Wednesday, December 23, 2009

The role of the CFO in managing liquidity in the company

Maintaining liquidity in the company is always one of the major challenges facing the financial directors of companies. However, it takes on particular significance in times of economic downturn.

One of the most popular valuation firms - so-called discounted cash flow (DCF) - says that the company is worth as much as its ability to generate cash. Valuation of the company's financial analysts make complex financial models and make use of complex financial theories, including servants to the valuation of the cost of capital.
I provide a simple example that shows the importance to the functioning of the company, and above all to improve liquidity, is the role of Chief Financial Officer supported by the controller.

At the beginning let's look at the global reckoning performance. In the following example for simplicity ignores the issues of income tax (assuming that the company has made losses for some time), was also accepted that the company is not financed from suppliers (ie, pay their obligations immediately).

The company generates a loss for accounting and a minimum return "check" (depreciation is the cost accountant, but not a cash expense) at about 4 thousand. USD per month. In addition, the company faced problems already with the traditional extension of payment by customers, the need to purchase raw materials "on reserve" close to satisfying the monthly demand for raw materials "from above".

All this means that the company has no funds for development, and when it came the financial crisis and the associated rigorous approach of banks to lend, the company faced the spectrum does not extend the bank credit agreement financial year. Practically this resulted in a need for a company of about 500 thousand. USD cash to repay obligations to the bank. Management saw an opportunity in the growth of sales and gain a new contract for the sale of product B for the amount of 50 thousand. month. Unfortunately, due to liquidity problems is not able to buy the necessary materials for the execution of the order - the more that the bank, the current situation of the company, refused to increase the turnover of credit. At the same time informed of the possibility of his dismissal, in the absence of an improved financial situation of the company.

Facing the prospect of such a company decided to outsource the services of professional financial advice as CFO in outsourcing. For companies outsourcing was more effective solution than employing budgetary CFO directly at time in the company. The purpose of the Chief Financial Officer CFO is to propose and implement changes to enable the company to regain liquidity. The first task is put before an expert analysis of the possibilities of obtaining short-term financing that would allow an increase in sales. In the course of discussions it became clear that the administration hoped that the specialist will help find short-term financing that will meet the increased contract for the sale of product B. However, the short-term loan for the purchase of raw materials rozwiązywałaby no structural problems of the company. The specialist decided to examine whether the company itself does not possess hidden reserves, which as a result of restructuring can be released.

You can see that, despite the generation small "cash earnings" the company must have a huge periodic liquidity problems. This follows from the fact that accounting for the VAT, the company must pay above. tax, although a substantial part is not yet recovered from their customers. VAT payable to the Tax Office in the case of product A is close to 80 thousand. USD. And keep in mind that the cycle of receivable from distributors involved in the sale of product A is an average of up to 55 days. Therefore, the company must either nieterminowo regulate their obligations to the Tax Office, bearing such cost penalty interest, or zadłużać the bank to settle its obligations in a timely VAT.
The need to finance receivables and inventories are closely linked to financial costs - so they can be directly attributed to each product. Assuming interest rate of 10 percent. per year for product A financial costs can be estimated at around 7 thousand. USD, while product B, this would be only a few hundred gold.

Therefore, the cost of storage, such as property tax, costs of security and lighting costs can be allocated to products A and B (depending on the degree to which they benefit from the magazine), the auditor estimated that the total cost of EUR 30 thousand. USD per month is divided into various products as follows: Product A - 26 thousand. USD, product B - 4 thousand. USD.

Analyzing spending on marketing and selling expenses marketingw located commissions and incentive fees to distributors. The company in this area always had a policy under which the budget for these costs is 15 percent. revenues.

Detailed analysis of marketing spending has shown that these are expenses related to advertising their product can be easily assigned to any groups assortment.

So far the Board had merely informed that after taking into account the direct costs of production, product A has resulted in 100 thousand a month. USD profit, and product B, 80 thousand. USD. At the level of the firm's net loss amounted to 15 thousand. USD. With only this knowledge, it was difficult to make a rational decision as to heal the liquidity in the company - particularly given the fact that the bank demanded the submission of a restructuring plan leading to a profit and liquidity.
After considering all the costs associated with the production of various ranges, it turned out that the product A generates only about 12 thousand. USD profits, while product B up to 40 thousand. USD. Profit generated by the product A barely enough to cover the cost of financing.
Furthermore, it appears that if the company did not have the need to maintain such high inventory levels of product A, then its demand for storage space would be much lower and the company would consider outsourcing of warehousing services. Assuming that the storage costs in outsourcing of product B would be higher than in their own warehouse, and so it would appear that: saves the company - rather than incur the cost of storage at 30 thousand. USD, an external company would pay only about 10 thousand. USD.

Eventually the company decided to withdraw from the production of A saved money earmarked for the purchase of raw materials to increase production and sales of product B. In addition, the company decided to get rid of equipment for the production of product A and leased storage space outside the company. Under the settlement, the company served the storage of B-products produced by the company. This allows the storage costs offset revenue, for simplicity in the following data shown so the cost of storage 0

With these treatments the company began to show profits and sharply improved its liquidity.

As a result of withdrawing from the production of a product, the company reduced the demand for cash (the long cycle of receivable from dealers who pośredniczyli the sale of the product range and a long cycle of rotation of the magazine). As a result of changes in product structure decreased the level of inventories and receivables.

The company - with 745 thousand. USD frozen in assets - has regained 592 thousand. USD. Thanks to the company without using a bank loan could operate. In addition, the company could recover some money out of property derived from the sale of equipment used to produce the range of A. With such an efficient restructuring, the company began to show net profits to earlier reported losses and freed about 600 thousand. USD cash. The Bank has not threatened the termination of credit, but even he began to seek that the company it has underwritten (as joke business, most banks offer loans to those who do not need them).
With access to their cash and additional bank financing, the company could start to increase its production capacity for product B, and strengthen marketing efforts and thereby increase its sales.
The company increased its production capacity by 100 percent., Which translates into increased sales.

The example cited shows how important the role of CFO in the company. However, many medium-sized businesses can not afford the employment of a person in this position due to budgetary constraints. Sometimes companies do not require specific features daily presence of CFO in the company, due to the generation of periodic tasks designed for this function. In this situation a good solution is outsourcing such services. It is important that the outsourcing is the cost variable, which can be flexibly adjusted to the current financial situation of the company. In addition, management companies must be mindful that the role of the CFO is not just budgeting and preparation of balance, but above all supporting the board in search of opportunities and sources of growth of the company, managing liquidity and taxes, cost reduction and process optimization and supervision of internal control and risk management in the company.

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