Cash Flow Control

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Cash Flow Control

Designing a cash flow reporting tool at Unilever Netherlands B.V.

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Cash Flow Control

Designing a cash flow reporting tool at Unilever Netherlands B.V.

The author is responsible for the contents of this paper. The copyrights of this paper are

founded on the author.

Author:

Pieter van Hooijdonk

Student Number:

1278401

Supervisor:

Dr. W. Westerman

Co-assessor:

Drs. A. Smeenge RA

Coaches Unilever:

Roger Sonneville, Karlijn Spoek

University of Groningen

Faculty of Economics and Business

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Preface

This thesis is the concluding piece of my study Management and Organization at the University of Groningen. I preferred to write my Master´s thesis about a financial subject in a real business environment. Unilever Netherlands offered me the great opportunity to conduct my Master´s thesis research at their Corporate Finance department during an internship of three months. Within the Corporate Finance department I studied Unilever´s management reporting structure and build a tool to provide management insight into the flow of cash through the organization. This thesis is the result of my research.

This thesis is come about with the support, coaching and critical feedback of various people. I would like to express thanks to the Unilever’s staff members who cooperated and participated in my research. I owe special thanks to Roger Sonneville and Karlijn Spoek of the Corporate Finance department for their support and coaching during my internship and their effort to get me enlightened in the subject matter. In addition I would like to express my gratitude to Dr. W. Westerman for his guidance and advice in the process of writing my thesis. Finally I would like to thank my parents who supported me throughout my study and made it possible for me to do all the things that I wanted to do in the past 25 years.

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Preface

Executive summary

The objective of this research was to design a cash flow reporting tool, which can be used as a management control instrument by the management of Unilever Netherlands. The tool had to provide better insight into the operational cash flow and its underlying components.

The lack of insight on operational cash flow has been defined as a management control issue. In carrying out the control function, managers seek to ensure that plan is being followed. Feedback, which signals whether operations are on track, is the key to effective control. The current management reporting should be modified to include feedback regarding the cash generation of Unilever NL.

Next, an overview was given of the various components which make up the flow of cash through the Unilever Netherlands organization. The cash flow management challenges at Unilever were discussed and from that, it was made clear that the working capital cycle requires the main focus from an operational cash flow perspective.

Based on this information it was possible to design an operational cash flow tool which provides Unilever Netherlands management the required insight in the operational cash flow and its underlying components. The designed operational cash flow management tool is defined as a management information system. The input data, the tool itself and the output in the form of an operational cash flow report have been elaborated.

The operational cash flow management tool could only be considered successful if it is properly implemented in the Unilever organization. Therefore, the implementation of the designed operational cash flow reporting tool has been discussed. It turned out that several issues have to be dealt with, to come to a proper implementation of the tool. The tool is easy to integrate into the existing reporting structure. However, an optimal fit between the operational cash flow report and financial reporting streams coming from other departments is lacking. Moreover the research took place during a far-reaching restructuring of the Unilever organization. This event brought along several issues regarding the supply of input data for the operational cash flow reporting tool.

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Table of contents

2 Research design ... 11 2.1 Type of research ... 11 2.2 Problem definition ... 11 2.2.1 Research objective ... 11 2.2.2 Research question ... 12 2.2.3 Sub-questions ... 12 2.2.4 Essential preconditions ... 13 2.3 Research model ... 14 2.3.1 Research framework ... 14 2.3.2 Research methods ... 15 3 Management control ... 16 3.1 Management control ... 16 3.2 Management reporting ... 17 3.3 Conclusion ... 18

4 Cash flow management ... 19

4.1 Cash flow through the business ... 19

4.2 Cash flow at Unilever... 21

4.3. Conclusion ... 23

5 The operational cash flow reporting tool ... 24

5.1 The management information system ... 24

5.2 Overview ... 26

5.2.1 Input ... 26

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Table of contents 5.2.3 Output ... 27 5.3 Conclusion ... 31

6 Implementation of the tool ... 32

6.1 System implementation ... 32 6.2. Success factors ... 32 6.2.1 Strategic policy ... 32 6.2.2 Culture ... 33 6.2.3 Administrative organization ... 33 6.2.4 Supply of information ... 33 6.3 Conclusion ... 34

7 Conclusions & recommendations ... 35

7.1 Conclusions ... 35

7.2 Recommendations... 36

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Introduction

Unilever measures its objective to create value for the shareholders by total shareholder return calculation. The contribution of the business to this objective is measured and communicated to investors through the two main measures: return on invested capital and ungeared free cash flow.1 Unilever committed itself to generate 25-30 billion Euros of ungeared free cash flow in the period 2005-2010.

In line with this strategy the generation of cash flow has become a key performance indicator by which local management of Unilever Netherlands is targeted by head office. As such, managing the operational cash flow has become a direct responsibility of local management since 2006. However, management of Unilever Netherlands lacks proper insight in the cash flow and its underlying elements. The need for better insight in the cash flow by local management of Unilever Netherlands led to this research paper. This paper deals with the design of a cash flow reporting tool that provides management insight into the cash flow of the operating company.

This report is divided into six chapters. In the first chapter the Unilever organization is described and in the second chapter the research design is elaborated. In chapter three and four a diagnosis is made of the current situation at Unilever Netherlands, which lays the foundation for the design of a cash flow reporting tool. The construction of this tool is discussed in chapter five. Chapter six deals with the implementation of the designed reporting tool. Finally in chapter seven conclusions and recommendations are made regarding this research.

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1 About Unilever

1.1 History

Unilever was created in 1930 when the Dutch margarine company Margarine Unie merged with British soap maker Lever Brothers2. Both companies were competing for the same raw materials, both were involved in large-scale marketing of household products and both used similar distribution channels. Between them, they had operations in over 40 countries. Margarine Unie grew through mergers with others margarine companies in the 1920s. Lever Brothers was founded in 1885 by William Hesketh Lever. Lever established soap factories around the world, and had plantations in many Third World countries. In 1917, Lever began to diversify into foods, acquiring fish, ice cream and canned foods businesses.

Unilever’s first decade, the 1930s, was a tough time as it started with the Great Depression and ended with World War II. But as the business rationalized operations, it also continued to diversify. Unilever’s operations around the world began to fragment in the 1940s, but the business continued to expand further into the foods market and to increase investment in research and development.

In the 1950s business boomed as new technology and the European Economic Community led to rising standards of living in the West, while new markets opened up in emerging economies around the globe.

In the 1960s Unilever was successfully developing new products, entering new markets and running a highly ambitious acquisition program.

Hard economic conditions and high inflation made the 1970s a tough time for all companies, but things were particularly difficult in the fast moving consumer goods sector as the big retailers started to flex their muscles.

By the 1980s Unilever was one of the world's biggest companies, nevertheless it took the decision to deplete its portfolio, and rationalized its businesses to focus on core products and brands.

In the 1990s Unilever expanded its business into Central and Eastern Europe and further sharpened its focus on fewer product categories, leading to the sale or withdrawal of two-thirds of its brands. The 21st century started with the launch of Path to Growth, a five-year strategic plan, and in 2004 Unilever further sharpened its focus on the needs of 21st century consumers with its Vitality mission.

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1 About Unilever

1.2 Profile

Unilever is one of the world’s leading suppliers of fast moving consumer goods across Foods and Home and Personal categories. Unilever has two parent companies: Unilever NV in Rotterdam, and Unilever PLC in London. The two parent companies, NV and PLC, together with their group companies, operate as a single economic entity. Unilever’s mission is to add vitality to life. Unilever is doing this by meeting everyday needs for nutrition, hygiene and personal care with brands that help people look good, feel good and get more out of life. The corporation sells products in over 150 countries and had annual sales of approximately € 39 billion in 2006. Unilever, with over 179.000 employees in approximately 100 countries, runs about 400 brands of which twelve have a yearly turnover of more than € 1 billion. Together these twelve brands make up about 55% of total sales3.

The main focus of Unilever’s strategy is a concentration of resources on areas where it has leading positions and on high growth spaces. To execute this strategy, Unilever’s business has been reorganized according to the “One Unilever” program. This program strives to streamline the organization structure and made management rest on three pillars: Categories, Regions and Functions. Regions are responsible for managing Unilever’s business in the regions, and for market operations. The regions are fully accountable for the profit performance of the business as well as growth, short-term cash flows and the in-year development of market shares. The two category teams cover Food and Home and Personal Care, and are responsible for each category and brands therein. They are fully responsible for brand development and innovation. Categories also lead the strategic elements of the supply chain and are accountable for long-term value creation in the business. Finally the five support functions (Finance, HR, IT, Communications and Legal) provide value-adding business partnership, strategic support and services to the whole business.

1.3 Unilever in the Netherlands

This research took place at the Unilever Netherlands B.V. In the remainder of this thesis Unilever Netherlands B.V. will be called “Unilever Netherlands”. Unilever Netherlands B.V., Unilever Research & Development Vlaardingen, the pension fund Progress and Shared Services are coordinated by a holding company called Unilever Netherlands Holdings B.V.. The board of directors of Unilever Holdings B.V. is responsible for the social and tax policies and contacts with government, consumers' organizations and social groupings. Next to the Unilever Netherlands Holding B.V., one of the two head quarters of Unilever is seated in the Netherlands. Unilever has also six factories in operations in the Netherlands. These factories are coordinated by the Unilever Supply Chain. The Unilever Supply Chain Company is the new centre of European supply chain organization in Unilever. It is responsible for supply of raw- and packaging materials, the whole factory network which includes production planning, volume allocation and investments for the 90 European production facilities, and the

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1 About Unilever

transport and warehousing of finished products from the European manufacturing sites to the end-user markets.

Figure 1.1 Unilever Netherlands (Unilever NL 2006 mensen, merken, maatschappij presentation)

Within the Unilever Netherlands B.V. operate four business units. These are Unilever Foods, Unilever Ice Cream, Unilever Home and Personal Care and Unilever Foodsolutions. The fourth business unit, Unilever Foodsolutions, is specialized in products and services for the professional kitchen. In the Netherlands Unilever brings a variety of products on the market, such as well-known brands as Hertog, Ola, Becel, Bertolli, Blue Band, Calvé, Knorr, Lipton, Unox, Axe, Cif, Dove and Omo.

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2 Research design

In this chapter the research design is described. Following the motive of this research, a research objective will be defined. To be able to reach this objective, a research question needs to be formulated. This research is subjected to several product and procedural preconditions, which also will be explained in this chapter. Based on this information, a research framework will be made explicit. This framework will function as a guideline in the research, and shows the linkage between the different elements taken into account.

2.1 Type of research

This research can be classified 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 flow management can be summarized as the process of monitoring, analyzing, and adjusting the operational cash flow. This research envisages delivering a framework that will be supportive to future policy decisions and that will assist to improve current operational cash flow management of Unilever Netherlands.

2.2 Problem definition

According to De Leeuw (2001) the purpose of a problem definition is twofold: reconcilement with the customer and internal steering of the research.

The problem definition contains three components (Leeuw de, 2001) • Research objective

• Research question • Essential preconditions

The research objective answers the questions “Who wants to know what and for what reason?” and “which deliverables should be produced?” I.e. it deals with the relevance of the research. The research question is formulated following the research objective and is elaborated using a conceptual framework. The preconditions point out the restrictions of the research methods and results.

2.2.1 Research objective

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2 Research design

To design and secure a cash flow reporting tool, which can be used as a management control instrument.

2.2.2 Research question

The following research question can be posed:

“How can current management reporting practice of Unilever Netherlands be improved so that insight is provided into operational cash flow and accordingly cash flow reports can be used as a management control instrument?”

2.2.3 Sub-questions

The main research question is divided into several questions. Answering the first two sub-questions will give the diagnosis of the research problem. The third sub-sub-questions will help to develop a design to solve the research problem and the last sub-questions will deal with the implementation of the proposed design.

Diagnosis

1. How is management control organized at Unilever?

This question will be answered in chapter three using a theoretical model. Special attention will be paid to the concept of management control reporting. The theoretical insights will be used to describe management control practice at Unilever Netherlands.

2. How is cash flow management organized at Unilever?

The answer to this sub-question will put cash flow and cash flow management in an organizational context and provides an understanding of the various components which make up the flow of cash through an organization. Using theoretical insights from cash flow management literature, cash flow management practice at Unilever Netherlands will be elaborated.

After answering sub-questions one and two, a diagnosis is made of the situation at Unilever Netherlands and its operational cash flow. The foundation is laid for the design phase.

Design

3. What should the actual operational cash flow reporting tool look like?

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The last sub-question deals with the issues concerning the implementation of the designed system.

Implementation

4. Which issues should be taken into account with respect to the implementation of the designed operational cash flow reporting tool at Unilever Netherlands?

The designed operational cash flow management tool can only be considered useful if its actually implemented in the Unilever organization. Answering this sub-question will elucidate which factors have a direct influence on the successfulness of the implementation of the designed tool.

By answering these sub-questions the main research-question will be answered. The findings of this research will be outlined in the conclusions & recommendations chapter.

2.2.4 Essential preconditions

This research is subject to several preconditions.

Product essential preconditions

- The research should result in an operational cash flow reporting tool and a brief manual how to utilize the reporting tool.

- The designed reporting model should be easy to produce each reporting period.

- The Business unit taken into account is Unilever Netherlands, which consists of the Dutch marketing & sales organization including the Foodsolutions division. Also the sourcing units located in the Netherlands have to be taken into account.

Procedural essential preconditions

- This research is conducted by order of the Corporate Finance department of Unilever Netherlands to improve its operational cash flow management. It therefore needs to meet their requirements. - This research is also conducted to be the researcher’s final assignment in completion of the

requirements for the Master of Science ‘Finance’ at the faculty of Management and Organization, University of Groningen. Therefore it should meet the methodological and scientific requirements. - _{Target completion date of the deliverables for Unilever Netherlands is June 2007. Target}

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2 Research design

2.3 Research model

In this paragraph the research model is explained. The scope of this research is very wide and practical; therefore it is important to define a research framework. The research framework functions as a guideline in the research. Moreover it helps to focus on the main issues and will help to avoid getting lost in details, which is essential in meeting the preconditions. Hence, the research planning will be elaborated and the research methods will be explained.

2.3.1 Research framework

This research started of with the question from the corporate controller of Unilever Netherlands, how to get a better insight in, and control on, the operational cash flow of the Dutch operation company. To be able to answer this question, it is essential to first make a diagnosis of the situation at Unilever Netherlands. To fully grasp the research problem, it has to be looked at from two different disciplines which complete each other. Firstly, from a management control point of view: the lack of insight on operational cash flow can be defined as a management control issue. Therefore chapter three elaborates the management control practice at Unilever Netherlands using theoretical insights from management control literature. Secondly, the research problem deals with a cash flow management issue. Therefore, the research problem is discussed from a cash flow management point of view in chapter four. In chapter five insights from both disciplines come together in the design of the operational cash flow management tool. Next, the implementation of the tool in the Unilever Netherlands organization is discussed. In the final chapter, the main conclusions and recommendations are presented. Figure 2.1 is showing the research framework.

Stage 1: Diagnosis

It is important to get a thorough understanding of the research problem and its stakeholders. Theoretical insights are used to elaborate the concept of management control and cash flow

Stage 3: Implementation Stage 2: Design Stage 1: Diagnosis

Management Control (H3)

Cash Flow Management (H4)

OCF Reporting Tool (H5)

Implementation of OCF reporting tool

(H6)

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management. Based on internal documentation and interviews with stakeholders this theoretical elaboration will be linked to management control and cash flow management at Unilever.

Stage 2: Design

A draft version of the operational cash flow report is presented to the stakeholders to agree on a final version. Next, the utilization of the operational cash flow management tool has to be discussed with the staff member responsible for the production of the management reports.

Stage 3: Implementation

In the third stage the implementation of the operational cash flow reporting tool is discussed to explore which factors affect the successfulness of the implementation of the tool.

2.3.2 Research methods

This research has taken place at the Corporate Finance department of Unilever Netherlands for three months. During this period the author had the opportunity to poke around in the Unilever organization, to interview stakeholders, and to explore the intranet. The major source of information for this research has been literature and internal documentation study, and interviews.

Literature study

Management control theories are used to elaborate the concept of management control and to describe management control practice at Unilever. Furthermore cash flow management literature is consulted on the subject of cash flow performance, business cycles, cash conversion cycles, and working capital management. Management information system literature is used as theoretical underpinning for the design of an operational cash flow management tool.

Interviewing stakeholders

The author had the opportunity to nose about at the office of Unilever Netherlands for three months. During this period, all stakeholders were very obliging to be interviewed and supportive to the research. The research has taken place in supervision of the corporate controller and in close collaboration with a staff member of the reporting & analysis team. They can be considered as the main contact persons. Furthermore, stakeholders like the controllers, financial accountants, financial administration employees, have been interviewed.

Internal documentation

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3 Management control

In this chapter the concept of management control is elaborated and applied to the Unilever Netherlands practice. Next, the concept of management reporting is discussed, and the management reporting procedures at Unilever Netherlands are explained.

3.1 Management control

“Management control is concerned with providing information to managers –that is people inside an organization who direct and control its operations” (Garrison, et al., 2003). According to Garrison, managers carry out three key tasks: planning, directing & motivating, and controlling. Planning involves selecting a course of action and specifying how the action will be implemented. Directing & motivating involves mobilizing people to carry out plans and run routine operations. Controlling involves ensuring that the plan is actually carried out, and is appropriately modified as circumstances change.

The work of management can be summarized in a cycle as shown as in figure 3.1. The model shows the planning and control cycle and illustrates the flow of management activities from planning through directing and motivating, controlling and back to planning again.

Figure 3.1 Planning and control cycle (Garrison, et al., 2003, p. 4)

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financial results and company data, such as analysis of current business processes, benchmarks with peer groups and target growth. In carrying out the control function, managers seek to ensure that plans are being followed. Feedback, which signals whether operations are on track, is the key to effective control. In sophisticated organizations this feedback is provided by detailed reports of various types. One of these reports, that compares budgeted to actual results, is called a performance report (Garrison, et al., 2003). Performance reports suggest where operations are not proceeding as planned and where some parts of the organization may require additional attention. Providing this kind of feedback to management, is one of the central purposes of management accounting, and is subject to this research. This research deals with the objective that management would like to have better feedback regarding the cash generation of Unilever Netherlands.

Management needs to assess business performance through the profit & loss account, to control assets through the balance sheet and to understand, via the cash flow statement, how cash moves in and out of the business. These three financial statements are the central framework for control of the business. At corporate level this is not a problem, at lower level however, it is more difficult to produce these three statements, depending on the extent of autonomy allowed to divisions. Generally, the more autonomy, the more likely the division is to have all three statements as part of its management reporting structure. Companies that do not allow much autonomy and who have a centralized approach to management may decide that it is only necessary or feasible to have a profit & loss account (Warner, 1999). For instance, someone managing a brand or a group of products at Unilever, may best be managed through profit & loss account only, because it is not practical to allocate centralized assets which are shared with other parts of the business. This implicates that managers at lower level are not motivated to control cash and manage assets. This makes it one of the weaknesses of many internal management accounting systems. There is, however, no point in trying to develop separate financial statements unless they are meaningful and motivating to managers. One answer is to develop other ways of making managers accountable for the decisions they make which impact cash and assets. This can be done by developing performance measures to support the profit & loss account. The research deals with the issues of cash flow control at the Dutch Unilever organization and the use of adequate performance measures.

3.2 Management reporting

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At Unilever Netherlands, the Reporting & Analysis team of the Corporate Finance Department is responsible for the management reporting. This team collects all required information, and produces monthly and quarterly reports about the business performance of Unilever Netherlands. The performance reports include actual results, forecasts and prior year results, and give information about financial performance of the company. It shows the main profit & loss figures, volumes sold, turnover, analysis of different costs groups and internal accounting measures such as underlying sales growth4, trading result5, trading contribution6. If applicable, this data is also provided at brand product, product category, or customer level. Furthermore these reports present market information such as market shares.

The Reporting & Analysis department produces a monthly and quarterly management report to European regional information office and a monthly report for the board of Unilever Netherlands and controllers plus accountable managers within Unilever Netherlands. The report to the regional information office has to be drawn up according to general requirements and instructions, which are standardized and mandatory for all divisions of Unilever Europe.

Unilever targets to streamline ways of reporting in Europe, and aims to have global harmonization and consistency of in- and output. However, the current report for the board of Unilever Netherlands and its controllers and managers, is drawn up to the specific needs of its “users”. It is this group of people that would like to have better insight in cash flow performance, as they are getting more and more targeted on cash delivery. The greater part of this research deals with the development of an operational cash flow performance overview, to be included in the monthly management reports to Unilever Netherlands management. The data of the current management reports is built up in Excel spreadsheets, using the reporting tool Abacus. The operational cash flow management tool should be easy to implement in this current management reporting structure.

3.3 Conclusion

In this chapter the concept of management control has been elaborated and applied to the Unilever Netherlands practice. Theoretical insights were used to describe management control practice at Unilever Netherlands. The importance of management reporting to management control has been pointed out. Moreover, management control difficulties regarding cash flow have been discussed. Finally the current management reporting practice has been elaborated.

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Underlying sales growth reflects changes in revenue at constant rates of exchange, excluding the effects of acquisitions and disposals.

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Unilever talks about trading results internally whereas other companies and Unilever’s external reporting would refer to operating profit.

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4 Cash flow management

The management of Unilever uses cash flow delivery in evaluating its operational performance and value creation. Consequently, management of Unilever Netherlands would like to have better control on the cash flow of its operating company. In this chapter the concept of cash flow management is elaborated using a business model. Moreover, the view of Unilever on cash flow, and Unilever’s cash flow management practices, are discussed. Based on the theoretical insights and the discussion about cash flow management at Unilever in this chapter, it is possible to design a cash flow tool that will help management to control the cash flow.

4.1 Cash flow through the business

Cash flow management is the process of monitoring, analyzing, and adjusting the business' cash flows. The most important point is to shorten the cash flow conversion period, so that the business can bring in money faster (Checkley, 1994). Cash flow analysis is the study of the cycle of business' cash inflows and outflows, with the purpose of maintaining an adequate cash flow for a business, and to provide the basis for cash flow management. Cash flow analysis involves examining the components of business that affect cash flow, such as accounts receivable, inventory, accounts payable, and credit terms. By performing a cash flow analysis on these separate components, one is able to identify cash flow problems and find ways to improve cash flow.

In order to competently manage the cash flow of a business, it is first necessary to develop a thorough understanding of the various components which make up the flow of cash through the business. The model in figure 4.1. provides a framework to assimilate the components of the cash flow of a business.

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From the model in figure 4.1 it can be seen that businesses are investing cash in a continues cycle through creditors, into stock and work-in-progress, and eventually finished goods, whereupon, following a sale of the item involved, becoming a debtor and the back to cash. This cycle is known as the working capital cycle (highlighted red in figure 4.1.). Next to the working capital cycle, the model shows cash purchasing fixed assets, and share capital and borrowings, as sources of cash. The investments box in the centre of the model represents the transfer of cash not needed in the working capital cycle, or for the purchase of fixed assets put into a deposit account. The dividends, interest, and taxation boxes represent the payment out of the business of the surpluses or profit generated, by trading to the shareholders and providers of borrowings.

The working capital cycle is the most active and volatile flow of cash funds through Unilever just as in most other businesses. As a result, working capital management is a key component of cash flow management (Checkley, 1994). There are small differences in the way working capital management is looked upon. In general, working capital management deals with the working capital cycle consisting of creditors, debtors, stocks and cash.

Scherr (1989) defines modern working capital management as “the management of the assets and liabilities in the top half of the balance sheet. Included here, are assets such as cash marketable securities, accounts receivable, inventory, prepaid expenses, and other current assets; also, liabilities such as accounts payable, wages payable, and accruals.”

According to Checkley (1994) working capital management is about managing the elements of the cash flow cycle. Checkley splits these elements up in: cash, creditors, overheads, labour, work in progress, finished goods and debtors.

Unilever uses the concept of ‘total working capital employed’. In figure 4.2 the composition of ‘total working capital employed’ can be seen.

Figure 4.2 Trading working capital

+ Trading stocks

Finished products

Packaging materials & ingredients Other

+ Trading debtors

Third party debtors Concern debtors

- Trading Creditors

Third party creditors Concern creditors Restructering creditors

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Trading working capital is split into trading stocks, debtors, creditors. Debtors and creditors are split in concern and third party. Concern debtors and creditors are related to operations with other Unilever companies, such as the Unilever food factories, or the Belgian marketing & sales organization of Unilever. Third party debtors and creditors are related to operations with third party companies, such as retailers, or an advertising agency. This split-up into concern and third party is important because more and more focus is given to the third party working capital movement, as it is the net contribution of the operating company to the Unilever cash flow, generated by the trading working capital movement. Restructuring creditors arise from reorganizations or closures within the business.

The flow of cash through the working capital cycle can be measured by using the cash conversion cycle metric. The cash conversion cycle is a metric that expresses the length of time, in days, a company takes in order to convert resource inputs into actual cash flows (Hill et al., 1995). It attempts to measure the amount of time each net input euro is tied up in the production and sales process before it is converted into cash through sale to customers. This metric looks at the amount of time needed to sell inventory, the amount of time needed to collect receivables, and the length of time the company takes to pay its bills. The cash conversion cycle is calculated as:

CCC = DIO + DSO- DPO Where:

DIO represents days inventory outstanding DSO represents days sales outstanding DPO represents days payable outstanding

The shorter the cycle, the less time capital is tied up in the business process, and thus the better for the company's cash flow generation.

4.2 Cash flow at Unilever

As most companies, Unilever believes cash flow information is useful to investors, because it provides a basis for measuring its operating performance, and therefore puts it in annual reports. The management of Unilever uses these financial measures also internally in evaluating its operational performance and value creation.

Unilever’s ambition for the creation of value for shareholders is measured by total shareholder return over a rolling three-year period compared with a peer group of 20 other companies. Unilever believes that the contribution of the business to this objective can be best measured and communicated to investors through the following measures:

- The delivery over time of ungeared free cash flow (UFCF), which expresses the translation of profit into cash, and thus longer-term economic value.

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Ungeared free cash flow (UFCF) expresses the generation of profit by the business and how this is translated into cash, and thus economic value. It is, therefore, not used as a liquidity measure within Unilever. The movement in UFCF is used by Unilever to measure progress against the longer-term value creation goals7. Unilever committed itself to generate 25-30 billion Euros of cash between 2005 & 2010.

As noted before, management and forecasting of cash flow has become a direct responsibility of the local organization. Therefore, UFCF is translated into a cash flow that is largely controllable for the management of the local organization: operational cash flow. Operational cash flow doesn’t deal with concern level items and aggregates to operating company level. The construction of operational cash flow is shown in figure 4.2.

Trading Contribution Add back:

Depreciation Financing charge Cash flow from TC

Trading working capital movement Trading stocks movement Trading debtor movement Trading creditor movement

capital expenditure

OCF before A/D Acquisition & disposal Operational Cash Flow

Figure 4.2 Construction of OCF

As management is interested in the relationship between cash flow and profit, the so called ‘funds flow’ format is used. This approach starts with operating earnings (trading contribution) and makes adjustments for non-cash expenses like depreciation and the financing charge. Trading contribution is the profit after all costs, controlled by the operating company. The financing charge is a statistical charge that estimates the cost of financing the capital employed in the business. It covers the weighted average cost of Unilever’s debt and equity funding. Next, the operating earnings are corrected for balance sheet changes and capital expenditure. Increases in balance sheet assets (inventory & accounts receivables) are like cash outflows. Increases in liabilities (account payable) are like cash inflows. The operational cash flow before acquisitions provides information on what has been generated from normal operations; the inclusion of acquisitions - particularly big ones - can distort the picture. The operational cash flow after acquisitions shows the total position.

In the previous paragraphs it was made clear which components make up the flow of cash through a business and the way Unilever approaches cash flow in its organization. The next step in this research was to define which components of operational cash flow require attention from an operational cash

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flow management perspective. By means of interviews with the corporate controller and several other stakeholders, a clear understanding of the relevant components of the operational cash flow was gained. Trading contribution is the main driver for operational cash flow delivery, but trading contribution targets are accurately managed and adjusted through profit & loss reports. Therefore, trading contribution needs no specific attention from an operational cash flow perspective. As noted before, working capital is a high priority business issue which directly impacts cash generation, and therefore should be focused on from an operational cash flow perspective. Goal of management is to improve stock and third-party debtor positions, and maintain third-party creditor positions. Capital expenditure is the main use at Unilever. However, capital expenditures are tightly managed through a well defined process. Therefore capital expenditure needs no specific attention from an operational cash flow perspective.

4.3. Conclusion

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5 The operational cash flow reporting tool

In chapter four, the concept of operational cash flow and its key components have been discussed. This chapter deals with the design of the operational cash flow reporting tool. The output of this operational cash flow reporting tool should function as the input for management, by which it can control the operational cash flow. The elements that require specific attention from an operational cash flow management perspective are discussed in paragraph 4.2. These elements have to be pinpointed in the output of the operational cash flow reporting tool. In this chapter, the operational cash flow reporting tool will be discussed, using insights from the management information systems literature.

5.1 The management information system

The operational cash flow reporting tool can be looked at as a Management Information System (MIS). The concept of MIS covers the broad field of systems that provides information for the management activities carried out within an organization (Curtis et al., 2002). Blumenthal (1969) defines management information systems as all methods, facilities and activities an organization uses to gather information. Organizations, in relation to management information systems, can be looked at in different ways. Blumenthal (1969) uses a system-oriented point of view and divides an organization up into three sub-systems:

1. Primary transformation system; this system is focused on the process of designing, manufacturing and sales of products and/or services.

2. Management system; this system is divided into making levels: strategical decision-making, tactical decision-making and operational decision-making.

3. Information system, focused on producing management information for the three decision-making levels.

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The primary transformation system contains all activities of an organization aimed at designing, producing, and sales of products and/or services. It deals with the core business of the organization. The primary transformation system or the core business of Unilever Netherlands is development, manufacturing, marketing and sales of fast moving consumer goods.

Primary transformation processes have to be directed by management systems. According to Blumenthal (1969), this happens in so called “management centers”. These management centers operate at different aggregation levels, and together they form the management system. The management centers correspond with the differentiation in strategic, tactical, and operational decisions. Strategical decisions deal with the objectives of the organization as a whole, and the desired strategy to reach these objectives. These kind of decisions have long term impact. The management system of Unilever at a strategical level, deals with the objective of creating long-term value for its shareholders. Tactical decisions deal with the choice which means to use, to execute a chosen strategy. The strategic objective to create long-term value for Unilever’s shareholders is incorporated on a tactical level by the objective to control business unit performance on operational cash flow generation. Controlling business units on operational cash flow generation is a mean to execute the strategy of creating-long term value for the shareholders. Operational decisions relate to actual execution of the chosen strategy and tactics. These kind of decisions have usually short term impact. Unilever’s tactic to control its business on operational cash flow should be backed up by operational decisions that impact the generation of cash flow such as debtor and creditor management. Input Actions Output Internal observations External observations Environment Information System Management System Strategical Tactical Operational

Primary transformation system

Information Data

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The third sub-system that is recognized by Blumenthal is the information system. The information system includes all methods, facilities, and activities an organization uses to gather information. The term “methods” encompasses the procedures and work regulations for the gathering, editing, and the distribution of data. The term “facilities” encompasses the means that are utilized in the information process, like employees. The term “activities” encompasses all activities that are aimed at transforming data into information. Unilever has many information systems. This research deals with one of these systems: an information system that provides management with operational cash flow information. This information system, called the operational cash flow reporting tool, has to fit in the current management reporting procedures and comply with the work regulations for gathering, editing, and distribution of data. Moreover, the operational cash flow reporting tool has to be executed with the current available facilities used in the management reporting process: the staff member responsible for the management reports should be able to produce the operational cash flow reports in a spreadsheet (Excel), using existing information supply. In paragraph 5.2 the operational cash flow reporting tool will be looked at more in detail.

5.2 Overview

During this research, an extensive amount of time has been invested in the design of a reporting tool that provides all useful information for analyzing the operational cash flow in a clear layout. A number of times, the design of the tool has been discussed with the corporate controller and the staff member of the analysis & reporting team responsible for the production of the management reports, to come to the desired reporting tool format. During this process of designing, several issues had to be dealt with: which information needs to be pinpointed in the operational cash flow report, which information sources to use and the information availability. Furthermore the user-friendliness for the reporting & analysis team, as well as for the actual users of the operational cash flow reports had to be considered. As can be seen in figure 5.1, an information system like the operational cash flow reporting tool receives input (internal observations and external observations), and generates an output to the management system. The input of the operational cash flow reporting tool consists only of internal observations, so external observations are not taken into account in this research. The reporting tool converts this input into output. The output of the reporting tool is the operational cash flow report. In the next sections of this chapter the input, the output and the reporting tool model will be elaborated.

5.2.1 Input

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greater part of this research, the former Unilever accounting department “Finance Focus” was still active. The required input for the report was discussed with the head accountant of the former Unilever accounting department and in consultation with him, the required data was determined and collected. During the research, several problems were discovered in the delivery of the data concerning operational cash flow and working capital by the accounting system; the reported operational cash flow data didn’t match the reported working capital data. It turned out, that these problems were caused firstly by the restructuring of Unilever supply chain organization, and secondly by the outsourcing of the accounting system to IBM. At the moment of writing Unilever and IBM are in the process of clearing out accounts, and adapting the accounting system to the current organization structure. It goes without a saying that the implementation of the OCF report can only be successfully executed when these accounting issues have been solved.

5.2.2 The reporting tool model

During this research, an extensive amount of time has been invested in the design of an Excel model which functions as reporting tool. The tool had to be easy to implement in current management reporting activities. Part of this research, was to write a brief manual how to operate the reporting tool. The input data discussed in the previous section, is manually imported in an Excel input sheet by the staff member responsible for the management reports. The input sheet contains all data concerning the operational cash flow of past 12 months and functions as a database. The reporting tool uses a rather technological simple Excel model to convert the input data in the required operational cash flow reports. The technical specifications of the model are not relevant in the further discussion of this research. The Excel model produces an operational cash flow report consisting of several tables and graphs. This report is directly imported as an additional section in the main management report, and it will be discussed in the next section.

5.2.3 Output

The operational cash flow reporting tool produces several tables and graphs that together form the operational cash flow report. This report is included to the main management report, and will help management to analyze the operational cash flow. In consultation with the corporate controller and the staff member directly responsible for the management reports, the components that had to be included in the operational cash flow report, were determined. Next, these components will be explained.

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Figure 5.2 Operational cash flow chart

The chart is drawn up according a lay-out that is customary in the Unilever management reports. In the first column, the actual figures and prior year figures are given. The actual figures are being compared to prior year figures instead of prior period figures to eliminate the effects of seasonality; certain of Unilever Netherlands businesses, such as ice cream, are subject to significant seasonal fluctuations in sales. The variance between actual and prior year results is also displayed in a graphic representation, which can be seen in figure 5.3. This graph shows in a glance what causes the variances between this year and prior year operational cash flow performance. Management has to determine what level of variance is meaningful or material to the business and what the context of the numbers is. Next, in the second column of the operational cash flow chart the year-to-date figures are given, which state the performance so far this year, starting from January 1. The third column contains the year-to-go figures, and compares the full year forecast to the actual figures so far this year. The year-to-go figures show what performance has to be realized in the remainder of the year to achieve the full year forecast. The final column shows the full year forecast and the variance between this forecast with the forecast made in the preceding period.

The operational cash flow forecasts are the responsibility of the corporate controller. The corporate controller already had to deliver quarterly forecast of the operational cash flow to the European headquarters. This forecast was done, based on a rough assessment of the operational cash flow results and prior forecasts. The controller looked for big movements in the different elements of the operational cash flow, and adapted the forecast roughly according to these movements. The designed operational cash flow report provides the controller with better insight, by showing movements in the operational cash flow and its underlying items. This will considerably improve the accuracy of the forecasts.

Business Unit

All figures in Euro / € `000 Q1 2007 YTD YTG Full Year Variance

Act 06 Act 07 vs. PY Act 06 Act 07 vs. PY

vs. previous forecast Trading Contribution

IWC Added Back

Financing Charge Added Back Financial Depreciation Added back Ammortization / Impairments NBV Fixed Asset Disposals Cash from TC stocks Movement Debtors Movement 3rd party Creditors Movement 3rd party Concern Indebtedness Restructuring Movement Working Capital Movement Gross Capital Expenditure

Elimination of P&L on business disposal OCF bef Bgroup Acq / ( Dis )

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Figure 5.3 Operational cash flow variance analysis (figures displayed are fictitious)

As noted in paragraph 4.2.3, the main focus of the operational cash flow report is on the working capital element. The construction of the trading working capital is displayed by the left graph of figure 5.4 and provides insight in the different elements of the trading working capital. The right graph of figure 5.4 shows the trading working capital as percentage of turnover, which indicates the working capital needs, relative to the realized turnover. The better Unilever Netherlands manages its working capital, the less cash is tied up in the day-to-day operations. An increase in working capital results in less operational cash flow generation as cash is tied up in the organization.

350.000- 300.000- 250.000- 200.000- 150.000- 100.000- 50.000-0 50.000 100.000 150.000 200.000

feb-06 mrt-06 apr-06 mei-06 jun-06 jul-06aug-06sep-06 okt-06 nov-06 dec-06 jan-07 feb-07

E u ro '0 0 0

Trading Working Capital

Closing stocks Closing 3rd party Debtors incl Debtors Other Closing 3rd Party Creditors incl Restructuring Creditors Closing Concern Indebtedness Closing Average Working Capital

-12,0% -10,0% -8,0% -6,0% -4,0% -2,0% 0,0% 2,0%

feb-06 mrt-06 apr-06 mei-06 jun-06 jul-06 aug-06 sep-06 okt-06 nov-06 dec-06 jan-07 feb-07

Average Working Capital as % Turnover

Average working Capital as % TO Average Working Capital as % TO (MAT)

Figure 5.4 Working capital graphs (figures displayed are fictitious)

As stated in paragraph 4.1, the flow of cash through the working capital cycle can be measured by using the cash conversion cycle metric. The cash conversion cycle is calculated as follows:

Cash Conversion Cycle = Inventory Days + Days Sales Outstanding – Days Payables Outstanding

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-35 -30 -25 -20 -15 -10 -5 0 5 10 15 20

jan-06 feb-06 mrt-06 apr-06 mei-06 jun-06 jul-06 aug-06 sep-06 okt-06 nov-06 dec-06 jan-07 feb-07 D

a y s

Cash Conversion Cycle

Cash Conversion Cycle Cash Coversion Cycle (MAT)

Figure 5.5 Cash conversion cycle (figures displayed are fictitious)

Days inventory (DI) represent the number of days cover for inventory and is reported using the graph of figure 5.6. This measure uses total supply chain cost and total days in the relevant period as the basis.

Days Inventory = Average inventory in the period X # days in the period Total Supply Chain Costs in the period

0 5 10 15 20 25 30 35 40 fe b -0 6 m rt-0 6 a p r-0 6 m e i-0 6 ju n -0 6 ju l-0 6 a u g -0 6 s e p -0 6 o k t-0 6 n o v -0 6 d e c -0 6 ja n -0 7 fe b -0 7 D a y s Days Inventory

sto cks - Other D a ys sto cks - Pa cking M a te ria l e n In gre die nts D a ys sto cks - Fin ish ed Produ cts D ays sto ck D ays (M AT)

Figure 5.6 Days inventory (figures displayed are fictitious)

Days sales outstanding (DSO) represents the number of days sales outstanding and is reported using the graph of figure 5.7. This measure uses turnover and total days in the period as the basis:

Days Sales Outstanding = Average Debtors in the period excluding concern debtors X # days in the period Total Turnover in the period

0 5 10 15 20 25 30 35 40 ja n -0 6 fe b -0 6 m rt-0 6 a p r-0 6 m e i-0 6 ju n -0 6 ju l-0 6 a u g -0 6 s e p -0 6 o k t-0 6 n o v -0 6 d e c -0 6 ja n -0 7 fe b -0 7 D a y s

Days of Sales Outstanding (3rd Party)

Debtor Days Debtor Days (MAT)

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Days payables outstanding (DPO) represents the number of days of outstanding payables and is reported using the graph of figure 5.8. This measure uses total cost and total days in the period as the basis:

Days Payables Outstanding = Average Creditors in the period excluding concern creditors X # days in the period Total Cost in the period

0 10 20 30 40 50 60 ja n -0 6 fe b -0 6 m rt-0 6 a p r-0 6 m e i-0 6 ju n -0 6 ju l-0 6 a u g -0 6 s e p -0 6 o k t-0 6 n o v -0 6 d e c -0 6 ja n -0 7 fe b -0 7 m rt-0 7 D a y s

D ays P ayables Outstan d ing (3rd P arty)

C red itors 3rd Pa rty D a ys Rerstru ctu rin g p ro vision D a ys C red ito rs D ays (MAT)

Figure 5.8 Days payables outstanding (figures displayed are fictitious)

As noted working capital improvement is considered to be an opportunity to help to deliver on the operational cash flow goal of Unilever Netherlands. If one can get money to move faster around the cycle (e.g. collect monies due from debtors more quickly), or to reduce the amount of money tied up (e.g. reduce inventory levels relative to sales), the business will generate more cash. Goal of Unilever Netherlands management is to improve third party debtors and maintain third party creditors. As discussed in chapter three, feedback that signals whether operations are on track, is the key to effective control. The different elements of the operational cash flow report help management to carry out the control function, and ensure that the plans concerning operational cash flow performance are being followed. The operational cash flow report shows where operations are not proceeding as planned and where some parts of the organization may require additional attention.

5.3 Conclusion

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6 Implementation of the tool

In the previous chapter, the operational cash flow management tool has been elaborated. This operational cash flow management tool can only be considered useful, if it is actually implemented in the Unilever organization. The issues concerning the implementation of the designed operational cash flow reporting tool will be discussed in this chapter. Firstly the implementation of the reporting tool as a management information system is discussed. Secondly in paragraph 6.2 four factors are identified that strongly affect the success rate of the operational cash flow reporting tool.

6.1 System implementation

The implementation of the reporting tool can be looked at as the implementation of a management information system. According to Long (1989) there are three issues that are important regarding the implementation of a management information system: user support, system and acceptance testing, and system conversion. The effective use of a newly designed information system is heavily dependent on the quality of the user manuals and training programs. As noted before a small user manual is provided with the reporting tool. This manual describes step by step how to use the reporting tool. Moreover the use of the reporting tool is extensively explained to the staff member responsible for the production of the management reports. The final step before system conversion and implementation is system and acceptance testing. During this research the tool is tested with prior period data. Due to the time limits of this research, the system couldn’t be tested with current data. The third and last test is the user acceptance test. The development of the reporting tool took place in close consultation with the users of the tool and they approved the final reporting tool design. Once accepting testing is complete, the information system can be put in operation. This normally involves a “conversion” from the existing system to the new one (Long 1989). The implementation of the reporting tool can be considered to be a pilot conversion. The current information system isn’t actually altered; the reporting tool is an extension to the current information system. The advantage of pilot conversion is that possible flaws in the tool can be dealt with before the tool is fully integrated in the existing information system.

6.2. Success factors

Wiebes and Van Dijk (1993) identify four factors that strongly affect the success rate of a cash management information system: strategic policy, culture, administrative organization, and the supply of information. These four factors are also applicable to the designed operational cash flow reporting tool. In the next section, the implementation of the designed operational cash flow reporting tool will be elaborated on the basis of these factors.