final assignment in completion of the requirements for the Master of Science ‘Financial Value Management ‘ at the faculty of Management and Organization in Groningen (The Netherlands). Therefore it should meet the methodological and scientific demands.

• The research will be presented as a thesis and will be verbally commented by the cash management department at Philips and the coaches within the University of Groningen.

• Target completion date of the field research and the resulting first thesis concept is January 2004.

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2.3 Conceptual framework

2.3.1 Cornerstones of the current Cash Management Structure of Philips In the first place the basics of the current CMS will be analyzed. As mentioned before, Philips is arguably proactive in their cash management, and invests in multiple cash management tools. These tools will be evaluated by current available professional literature and if found suitable, included in the design, rather than reviewing all possibilities.

2.3.2 Country restrictions

Some local governments protect their country and foreign currency reserves by creating laws that forbid Philips to repatriate the cash generated in that specific country. It can also be the case that currencies are not allowed to leave the country. Other governments try to keep the cash in their country, by imposing tax on the repatriation of funds. As a result, it is not impossible for Philips to repatriate the cash but it is often very expensive. These country restrictions will force Philips to find alternative solutions.

2.3.2 Bank relationship

The Cash Management Structure partly consists of all kinds of (global and local) banks. The banks and Philips together have a relationship, which exerts influence on the CMS. Philips has to elaborate a global banking strategy taking into account the number of banks, their size, quality, expertise, and pricing. These parameters determine to what extend the objectives are met.

Best-in-class Cash management structure

of Philips Scenario A Scenario B

Scenario D Scenario C

Banking relationships Local or Global?

Electronic banking systems/

credit ratings/expertise/

service/cut off times/

problem resolutions

Objectives

• Cost savings

• Faster concentration of cash

• Shorten the balance sheet Figure 2.3

Internal considerations Economical considerations Strategic considerations Organizational structure Country restrictions

Legal restrictions Fiscal restrictions Regulatory restrictions

Cornerstones of the current cash management

structure of Philips Theories, literature, professional knowledge

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2.3.4 Internal restrictions

In some countries, the balance amount is that low that is not beneficial to transfer the money or keep different account structures active. A limit should be considered to keep the cost of the CMS as low as possible. The management of Philips may also have strategic or organizational considerations why a structure is implemented in a certain country. In the knowledge that treasury facilitates the business instead of dictating it, the CMS needs to adapted to these considerations.

2.3.5 Recommended Cash Management Structure of Philips

After having designed a theoretical best in class CMS and applied the three real life factors to this structure the design will contain different scenarios dependent on the impact of these influences. These real life factors will make it necessary or desirable to adapt the theoretical perfect CMS, to a CMS that give the proper solutions for every county where Philips has cash flows.

2.3.6 Research objectives

Taking the above-mentioned concepts into account, the design should meet the research objectives, by comparing the recommended CMS with the current CMS of Philips.

• Cost savings

The cost saving objective is very clear. Why waste money if the same is possible for less. Corporate Treasury has an excellent financial planning expertise for the whole group, which puts the Group in a position to decide to deposit or borrow from the money market against favourable interest rates.

• Faster concentration of cash

By designing a new CMS cash should be able to be transferred more efficiently to the central Philips bank accounts. To achieve this objective it is necessary to focus on simplicity, logic, and standardization.

• Shortening the balance sheet

In consultation with corporate finance the generated cash is available for investments, repaying debt or other strategic decisions in future. This objective is key in this difficult economic climate, to recover the credit rating to a single A credit rating. The most important advantage about this objective is the flexibility that Philips creates to make investment of financing decisions.

2.4 Sub questions

The sub-questions are derived from the conceptual framework.

1. What should be the theoretical best in class CMS of Philips based on the cornerstones of the current CMS of Philips, not yet taking into account country restrictions, bank relationships and internal considerations?

2. What should be the optimal CMS, if country restrictions are applied to cash flows in certain countries?

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3. What should be the optimal CMS, taking into account the influence of the bank relationships in the various countries?

4. What should be the optimal CMS, if internal considerations within Philips are applied to the Cash Management Structure?

5. What different scenarios can be derived, by analysing the matrix of the designed CMS in order of the contribution to the objectives of this design?

6. How can the actual CMS of Philips be classified into the designed matrix structure, resulting in improvements per country?

2.4.1 Additional explanation of the sub questions

• Sub question 1 is answered in chapter 4. The CMS is divided in four parts and for each part a best in class solution is developed by reviewing the actual possibilities described in literature. Besides this input, the expertise of Philips current process is described and used in the design, when it has proven to be best in class. The result is a theoretical design that provided a solution for all parts of the CMS. These solutions are for all concerning countries the same and cannot be interpreted as such because real-factors influence this solution.

• Sub question 2 is answered in chapter 5 and elaborates applicable country restrictions. In some countries this real-life factor is influencing the theoretical designed CMS considerably, resulting in several alternative structures. The adapted design becomes various per country, and more decentralized. This necessity is resulting in being best in class taking into account these country restrictions.

• Sub question 3 is answered in chapter 6 and evaluates the bank relationships per country. A discussion of the choice between local and global bank is dependent on the possibilities and the desirability’s, which are discussed. After this analysis the CMS per country is linked to the best present bank relationships per country and adapted to the second real-life factor.

• Sub question 4 is answered in chapter 7 and takes internal considerations into account. The CMS should be in line with certain business decisions and meet the objective of being cost saving. The discussion of this real-life factor preserves Philips of spending money and effort on implementing a structure in countries where it is more advantageous to leave everything as it is. The result is an adapted CMS tailor-made for the current internal situation of Philips. With the completion of this chapter the designed CMS is finished.

• Sub question 5 is answered in chapter 6. It combines and analyses the results of the best in class CMS, taking into account the influences of country restrictions, bank relationships and internal considerations. The results of this analysis are five scenarios that are multiple interpretable and therefore a contribution to the scientific discussion of cash management issues within multinationals.

• Sub question 6 is answered in chapter 9, and provides improvement areas for Philips, discussing the current status of Philips’ CMS. The designed CMS and the resulting scenarios provide the best in class situation. To become aware of the improvement areas for Philips, it is necessary to compare the

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design with the current situation. The structure of the designed matrix will be used to classify the actual situation of Philips’ CMS. By analysing the differences of this matrix with the best in class designed matrix, improvements per country can be achieved.

The rationale behind this order of steps is discussed in this section. It is not possible to discuss the current situation of Philips in chapter 4 as the alternative structures, the reflections on the bank relationships and the internal considerations aren’t apparent in that stage of the research. Therefore this solution is developed, clarified by distinguishing the several research stages in the technical research design⁷. It is necessary to design before it is possible to test.

To ensure that this design is usable it needs to be developed by continuous diagnoses of the area to be tested, ensuring that influences and accents are correctly implemented in the design.

7 Discussed in chapter 3