Delivering value throughout the automation journey
Revenue
In accounting, revenue is the income that a business has from its normal business activities, usually from the sale of goods and services to customers. Revenue is also referred to as sales or turnover. Some companies receive revenue from interest, royalties, or other fees.[1] Revenue may refer to business income in general, or it may refer to the amount, in a monetary unit, earned during a period of time, as in "Last year, Company X had revenue of $42 million". Profits or net income generally imply total revenue minus total expenses in a given period. In accounting, in the balance statement it is a subsection of the Equity section and revenue increases equity, it is often referred to as the "top line" due to its position on the income statement at the very top. This is to be contrasted with the "bottom line" which denotes net income (gross revenues minus total expenses).[2]
For non-profit organizations, annual revenue may be referred to as gross receipts.[3] This revenue includes donations from individuals and corporations, support from government agencies, income from activities related to the organization's mission, and income from fundraising activities, membership dues, and financial securities such as stocks, bonds or investment funds.
In general usage, revenue is income received by an organization in the form of cash or cash equivalents. Sales revenue or revenues is income received from selling goods or services over a period of time. Tax revenue is income that a government receives from taxpayers.
In more formal usage, revenue is a calculation or estimation of periodic income based on a particular standard accounting practice or the rules established by a government or government agency. Two common accounting methods, cash basis accounting and accrual basis accounting, do not use the same process for measuring revenue. Corporations that offer shares for sale to the public are usually required by law to report revenue based on generally accepted accounting principles or International Financial Reporting Standards.
In a double-entry bookkeeping system, revenue accounts are general ledger accounts that are summarized periodically under the heading Revenue or Revenues on an income statement. Revenue account names describe the type of revenue, such as "Repair service revenue", "Rent revenue earned" or "Sales .
Money income from activities that are ordinary for a particular corporation, company, partnership, or sole-proprietorship. For some businesses, such as manufacturing or grocery, most revenue is from the sale of goods. Service businesses such as law firms and barber shops receive most of their revenue from rendering services. Lending businesses such as car rentals and banks receive most of their revenue from fees and interest generated by lending assets to other organizations or individuals.
Revenues from a business's primary activities are reported as sales, sales revenue or net sales. This includes product returns and discounts for early payment of invoices. Most businesses also have revenue that is incidental to the business's primary activities, such as interest earned on deposits in a demand account. This is included in revenue but not included in net sales. Sales revenue does not include sales tax collected by the business. Other revenue (a.k.a. non-operating revenue) is revenue from peripheral (non-core) operations. For example, a company that manufactures and sells automobiles would record the revenue from the sale of an automobile as "regular" revenue. If that same company also rented a portion of one of its buildings, it would record that revenue as “other revenue” and disclose it separately on its income statement to show that it is from something other than its core operations. The combination of all the revenue generating systems of a business is called its revenue model.
Financial statement analysis
Revenue is a crucial part of financial statement analysis. The company’s performance is measured to the extent to which its asset inflows (revenues) compare with its asset outflows (expenses). Net income is the result of this equation, but revenue typically enjoys equal attention during a standard earnings call. If a company displays solid “top-line growth”, analysts could view the period’s performance as positive even if earnings growth, or “bottom-line growth” is stagnant. Conversely, high net income growth would be tainted if a company failed to produce significant revenue growth. Consistent revenue growth, if accompanied by net income growth, contributes to the value of an enterprise and therefore the stock price.
Revenue is used as an indication of earnings quality. There are several financial ratios attached to it, the most important being gross margin and profit margin. Also, companies use revenue to determine bad debt expense using the income statement method.
Price / Sales is sometimes used as a substitute for a Price to earnings ratio when earnings are negative and the P/E is meaningless. Though a company may have negative earnings, it almost always has positive revenue. Gross Margin is a calculation of revenue less cost of goods sold, and is used to determine how well sales cover direct variable costs relating to the production of goods.
Net income/sales, or profit margin, is calculated by investors to determine how efficiently a company turns revenues into profits.
Government revenue
Government revenue includes all amounts of money (i.e., taxes and fees) received from sources outside the government entity. Large governments usually have an agency or department responsible for collecting government revenue from companies and individuals.
Government revenue may also include reserve bankcurrency which is printed. This is recorded as an advance to the retail bank together with a corresponding currency in circulation expense entry, that is, the income derived from the Official Cash rate payable by the retail banks for instruments such as 90-day bills. There is a question as to whether using generic business-based accounting standards can give a fair and accurate picture of government accounts, in that with a monetary policy statement to the reserve bank directing a positive inflation rate, the expense provision for the return of currency to the reserve bank is largely symbolic, such that to totally cancel the currency in circulation provision, all currency would have to be returned to the reserve bank and cancelled.
Association non-dues revenue
Association non-dues revenue is revenue generated through means besides association membership fees. This revenue can be found through means of sponsorships, donations or outsourcing the association's digital media outlets.
One of the everyday jobs of the treasurer is to manage the cash, and flow of funds through the organization. If the amount or receipt and collection activities are out of control, the entire firm may face bankruptcy. There is an old saying, “If you pay attention to the pennies, the dollars will take care of themselves.” In this spirit, this paper looks at taking care of the daily amounts of cash flowing through the firm in a systematic fashion. The purpose is to understand the importance of the inter-relationships involved and to be able to measure the amount and speed of the cash flow. Once something can be measured, it can be managed.
Most of us have more options for raising money than we think. ... programs that go under names such as “working capital loan” or “line of credit. ... Charge card and credit card companies, as well as some electronic payment .
Legal tender is a medium of payment recognized by a legal system to be valid for meeting a financial obligation.[1] Paper currency and coins are common forms of legal tender in many countries. Legal tender is variously defined in different jurisdictions. Formally, it is anything which when offered in payment extinguishes the debt. Thus, personal cheques, credit cards, and similar non-cash methods of payment are not usually legal tender. The law does not relieve the debt obligation until payment is tendered. Coins and banknotes are usually defined as legal tender. Some jurisdictions may forbid or restrict payment made other than by legal tender. For example, such a law might outlaw the use of foreign coins and bank notes or require a license to perform financial transactions in a foreign currency.
Generally, designation of a particular form of money as legal tender means "that the designated money is valid payment for all debts unless there is a specific agreement to the contrary".[2] In some jurisdictions legal tender can be refused as payment if no debt exists prior to the time of payment (where the obligation to pay may arise at the same time as the offer of payment). For example, vending machines and transport staff do not have to accept the largest denomination of banknote. Shopkeepers may reject large banknotes: this is covered by the legal concept known as invitation to treat. Under the law, United States money as identified above is a valid and legal offer of payment for antecedent debts when tendered to a creditor. By contrast, federal statutes do not require that someone who is not a pre-existing creditor must accept currency or coins as payment for goods or services. Private businesses may formulate their own policies on whether to accept cash unless state law requires otherwise.[
The right, in many jurisdictions, of a trader to refuse to do business with any person, means a purchaser may not insist on making a purchase and so declaring a legal tender in law, as anything other than an offered payment for debts already incurred would not be effective.
Etymology
The term "legal tender" is from Middle English tendren, French tendre (verb form), meaning to offer. The Latin root is tendere (to stretch out), and the sense of tender as an offer is related to the etymology of the English word "extend" (to hold outward).
Withdrawal and replacement of legal tender
Demonetisation
Coins and banknotes may cease to be legal tender if new notes of the same currency replace them or if a new currency is introduced replacing the former one.[6] Examples of this are:
The United Kingdom, adopting decimal currency in place of pounds, shillings, and pence in 1971, Banknotes remained unchanged (except for the replacement of the 10 shilling note by the 50 pence coin). In 1968 and 1969 decimal coins which had precise equivalent values in the old currency (5p, 10p, 50p - 1, 2, and 10 shillings respectively) were introduced, while decimal coins with no precise equivalent (½p, 1p, 2p equal to 1.2d (old pence), 2.4d, 4.8d respectively) were introduced on 15 February 1971. The smallest and largest non-decimal circulating coins, the half penny and half crown, were withdrawn in 1969, and the other non-decimal coins with no precise equivalent in the new currency (1d, 3d) were withdrawn later in 1971. Non-decimal coins with precise decimal equivalents (6d ( = 2½p), 1 and 2 shillings) remained legal tender either until the coins no longer circulated (1980 in the case of the 6d), or the equivalent decimal coins were reduced in size in the early 1990s. The 6d coin was permitted to remain in large circulation throughout the United Kingdom due to the London Underground committee's large investment in coin-operated ticketing machines that used it.[ Old coins returned to the Royal Mint through the UK banking system will be redeemed by exchanging them for legal tender currency with no time limits; but coins issued before 1947 have a higher value for their silver content than for their monetary value.[
Currencies used in the Eurozone before being replaced by the euro are not legal tender, but all banknotes are redeemable for euros for a minimum of 10 years (for certain notes, there is no time limit).[
India demonetised its 500 and 1000 rupee notes on November 8, 2016. This action affected 86 percent of all cash in circulation. The demonetisation action was intended to curb black money, the hoarding of unaccounted cash, and sponsorship of terrorism, but also led to long queues from bank runs, leaving more than 30 people dead.[7] The old notes are now being replaced by new 500 and 2000 rupee notes.
Individual coins or banknotes can be demonetised and cease to be legal tender (for example, the pre-decimal United Kingdom farthing or the Bank of England 1 pound note), but the Bank of England does redeem all Bank of England banknotes by exchanging them for legal tender currency at its counters in London (or by post) regardless of how old they are. Banknotes issued by retail banks in the UK (Scotland and Northern Ireland) are not legal tender, but one of the criteria for legal protection under the Forgery and Counterfeiting Act is that banknotes must be payable on demand, therefore withdrawn notes remain a liability of the issuing bank without any time limits.[
In the case of the euro, coins and banknotes of former national currencies were in some cases considered legal tender from 1 January 1999 until 28 February 2002. Legally, those coins and banknotes were considered non-decimal sub-divisions of the euro.
When the Iraqi Swiss dinar ceased to be legal tender in Iraq, it still circulated in the northern Kurdish regions, and despite lacking government backing, it had a stable market value for more than a decade. This example is often cited to demonstrate that the value of a currency is not derived purely from its legal status[ (but this currency would not be legal tender).
This is also true of the paper money issued by the Confederate States of America during the American Civil War. The Confederate currency became worthless by its own terms after the war, since it could only be redeemed a stated number of years after a peace treaty was signed between the Confederacy and the United States (which never happened, as the Confederacy was defeated and dissolved).
Demonetisation is currently prohibited in the United States and the Coinage Act of 1965 applies to all US coins and currency regardless of age. The closest historical equivalent in the US, other than Confederate money, was from 1933 to 1974, when the government banned most private ownership of gold bullion, including gold coins held for non-numismatic purposes. Now, however, even surviving pre-1933 gold coins are legal tender under the 1964 act
Withdrawal from circulation
Banknotes and coins may be withdrawn from circulation, but remain legal tender. United States banknotes issued at any date remain legal tender even after they are withdrawn from circulation. Canadian 1- and 2-dollar bills remain legal tender even if they have been withdrawn and replaced by coins, but Canadian $1,000 bills remain legal tender even if they are removed from circulation as they arrive at a bank. However, Bank of England notes that are withdrawn from circulation generally cease to be legal tender but remain redeemable for current currency at the Bank of England itself or by post. All paper and polymer issues of New Zealand banknotes issued from 1967 onwards (and 1- and 2-dollar notes until 1993) are still legal tender; however, 1- and 2-cent coins are no longer used in Australia and New Zealand.
Cashless society
A cashless society describes an economic state whereby financial transactions are not conducted with money in the form of physical banknotes or coins, but rather through the transfer of digital information (usually an electronic representation of money) between the transacting partiesCashless societies have existed, based on barter and other methods of exchange, and cashless transactions have also become possible using digital currencies such as bitcoin. However this article discusses and focuses on the term "cashless society" in the sense of a move towards, and implications of, a society where cash is replaced by its digital equivalent - in other words, legal tender (money) exists, is recorded, and is exchanged only in electronic digital form.
Commemorative issues
Sometimes currency issues such as commemorative coins or transfer bills may be issued that are not intended for public circulation but are nonetheless legal tender. An example of such currency is Maundy money. Some currency issuers, particularly the Scottish banks, issue special commemorative banknotes which are intended for ordinary circulation. As well, some standard coins are minted on higher-quality dies as 'uncirculated' versions of the coin, for collectors to purchase at a premium; these coins are nevertheless legal tender. Some countries issue precious-metal coins which have a currency value indicated on them which is far below the value of the metal the coin contains: these coins are known as "non-circulating legal tender" or "NCLT".
United States
Before the Civil War (1861 to 1865), silver coins were legal tender only up to the sum of $5. Before 1853, when U.S. silver coins were reduced in weight 7%, coins had exactly their value in metal (from 1830 to 1852). Two silver 50 cent coins had exactly $1 worth of silver. A gold U.S. dollar of 1849 had $1 worth of gold. With the flood of gold coming out of the California mines in the early 1850s, the price of silver rose (gold went down). Thus, 50 cent coins of 1840 to 1852 were worth 53 cents if melted down. The government could increase the value of the gold coins (expensive) or reduce the size of all U.S. silver coins. With the reduction of 1853, a 50-cent coin now had only 48 cents of silver. This is the reason for the $5 limit of silver coins as legal tender; paying somebody $100 in the new silver coins would be giving them $96 worth of silver. Most people preferred bank check or gold coins for large purchases.
During the early American Civil War, the federal government first issued United States Notes (the first greenback notes) which were not redeemable in gold and silver coins but could be used to pay "all dues" to the federal government. Since land purchases and duties on imports were payable only in gold or the new Demand Notes, the Demand Notes were bought by importers and land speculators for about 97 cents on the gold dollar and never lost value. 1862 greenbacks (Legal Tender Notes) at first traded for 97 cents on the dollar but gained/lost value depending on fortunes of the Union army. The value of Legal Tender Greenbacks swung wildly but trading was from 85 to 33 cents on the gold dollar.
This resulted in a situation in which the greenback "Legal Tender" notes of 1862 were fiat, and so gold and silver were held and paper circulated at a discount because of Gresham's Law. The 1861 Demand Notes were a huge success but robbed the customs house of much needed gold coin (interest on most bonds back then was paid in gold). A money-strapped Congress which had to pay for the war eventually adopted the Legal Tender Act of 1862, issuing United States Notes backed only by treasury securities, and compelled the people to accept the new notes at a discount; prices rose except for those who had gold and/or silver coins.
Following the Civil War, paper currency was disputed as to if it must be accepted as payment. In 1869, Hepburn v. Griswold found that Henry Griswold would not have to accept paper currency because it could not truly be "legal tender" and was unconstitutional as a legally enforceable means to pay debts. This led to the Legal Tender Cases in 1870, which overturned the previous ruling and established the paper currency as constitutional and proper legal tender that must be accepted in all situations.
With the 1884 Supreme Court ruling in Juilliard v. Greenman, the "Supreme Court ruled that Congress had the right to issue notes to be legal tender for the payment of public and private debt. Legal-tender notes are treasury notes or banknotes that, in the eyes of the law, must be accepted in the payment of debts."[37] The ruling in the Legal Tender Cases (which include Juilliard v. Greenman) led to later courts to "support the federal government's invalidation of gold clauses in private contracts in the 1930s."[38]
On the other hand, coins made of gold or silver may not necessarily be legal tender, if they are not fiat money in the jurisdiction where they are proffered as payment. The Coinage Act of 1965 states (in part):
United States coins and currency (including Federal reserve notes and circulating notes of Federal reserve banks and national banks) are legal tender for all debts, public charges, taxes and dues. Foreign gold or silver coins are not legal tender for debts.
There is no federal law stating that a private business, a person, or an organization must accept currency or coins for payment. Private businesses are free to create their own policies on whether or not they accept cash, unless there is a specific state law which says otherwise. For example, a bus line may prohibit payment of fares in cents or dollar bills. In addition, movie theaters, convenience stores, and gas stations may refuse to accept large denomination currency as a matter of policy or safety
XXX . V Working capital management
Working capital is the capital available for conducting the day-to-day operations of an organization; normally the excess of current assets over current liabilities.
Working capital management is the management of all aspects of both current assets and current liabilities, to minimize the risk of insolvency while maximizing the return on assets.
The main objective of working capital management is to get the balance of current assets and current liabilities right.
Importance of working capital management
Current assets are a major financial position statement item and especially significant to smaller firms. Mismanagement of working capital is therefore a common cause of business failure, e.g.:
inability to meet bills as they fall due
demands on cash during periods of growth being too great (overtrading)
overstocking
Working capital management is a key factor in an organisation's long-term success.
The balancing act: Profitability v Liquidity
The decision regarding the level of overall investment in working capital is a cost/benefit trade-off - liquidity versus profitability.
Unprofitable companies can survive if they have liquidity. Profitable companies can fail if they run out of cash to pay their liabilities (wages, amounts due to suppliers, overdraft interest, etc.).
Liquidity in the context of working capital management means having enough cash or ready access to cash to meet all payment obligations when these fall due. The main sources of liquidity are usually:
cash in the bank
short-term investments that can be cashed in easily and quickly
cash inflows from normal trading operations (cash sales and payments by receivables for credit sales)
an overdraft facility or other ready source of extra borrowing.
Cash balances and cash flows need to be monitored just as closely as trading profits.
Elements of working capital
Managing working capital involves managing the individual elements which make up working capital:
In the same way as for long-term investments, a firm must make a decision about what source of finance is best used for the funding of working capital requirements.
The decision about whether to choose short- or long-term options depends upon a number of factors:
the extent to which current assets are permanent or fluctuating
the costs and risks of short-term finance
the attitude of management to risk
Permanent or fluctuating current assets
In most businesses a proportion of the current assets are fixed over time, i.e. 'permanent'. For example:
buffer inventory,
receivables during the credit period,
minimum cash balances.
The choice of how to finance the permanent current assets is a matter for managerial judgement, but includes an analysis of the cost and risks of short-term finance.
The attitude of management to risk: aggressive, conservative and matching funding policies
There is no ideal funding package, but three approaches may be identified.
Aggressive - finance most current assets, including 'permanent' ones, with short-term finance. Risky but profitable.
Conservative - long-term finance is used for most current assets, including a proportion of fluctuating current assets. Stable but expensive.
Matching - the duration of the finance is matched to the duration of the investment.
A firm choosing to have a lower level of working capital than rivals is said to have an 'aggressive' approach, whereas a firm with a higher level of working capital has a 'conservative' approach.
An aggressive approach will result in higher profitability and higher risk, while a conservative approach will result in lower profitability and lower risk.
Over-capitalisation
If there are excessive inventories, accounts receivable and cash,and very few accounts payable, there will be an over-investment by the company in current assets. Working capital will be excessive and the company will be over-capitalised.
Overtrading
Cash flow is the lifeblood of the thriving business. Effective and efficient management of the working capital investment is essential to maintaining control of business cash flow. Management must have full awareness of the profitability versus liquidity trade-off.
For example, healthy trading growth typically produces:
increased profitability
the need to increase investment in non-current assets and working capital.
In contrast to over-capitalisation, if the business does not have access to sufficient capital to fund the increase, it is said to be"overtrading". This can cause serious trouble for the business as it is unable to pay its business creditors.
The cash operating cycle
The elements of the operating cycle
The cash operating cycle is the length of time between the company's outlay on raw materials, wages and other expenditures and the inflow of cash from the sale of goods.
The faster a firm can 'push' items around the cycle the lower its investment in working capital will be.
Calculation of the cash operating cycle
For a manufacturing business, the cash operating cycle is calculated as:
For a wholesale or retail business, there will be no raw materials or WIP holding periods, and the cycle simplifies to:
The cycle may be measured in days, weeks or months. The holding periods are calculated using a series of working capital ratios.
Factors affecting the length of the operating cycle
Length of the cycle depends on:
liquidity versus profitability decisions
terms of trade
management efficiency
industry norms, e.g. retail versus construction.
The optimum level of working capital is the amount that results in no idle cash or unused inventory, but that does not put a strain on liquid resources.
Working capital ratios
Ratios to determine the operating cycle
The periods used to determine the cash operating cycle are calculated by using a series of working capital ratios.
The ratios for the individual components (inventory, receivables and payables) are normally expressed as the number of days/weeks/months of the relevant income statement figure they represent.
Inventory holding period
This ratio calculates the length of time inventory is held between purchase and sale.
Calculated as:
In some cases, a more detailed breakdown of inventory may be required. Inventory holding periods can be calculated for each type of inventory: raw materials, work-in-progress and finished goods.
Raw material inventory holding period
The length of time raw materials are held between purchase and being used in production.
Calculated as:
WIP holding period
The length of time goods spend in production.
Calculated as:
Finished goods inventory period
The length of time finished goods are held between completion or purchase and sale.
Calculated as:
For all inventory period ratios, a low ratio is usually seen as a sign of good working capital management. It is very expensive to hold inventory and thus minimum inventory holding usually points to good practice.
Trade receivables days
The length of time credit is extended to customers.
Calculated as:
Generally shorter credit periods are seen as financially sensible but the length will also depend upon the nature of the business.
Trade payables days
The average period of credit extended by suppliers.
Calculated as:
Generally, increasing payables days suggests advantage is being taken of available credit but there are risks:
losing supplier goodwill
losing prompt payment discounts
suppliers increasing the price to compensate.
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Working capital liquidity ratios
Two key measures, the current ratio and the quick ratio, are used to assess short-term liquidity. Generally a higher ratio indicates better liquidity.
Current ratio
Measures how much of the total current assets are financed by current liabilities.
A measure of 2:1 means that current liabilities can be paid twice over out of existing current assets.
Quick (acid test) ratio
The quick or acid test ratio measures how well current liabilities are covered by liquid assets. This ratio is particularly useful where inventory holding periods are long.
A measure of 1:1 means that the company is able to meet existing liabilities if they all fall due at once.
Working capital turnover
One final ratio that relates to working capital is the working capital turnover ratio and is calculated as:
This measures how efficiently management is utilising its investment in working capital to generate sales and can be useful when assessing whether a company is overtrading. It must be interpreted in the light of the other ratios used.
Working capital investment levels
The level of working capital required (the financial position statement figure) is affected by the following factors:
The nature of the business,
Uncertainty in supplier deliveries.
The overall level of activity of the business.
The company's credit policy.
The credit policy of suppliers.
The length of the operating cycle.
The working capital ratios can be used to predict the levels of investment required. This is done by re-arranging the formulas. For example:
XXX . V0 Business Planning Papers: Managing Working Capital
Cash flows in a cycle into, around and out of a business. It is the business's life blood and every manager's primary task is to help keep it flowing and to use the cashflow to generate profits. If a business is operating profitably, then it should, in theory, generate cash surpluses. If it doesn't generate surpluses, the business will eventually run out of cash and expire. Click here for more information about the vital distinction between profits and cashflow.
The faster a business expands, the more cash it will need for working capital and investment. The cheapest and best sources of cash exist as working capital right within business. Good management of working capital will generate cash will help improve profits and reduce risks. Bear in mind that the cost of providing credit to customers and holding stocks can represent a substantial proportion of a firm's total profits.
There are two elements in the business cycle that absorb cash - Inventory (stocks and work-in-progress) and Receivables (debtors owing you money). The main sources of cash are Payables (your creditors) and Equity and Loans.
Each component of working capital (namely inventory, receivables and payables) has two dimensions ........TIME ......... and MONEY. When it comes to managing working capital - TIME IS MONEY. If you can get money to move faster around the cycle (e.g. collect monies due from debtors more quickly) or reduce the amount of money tied up (e.g. reduce inventory levels relative to sales), the business will generate more cash or it will need to borrow less money to fund working capital. As a consequence, you could reduce the cost of bank interest or you'll have additional free money available to support additional sales growth or investment. Similarly, if you can negotiate improved terms with suppliers e.g. get longer credit or an increased credit limit, you effectively create free finance to help fund future sales.
If you .......
Then ......
Collect receivables (debtors) faster
You release cash from the cycle
Collect receivables (debtors) slower
Your receivables soak up cash
Get better credit (in terms of duration or amount) from suppliers
You increase your cash resources
Shift inventory (stocks) faster
You free up cash
Move inventory (stocks) slower
You consume more cash
It can be tempting to pay cash, if available, for fixed assets e.g. computers, plant, vehicles etc. If you do pay cash, remember that this is now longer available for working capital. Therefore, if cash is tight, consider other ways of financing capital investment - loans, equity, leasing etc. Similarly, if you pay dividends or increase drawings, these are cash outflows and, like water flowing down a plug hole, they remove liquidity from the business.
More businesses fail for lack of cash than for want of profit.
Sources of additional working capital include the following:
Existing cash reserves
Profits (when you secure it as cash !)
Payables (credit from suppliers)
New equity or loans from shareholders
Bank overdrafts or lines of credit
Long-term loans
If you have insufficient working capital and try to increase sales, you can easily over-stretch the financial resources of the business. This is called overtrading. Early warning signs include:
Pressure on existing cash
Exceptional cash generating activities e.g. offering high discounts for early cash payment
Bank overdraft exceeds authorized limit
Seeking greater overdrafts or lines of credit
Part-paying suppliers or other creditors
Paying bills in cash to secure additional supplies
Management pre-occupation with surviving rather than managing
Frequent short-term emergency requests to the bank (to help pay wages, pending receipt of a cheque).
Cashflow can be significantly enhanced if the amounts owing to a business are collected faster. Every business needs to know.... who owes them money.... how much is owed.... how long it is owing.... for what it is owed.
Late payments erode profits and can lead to bad debts.
Slow payment has a crippling effect on business, in particular on small businesses who can least afford it. If you don't manage debtors, they will begin to manage your business as you will gradually lose control due to reduced cashflow and, of course, you could experience an increased incidence of bad debt. The following measures will help manage your debtors:
Have the right mental attitude to the control of credit and make sure that it gets the priority it deserves.
Establish clear credit practices as a matter of company policy.
Make sure that these practices are clearly understood by staff, suppliers and customers.
Be professional when accepting new accounts, and especially larger ones.
Check out each customer thoroughly before you offer credit. Use credit agencies, bank references, industry sources etc.
Establish credit limits for each customer... and stick to them.
Continuously review these limits when you suspect tough times are coming or if operating in a volatile sector.
Keep very close to your larger customers.
Invoice promptly and clearly.
Consider charging penalties on overdue accounts.
Consider accepting credit /debit cards as a payment option.
Monitor your debtor balances and ageing schedules, and don't let any debts get too large or too old.
Recognize that the longer someone owes you, the greater the chance you will never get paid. If the average age of your debtors is getting longer, or is already very long, you may need to look for the following possible defects:
weak credit judgement
poor collection procedures
lax enforcement of credit terms
slow issue of invoices or statements
errors in invoices or statements
customer dissatisfaction.
Debtors due over 90 days (unless within agreed credit terms) should generally demand immediate attention. Look for the warning signs of a future bad debt. For example.........
longer credit terms taken with approval, particularly for smaller orders
use of post-dated checks by debtors who normally settle within agreed terms
evidence of customers switching to additional suppliers for the same goods
new customers who are reluctant to give credit references
receiving part payments from debtors.
Profits only come from paid sales.
The act of collecting money is one which most people dislike for many reasons and therefore put on the long finger because they convince themselves there is something more urgent or important that demand their attention now. There is nothing more important than getting paid for your product or service. A customer who does not pay is not a customer. Here are a few ideas that may help you in collecting money from debtors:
Develop appropriate procedures for handling late payments.
Track and pursue late payers.
Get external help if your own efforts fail.
Don't feel guilty asking for money.... its yours and you are entitled to it.
Make that call now. And keep asking until you get some satisfaction.
In difficult circumstances, take what you can now and agree terms for the remainder. It lessens the problem.
When asking for your money, be hard on the issue - but soft on the person. Don't give the debtor any excuses for not paying.
Make it your objective is to get the money - not to score points or get even.
Creditors are a vital part of effective cash management and should be managed carefully to enhance the cash position.
Purchasing initiates cash outflows and an over-zealous purchasing function can create liquidity problems. Consider the following:
Who authorizes purchasing in your company - is it tightly managed or spread among a number of (junior) people?
Are purchase quantities geared to demand forecasts?
Do you use order quantities which take account of stock-holding and purchasing costs?
Do you know the cost to the company of carrying stock ?
Do you have alternative sources of supply ? If not, get quotes from major suppliers and shop around for the best discounts, credit terms, and reduce dependence on a single supplier.
How many of your suppliers have a returns policy ?
Are you in a position to pass on cost increases quickly through price increases to your customers ?
If a supplier of goods or services lets you down can you charge back the cost of the delay ?
Can you arrange (with confidence !) to have delivery of supplies staggered or on a just-in-time basis ?
There is an old adage in business that if you can buy well then you can sell well. Management of your creditors and suppliers is just as important as the management of your debtors. It is important to look after your creditors - slow payment by you may create ill-feeling and can signal that your company is inefficient (or in trouble!). Remember, a good supplier is someone who will work with you to enhance the future viability and profitability of your company.
Managing inventory is a juggling act. Excessive stocks can place a heavy burden on the cash resources of a business. Insufficient stocks can result in lost sales, delays for customers etc.
The key is to know how quickly your overall stock is moving or, put another way, how long each item of stock sit on shelves before being sold. Obviously, average stock-holding periods will be influenced by the nature of the business. For example, a fresh vegetable shop might turn over its entire stock every few days while a motor factor would be much slower as it may carry a wide range of rarely-used spare parts in case somebody needs them.
Nowadays, many large manufacturers operate on a just-in-time (JIT) basis whereby all the components to be assembled on a particular today, arrive at the factory early that morning, no earlier - no later. This helps to minimize manufacturing costs as JIT stocks take up little space, minimize stock-holding and virtually eliminate the risks of obsolete or damaged stock. Because JIT manufacturers hold stock for a very short time, they are able to conserve substantial cash. JIT is a good model to strive for as it embraces all the principles of prudent stock management.
The key issue for a business is to identify the fast and slow stock movers with the objectives of establishing optimum stock levels for each category and, thereby, minimize the cash tied up in stocks. Factors to be considered when determining optimum stock levels include:
What are the projected sales of each product?
How widely available are raw materials, components etc.?
How long does it take for delivery by suppliers?
Can you remove slow movers from your product range without compromising best sellers?
Remember that stock sitting on shelves for long periods of time ties up money which is not working for you. For better stock control, try the following:
Review the effectiveness of existing purchasing and inventory systems.
Know the stock turn for all major items of inventory.
Apply tight controls to the significant few items and simplify controls for the trivial many.
Sell off outdated or slow moving merchandise - it gets more difficult to sell the longer you keep it.
Consider having part of your product outsourced to another manufacturer rather than make it yourself.
Review your security procedures to ensure that no stock "is going out the back door !"
6. Key Working Capital Ratios
The following, easily calculated, ratios are important measures of working capital utilization.
Ratio
Formulae
Result
Interpretation
Stock Turnover (in days)
Average Stock * 365/ Cost of Goods Sold
= x days
On average, you turn over the value of your entire stock every x days. You may need to break this down into product groups for effective stock management. Obsolete stock, slow moving lines will extend overall stock turnover days. Faster production, fewer product lines, just in time ordering will reduce average days.
Receivables Ratio (in days)
Debtors * 365/ Sales
= x days
It take you on average x days to collect monies due to you. If your official credit terms are 45 day and it takes you 65 days... why ? One or more large or slow debts can drag out the average days. Effective debtor management will minimize the days.
Payables Ratio (in days)
Creditors * 365/ Cost of Sales (or Purchases)
= x days
On average, you pay your suppliers every x days. If you negotiate better credit terms this will increase. If you pay earlier, say, to get a discount this will decline. If you simply defer paying your suppliers (without agreement) this will also increase - but your reputation, the quality of service and any flexibility provided by your suppliers may suffer.
Current Ratio
Total Current Assets/ Total Current Liabilities
= x times
Current Assets are assets that you can readily turn in to cash or will do so within 12 months in the course of business. Current Liabilities are amount you are due to pay within the coming 12 months. For example, 1.5 times means that you should be able to lay your hands on $1.50 for every $1.00 you owe. Less than 1 times e.g. 0.75 means that you could have liquidity problems and be under pressure to generate sufficient cash to meet oncoming demands.
Quick Ratio
(Total Current Assets - Inventory)/ Total Current Liabilities
= x times
Similar to the Current Ratio but takes account of the fact that it may take time to convert inventory into cash.
Working Capital Ratio
(Inventory + Receivables - Payables)/ Sales
As % Sales
A high percentage means that working capital needs are high relative to your sales.
Other working capital measures include the following:
Bad debts expressed as a percentage of sales.
Cost of bank loans, lines of credit, invoice discounting etc.
Debtor concentration - degree of dependency on a limited number of customers.
Once ratios have been established for your business, it is important to track them over time and to compare them with ratios for other comparable businesses or industry sectors.
When planning the development of a business, it is critical that the impact of working capital be fully assessed when making cashflow forecasts.
XXX . V000 case e-money
Electronic Money
Electronic money (e-money) is broadly defined as an electronic store of monetary value on a technical device that may be widely used for making payments to entities other than the e-money issuer. The device acts as a prepaid bearer instrument which does not necessarily involve bank accounts in transactions.
E-money products can be hardware-based or software-based, depending on the technology used to store the monetary value.
Hardware-based products
In the case of hardware-based products, the purchasing power resides in a personal physical device, such as a chip card, with hardware-based security features. Monetary values are typically transferred by means of device readers that do not need real-time network connectivity to a remote server.
Software-based products
Software-based products employ specialised software that functions on common personal devices such as personal computers or tablets. To enable the transfer of monetary values, the personal device typically needs to establish an online connection with a remote server that controls the use of the purchasing power. Schemes mixing both hardware and software-based features also exist. ECB statistics on electronic money do not distinguish between hardware-based and software-based e-money.
Directive 2009/110/EC of the European Parliament and Council of 16 September 2009 on the taking up, pursuit and prudential supervision of the business of electronic money institutions established a new legal basis for e-money issuance in the European Union.
Article 2(1) of the Directive defines an “electronic money institution” as a legal person that has been granted authorisation to issue e-money. Furthermore, according to Article 2(2) of the Directive, “electronic money” means “electronically, including magnetically, stored monetary value as represented by a claim on the issuer which is issued on receipt of funds for the purpose of making payment transactions […], and which is accepted by a natural or legal person other than the electronic money issuer”. Credit institutions, as well as other financial and non-financial institutions, may issue e-money.
In order to align the ECB’s monetary financial institution (MFI) balance sheet statistics with the new definitions, Regulation ECB/2008/32 was amended by Regulation ECB/2011/12 and Guideline ECB/2007/9 by Guideline ECB/2011/13. Data complying with the revised reporting scheme are available as of the reporting period December 2011.
Data on e-money issued by euro area MFIs start in September 1997, while national data may start later depending on their date of availability. As a consequence, as statistical developments are affected by changes in the reporting population, statistical developments of euro area aggregates are affected by changes in the number of euro area countries for which e-money statistics are available. Aggregated total issuance by euro area MFIs is available on a monthly basis, while national issuance by all electronic money institutions is available only annually.
The amount outstanding of e-money issued by euro area MFIs is included in the item “overnight deposits” on the MFI balance sheet
XXX . V0000 The Modern Working Capital Management
Traditionally, investors, creditors and bankers have considered working capital as a critical element to watch, as important as the financial position portrayed in the balance sheet and the profitability shown in the income statement. Working capital is a measure of the company’s efficiency and short term financial health. It refers to that part of the company’s capital, which is required for financing short-term or current assets such a cash marketable securities, debtors and inventories. It is a company’s surplus of current assets over current liabilities, which measures the extent to which it can finance any increase in turnover from other fund sources. Funds thus, invested in current assets keep revolving and are constantly converted into cash and this cash flow is again used in exchange for other current assets. That is why working capital is also known as revolving or circulating capital or short-term capital.
Formula for Working Capital: “Current Assets – Current Liabilities”
Illustration to calculate working capital: Components of the balance sheet: (Rs)
Current Assets
Current Liabilities
Cash
1500
Accounts payable
1500
Marketable securities
500
Accrued expenses
1000
Accounts receivables
2000
Notes payable
500
Inventory
2500
Current portion- long term debt
1500
Total current assets
6500
Total current liabilities
4500
Current Assets
Cash
Current Liabilities
1500
undefined
Accounts payable
undefined
1500
Current Assets
Marketable securities
Current Liabilities
500
undefined
Accrued expenses
undefined
1000
Current Assets
Accounts receivables
Current Liabilities
2000
undefined
Notes payable
undefined
500
Current Assets
Inventory
Current Liabilities
2500
undefined
Current portion- long term debt
undefined
1500
Current Assets
Total current assets
Current Liabilities
6500
undefined
Total current liabilities
undefined
4500
WC = CA- CL
=6500-4500
=2000
Net working capital is defined as the excess of current assets over current liabilities. Working capital mentioned in the balance sheet is an indication of the company’s current solvency in repaying its creditors. That is why when companies indicate shortage of working capital they in fact imply scarcity of cash resources.
Factors effecting working capital:
• Nature of business: generally working capital is higher in manufacturing compared to service based organizations • Volume of sales: higher the sale, higher the working capital required • Seasonality: peak seasons for sales need more working capital • Length of operating and cash cycle: longer the operating and cash cycle, more is the requirement of working capital
Working capital Approaches:
A) Matching or hedging approach: This approach matches assets and liabilities to maturities. Basically, a company uses long term sources to finance fixed assets and permanent current assets and short term financing to finance temporary current assets. Example: A fixed asset which is expected to provide cash flow for 5 years should be financed by approx 5 years long-term debts. Assuming the company needs to have additional inventories for 2 months, it will then seek short term 2 months bank credit to match it. B) Conservative approach: it is conservative because the company prefers to have more cash on hand. That is why, fixed and part of current assets are financed by long-term or permanent funds. As permanent or long-term sources are more expensive, this leads to “lower risk lower return”. C) Aggressive approach: The Company wants to take high risk where short term funds are used to a very high degree to finance current and even fixed assets.
Classification of Working Capital:
Working capital can be categorized on basis of Concept (gross working capital and net working capital) and basis of time (Permanent/ fixed WC and temporary/variable WC). The two major components of Working Capital are Current Assets and Current Liabilities. One of the major aspects of an effective working capital management is to have regular analysis of the company’s currents assets and liabilities. This helps to take into account unforeseen events such as changes in the market conditions and competitor activities. Furthermore, steps taken to increase sales income and collecting accounts receivable also improves a company’s working capital.
Working Capital in adequate amount:
For every business entity adequate amount of working capital is required to run the operations. It needs to be seen that there is neither excess nor shortage of working capital. Both excess as well as shortage of working capital situations are bad for any business. However, out of the two, inadequacy or shortage of working capital is more dangerous from the point of view of the company operations. Inadequate working capital has its disadvantages where the company is not capable to pay off its short term liabilities in time, difficulty in exploring favorable market situations, day to day liquidity worsens and ROA and ROI fall sharply. On the other hand, one should keep in mind that excess of working capital also leads to wrong indications like idle funds, poor ROI, unnecessary purchase and accumulation of inventories over required level due to low rate of return on investments, all of which leads to fall in the market value of shares and credit worthiness of the company.
Working capital cycle:
The working capital cycle (WCC) is the amount of time it takes to turn the net current assets and current liabilities into cash. The longer the cycle is, the longer a business is tying-up funds in its working capital without earning any return on it. This is also one of the essential parameters to be recorded in working capital management.
Working Capital Management:
Working Capital Management (WCM) refers to all the strategies adopted by the company to manage the relationship between its short term assets and short term liabilities with the objective to ensure that it continues with its operations and meet its debt obligations when they fall due. In other words, it refers to all aspects of administration of current assets and current liabilities. Efficient management of working capital is a fundamental part of the overall corporate strategy. The WC policies of different companies have an impact on the profitability, liquidity and structural health of the organization. Although investing in good long-term capital projects receives more emphasis than the day-to-day work associated with managing working capital, companies that do not handle this financial aspect (working capital) well will not attract the capital necessary to fund those highly visible ventures; in other words, you must get through the short run to get to the long run.
Components associated with WCM:
Often the interrelationships among the working capital components create real challenges for the financial managers. Inventory is purchased from suppliers, sale of which generates accounts receivable and collected in cash from customers to pay off those suppliers. Working capital has to be managed because the firm cannot always control how quickly the customers will buy, and once they have made purchases, exactly when they will pay. That is why; controlling the “cash-to-cash” cycle is paramount.
The different components of working capital management of any organization are:
• Cash and Cash equivalents
• Inventory
• Debtors / accounts receivables
• Creditors / accounts payable
A) Cash and Cash equivalents:
One of the most important working capital components to be managed by all organizations is cash and cash equivalents. Cash management helps in determining the optimal size of the firm’s liquid asset balance. It indicates the appropriate types and amounts of short-term investments alongwith efficient ways of controlling collection and payout of cash. Good cash management implies the co-relation between maintaining adequate liquidity with minimum cash in bank. All companies strongly emphasize on cash management as it is the key to maintain the firm’s credit rating, minimize interest cost and avoid insolvency.
B) Management of inventories:
Inventories include raw material, WIP (work in progress) and finished goods. Where excessive stocks can place a heavy burden on the cash resources of a business, insufficient stocks can result in reduced sales, delays for customers etc. Inventory management involves the control of assets that are produced to be sold in the normal course of business.
For better stock/inventory control:
o Regularly review the effectiveness of existing purchase and inventory systems
o Keep a track of stocks for all major items of inventory
o Slow moving stock needs to be disposed as it becomes difficult to sell if kept for long
o Outsourcing should also be a part of the strategy where part of the production can be done through another manufacturer
o A close check needs to be kept on the security procedures as well
C) Management of receivables:
Receivables contribute to a significant portion of the current assets. For investments into receivables there are certain costs (opportunity cost and time value) that any company has to bear, alongwith the risk of bad debts associated to it. It is, therefore necessary to have a proper control and management of receivables which helps in taking sound investment decisions in debtors. Thereby, for effective receivables management one needs to have control of the credits and make sure clear credit practices are a part of the company policy, which is adopted by all others associated with the organization. One has to be vigilant enough when accepting new accounts, especially larger ones. Thereby, the principle lies in establishing appropriate credit limits for every customer and stick to them.
Effectively managing accounts receivables:
o Process and maintain records efficiently by regularly coordinating and communicating with credit managers’ and treasury in-charges
o Prepare performance measurement reports
o Control accuracy and security of accounts receivable records.
o Captive finance subsidiary can be used to centralize accounts receivable functions and provide financing for company’s sales
D) Management of accounts payable:
Creditors are a vital part of effective cash management and have to be managed carefully to enhance the cash position of the business. One has to keep in mind that purchasing initiates cash outflows and an undefined purchasing function can create liquidity problems for the company. The trade credit terms are to be defined by companies as they vary across industries and also among companies.
Factors to consider:
o Trade credit and the cost of alternative forms of short-term financing are to be defined
o The disbursement float which is the amount paid but not credited to the payers account needs to be controlled
o Inventory management system should be in place
o Appropriate methods need to be adopted for customer-to-business payment through e-commerce
o Company has to centralize the financial function with regards to the number, size and location of vendors
Time and money concept in Working Capital:
Every component of working capital (namely inventory, receivables and payables) has two dimensions TIME and MONEY, in managing working capital. By making the money move faster around the cycle, one can reduce the amount of money tied up. This helps the business generate more cash or it will need to borrow less money to fund its working capital. Consequently, it would either reduce the cost of interest or have free funds to support additional sales growth or investments of the company. Similarly, if one can negotiate on better terms with suppliers i.e. get an increased credit limit or longer credit; it will effectively create additional cash to help fund future sales.
Hence to conclude, Working capital in lay men terms can be compared to the blood vessels in any human body which makes the body function properly and thus make maximum utilization of the human or company assets.
XXX . V000000 Working Capital Management: Everything We Need to Know
we start witht he 1) introduction to working capital management, and continue then with 2) the working capital cycle, 3) approaches to working capital management, 4) significance of adequate working capital, 5) factors for determining the amoung of working capital needed.
INTRODUCTION TO WORKING CAPITAL MANAGEMENT
Any firm, from time to time, employs its short-term assets as well as short-term financing sources to carry out its day to day business. It is this management of such assets as well as liabilities which is described as working capital management. Working capital management is a quintessential part of financial management as a subject. It can also be compared with long-term decision-making the process as both of the domains deal with the analysis of risk and profitability.
1) Definition of Working Capital
Working capital is formally arrived at by subtracting the current liabilities from current assets of a firm on the day the balance sheet is drawn up. Working capital is also represented by a firm’s net investment in current assets necessary to support its everyday business. Working capital frequently changes its form and is sometimes also referred to as circulating capital. According to Gretsenberg:
“circulating capital means current assets of a company that are changed in the ordinary course of business from one form to another.”
2) Types of working capital
Working capital, as mentioned above, can take different forms. For example, it can take the form of cash and then change to inventories and/or receivables and back to cash.
Gross and Net Working Capital: The total of current assets is known as gross working capital whereas the difference between the current assets and current liabilities is known as the net working capital.
Permanent Working Capital: This type of working capital is the minimum amount of working capital that must always remain invested. In all cases, some amount of cash, stock and/or account receivables are always locked in. These assets are necessary for the firm to carry out its day to day business. Such funds are drawn from long term sources and are necessary for running and existence of the business.
Variable Working Capital: Working capital requirements of a business firm might increase or decrease from time to time due to various factors. Such variable funds are drawn from short-term sources and are referred to as variable working capital.
3) Objectives of working capital management
The main objectives of working capital management are:
Maintaining the working capital operating cycle and to ensure its smooth operation. Maintaining the smooth operation of the operating cycle is essential for the business to function. The operating cycle here refers to the entire life cycle of a business. From the acquisition of the raw material to the smooth production and delivery of the end products – working capital management strives to ensure smoothness, and it is one of the main objectives of the concept.
Mitigating the cost of capital. Minimizing the cost of capital is another very important objective that working capital management strives to achieve. The cost of capital is the capital that is spent on maintaining the working capital. It needs to be ensured that the costs involved for maintenance of healthy working capital are carefully monitored, negotiated and managed.
Maximising the return on current asset investments. Maximising the return on current investments is another objective of working capital management. The ROI on currently invested assets should be greater than the weighted average cost of the capital so that wealth maximization is ensured.
THE WORKING CAPITAL CYCLE
The working capital cycle refers to the minimum amount of time which is required to convert net current assets and net current liabilities into cash. From a more simplistic viewpoint, working capital cycle is the amount of time between the payment for goods supplied and the final receipt of cash accumulated from the sale of the same goods. There are mainly the following elements of which the working capital cycle is comprised of: Cash: The cash refers to the funds available for the purchase of goods. Maintaining a healthy level of liquidity with some buffer is always a best practice. It is extremely important to maintain a reserve fund which can be utilized when:
There is a shortage of cash inflow for some reason. In the absence of reserve cash, the day to day business will get hampered.
Some new opportunity springs up. In such a case, the absence of reserve cash will pose a hindrance.
In case of any contingency, absence of a reserve fund can cripple the company and poses a threat to the solvency of the firm.
Creditors and Debtors:
The creditors refer to the accounts payable. It refers to the amount that has to be paid to suppliers for the purchase of goods and /or services.
Debtors refer to the accounts receivables. It refers to the amount that is collected for providing goods and/or services.
Inventory: Inventory refers to the stock in hand. Inventories are an integral component of working capital and careful planning, and proper investment is necessary to maintain the inventory in a healthy state of affairs. Management of inventory has two aspects and involves a trade-off between cost and risk factors. Maintaining a sizable inventory has its accompanying costs that include locking of funds, increased maintenance and documentation cost and increased cost of storage. Apart from these things, there is also a chance of damage to the stored goods. On the other hand, maintaining a small inventory can disrupt the business lifecycle and can have serious impacts on the delivery schedule. As a result, it is extremely important to maintain the inventory at optimum levels which can be arrived at after careful analysis and a bit of experimentation.
Properties of a healthy working capital cycle
It is essential for the business to maintain a healthy working capital cycle. The following points are necessary for the smooth functioning of the working capital cycle:
Sourcing of raw material: Sourcing of raw material is the beginning point for most businesses. It should be ensured that the raw materials that are necessary for producing the desired goods are available at all times. In a healthy working capital cycle, production ideally should never stop because of the shortage of raw materials.
Production planning: Production planning is another important aspect that needs to be addressed. It should be ensured that all the conditions that are necessary for the production to start are met. A carefully constructed plan needs to be present in order to mitigate the risks and avert unforeseen issues. Proper planning of production is essential for the production of goods or services and is one of the basic principles that must be followed to achieve smooth functioning of the entire production lifecycle.
Selling: Selling the produced goods as soon as possible is another objective that should be pursued with utmost urgency. Once the goods are produced and are moved into the inventory, the focus should be on selling the goods as soon as possible.
Payouts and collections: The accounts receivables need to be collected on time in order to maintain the flow of cash. It is also extremely important to ensure timely payouts to the creditors to ensure smooth functioning of the business.
Liquidity: Maintaining the liquidity along with some room for adjustments is another important aspect that needs to be kept in mind for the smooth functioning of the working capital cycle.
APPROACHES TO WORKING CAPITAL MANAGEMENT
The short-term interest rates are, in most cases, cheaper compared to their long-term counterparts. This is due to the amount of premium which is higher for short term loans. As a result, financing the working capital from long-term sources means more cost. However, the risk factor is higher in case of short term finances. In case of short-term sources, fluctuations in refinancing rates are a major cause for concern, and they pose a major threat to business.
There are mainly three strategies that can be employed in order to manage the working capital. Each of these strategies takes into consideration the risk and profitability factors and has its share of pros and cons. The three strategies are:
The Conservative Approach: As the name suggests, the conservative strategy involves low risk and low profitability. In this strategy, apart from the permanent working capital, the variable working capital is also financed from the long-term sources. This means an increased cost capital. However, it also means that the risks of interest rate fluctuations are significantly lower.
The Aggressive Approach: The main goal of this strategy is to maximize profits while taking higher risks. In this approach, the entire variable working capital, some parts or the entire permanent working capital and sometimes the fixed assets are funded from short-term sources. This results in significantly higher risks. The cost capital is significantly decreased in this approach that maximizes the profit.
The Moderate or the Hedging Approach: This approach involves moderate risks along with moderate profitability. In this approach, the fixed assets and the permanent working capital are financed from long-term sources whereas the variable working capital is sourced from the short-terms sources.
SIGNIFICANCE OF ADEQUATE WORKING CAPITAL
Maintenance of adequate working capital is extremely important because of the following factors:
Adequate working capital ensures sufficient liquidity that ensures the solvency of the organisation.
Working capital ensured prompt and on-time payments to the creditors of the organisation that helps to build trust and reputation.
Lenders base their decisions for approving loans based on the credit history of the organisation. A good credit history can not only help an organisation to get fast approvals but also can result in reduced interest rates.
Earning of profits is not a sufficient guarantee that the company can pay dividends in cash. Adequate working capital ensures that dividends are regularly paid.
A firm maintaining adequate working capital can afford to buy raw materials and other accessories as and when needed. This ensures an uninterrupted flow of production. Adequate working capital, therefore, contributes to the fuller utilisation of resources of the enterprise.
FACTORS FOR DETERMINING THE AMOUNT OF WORKING CAPITAL NEEDED
Factoring out the amount of working capital needed for running a business is an extremely important as well as difficult task. However, it is extremely critical for any firm to estimate this figure so that it can operate smoothly and be fully functional. There are several factors that need to be considered before arriving at a more or less accurate figure. The following are some of those factors that determine the amount of liquid cash and assets required for any firm to operate smoothly:
Nature of business: A trading company requires large working capital. Industrial companies may require lower working capital. A banking company, for example, requires the maximum amount of working capital. Basic and key industries, public utilities, etc. require low working capital because they have a steady demand and continuous cash-inflow to meet current liabilities.
Size of the business unit: The amount of working capital depends directly upon the volume of business. The greater the size of a business unit, the larger will be the requirements of working capital.
Terms of purchase and terms of sale: Use of trade credit may lead to lower working capital while cash purchases will demand larger working capital. Similarly, credit sales will require larger working capital while cash sales will require lower working capital.
Turnover of inventories: If inventories are large and their turnover is slow, we shall require larger capital but if inventories are small and their turnover is quick, we shall require lower working capital.
Process of manufacture: Long-running and more complex process of production requires larger working capital while simple, short period process of production requires lower working capital.
Importance of labour: Capital intensive industries e.g. mechanized and automated industries generally require less working capital while labour intensive industries such as small scale and cottage industries require larger working capital.
XXX . V000000 value-based management
ecent years have seen a plethora of new management approaches for improving organizational performance: total quality management, flat organizations, empowerment, continuous improvement, reengineering, kaizen, team building, and so on. Many have succeeded—but quite a few have failed. Often the cause of failure was performance targets that were unclear or not properly aligned with the ultimate goal of creating value. Value-based management (VBM) tackles this problem head on. It provides a precise and unambiguous metric—value—upon which an entire organization can be built.
The thinking behind VBM is simple. The value of a company is determined by its discounted future cash flows. Value is created only when companies invest capital at returns that exceed the cost of that capital. VBM extends these concepts by focusing on how companies use them to make both major strategic and everyday operating decisions. Properly executed, it is an approach to management that aligns a company's overall aspirations, analytical techniques, and management processes to focus management decision making on the key drivers of value.
Principles
VBM is very different from 1960s-style planning systems. It is not a staff-driven exercise. It focuses on better decision making at all levels in an organization. It recognizes that top-down command-and-control structures cannot work well, especially in large multibusiness corporations. Instead, it calls on managers to use value-based performance metrics for making better decisions. It entails managing the balance sheet as well as the income statement, and balancing long- and short-term perspectives.
Exhibit 1
When VBM is implemented well, it brings tremendous benefit. It is like restructuring to achieve maximum value on a continuing basis. It works. It has high impact, often realized in improved economic performance, as illustrated in Exhibit 1.
Pitfalls
Yet value-based management is not without pitfalls. It can become a staff-captured exercise that has no effect on operating managers at the front line or on the decisions that they make.
A few years ago, the chief planning officer of a large company gave us a preview of a presentation intended for his chief financial officer and board of directors. For about two hours we listened to details of how each business unit had been valued, complete with cash flow forecasts, cost of capital, separate capital structures, and the assumptions underlying the calculations of continuing value. When the time came for us to comment, we had to give the team A+ for their valuation skills. Their methodology was impeccable. But they deserved an F for management content.
None of the company's significant strategic or operating issues were on the table. The team had not even talked to any of the operating managers at the group or business-unit level. Scarcely relevant to the real decision makers, their presentation was a staff-captured exercise that would have no real impact on how the company was run. Instead of value-based management, this company simply had value veneering.
Not methodology
The focus of VBM should not be on methodology. It should be on the why and how of changing your corporate culture. A value-based manager is as interested in the subtleties of organizational behavior as in using valuation as a performance metric and decision-making tool.
When VBM is working well, an organization's management processes provide decision makers at all levels with the right information and incentives to make value-creating decisions. Take the manager of a business unit. VBM would provide him or her with the information to quantify and compare the value of alternative strategies and the incentive to choose the value-maximizing strategy. Such an incentive is created by specific financial targets set by senior management, by evaluation and compensation systems that reinforce value creation, and—most importantly—by the strategy review process between manager and superiors. In addition, the manager's own evaluation would be based on long- and short-term targets that measure progress toward the overall value creation objective.
VBM operates at other levels too. Line managers and supervisors, for instance, can have targets and performance measures that are tailored to their particular circumstances but driven by the overall strategy. A production manager might work to targets for cost per unit, quality, and turnaround time. At the top of the organization, on the other hand, VBM informs the board of directors and corporate center about the value of their strategies and helps them to evaluate mergers, acquisitions, and divestitures.
Value-based management can best be understood as a marriage between a value creation mindset and the management processes and systems that are necessary to translate that mindset into action. Taken alone, either element is insufficient. Taken together, they can have a huge and sustained impact.
A value creation mindset means that senior managers are fully aware that their ultimate financial objective is maximizing value; that they have clear rules for deciding when other objectives (such as employment or environmental goals) outweigh this imperative; and that they have a solid analytical understanding of which performance variables drive the value of the company. They must know, for instance, whether more value is created by increasing revenue growth or by improving margins, and they must ensure that their strategy focuses resources and attention on the right option. Management processes and systems encourage managers and employees to behave in a way that maximizes the value of the organization. Planning, target setting, performance measurement, and incentive systems are working effectively when the communication that surrounds them is tightly linked to value creation.
The value mindset
The first step in VBM is embracing value maximization as the ultimate financial objective for a company. Traditional financial performance measures, such as earnings or earnings growth, are not always good proxies for value creation. To focus more directly on creating value, companies should set goals in terms of discounted cash flow value, the most direct measure of value creation. Such targets also need to be translated into shorter-term, more objective financial performance targets.
Companies also need nonfinancial goals—goals concerning customer satisfaction, product innovation, and employee satisfaction, for example—to inspire and guide the entire organization. Such objectives do not contradict value maximization. On the contrary, the most prosperous companies are usually the ones that excel in precisely these areas. Nonfinancial goals must, however, be carefully considered in light of a company's financial circumstances. A defense contractor in the United States, where shrinkage is a certainty, should not adopt a "no layoffs" objective, for example.
Objectives must also be tailored to the different levels within an organization. For the head of a business unit, the objective may be explicit value creation measured in financial terms. A functional manager's goals could be expressed in terms of customer service, market share, product quality, or productivity. A manufacturing manager might focus on cost per unit, cycle time, or defect rate. In product development, the issues might be the time it takes to develop a new product, the number of products developed, and their performance compared with the competition.
Even within the realm of financial goals, managers are often confronted with many choices: boosting earnings per share, maximizing the price/earnings ratio or the market-to-book ratio, and increasing the return on assets, to name a few. We strongly believe that value is the only correct criterion of performance.
Exhibit 2 compares various measures of corporate performance along two dimensions: the need to take a long-term view and the need to manage the company's balance sheet. Only discounted cash flow valuation handles both adequately. Companies that focus on this year's net income or on return on sales are myopic and may overlook major balance sheet opportunities, such as working capital improvement or capital expenditure efficiency.
Exhibit 2
Decision making can be heavily influenced by the choice of a performance metric. Shifting to a value mindset can make an enormous difference. Real-life cases that show how focusing on value can transform decision making are described in the sidebars "VBM in action."
Finding the value drivers
Sidebar
VBM in action: Managing the balance sheet
In Company X, a large consumer products company, the performance of each of its 50 business units was measured by its operating margin or return on sales (ROS). As Exhibit 8 shows, Company X was "doing better" than its average competitor because it was earning a 15.1 percent ROS compared with an industry average of only 14.3 percent.
But Company X had a problem. Its stock price was not performing well against the competition. Management was dissatisfied and began to ask questions. No one could understand why the stock market "didn't appreciate" the company's success.
Taking the analysis a little further, we see that Company X's return on invested capital (ROIC) pretax was 27.2 percent, while competitors earned 34.3 percent. Company X was employing the wrong performance metric. Using ROS meant that it was completely ignoring balance sheet management. Consequently, its capital turnover (sales divided by invested capital) was only 1.8, versus 2.4 for its competitors.
Exhibit 8
All told, the impact of improvement in the balance sheet amounted to roughly $500 million. Of that total, $146 million derived from improved management of working capital, particularly inventories. Because of its emphasis on sales, Company X was overproducing and carrying excess inventories to minimize the probability of stockout. Obsolete and outdated inventories necessitated periodic write-downs. Inventory management was a shambles.
An even larger value creation opportunity existed in consolidating manufacturing operations. Several plants in adjacent geographical areas were underutilized. When the least productive were closed and output shifted to the most productive facilities, two benefits emerged. First, less capital was employed to produce the same finished goods; and second, production became more efficient, raising operating margins. The value of consolidating operations was about $364 million.
Company X failed to manage its balance sheet because of its emphasis on the wrong performance metric—return on sales. When it moved to ROIC and value creation, it discovered opportunities that had previously been missed.
An important part of VBM is a deep understanding of the performance variables that will actually create the value of the business—the key value drivers. Such an understanding is essential because an organization cannot act directly on value. It has to act on things it can influence—customer satisfaction, cost, capital expenditures, and so on. Moreover, it is through these drivers of value that senior management learns to understand the rest of the organization and to establish a dialogue about what it expects to be accomplished.
A value driver is any variable that affects the value of the company. To be useful, however, value drivers need to be organized so that managers can identify which have the greatest impact on value and assign responsibility for them to individuals who can help the organization meet its targets.
Sidebar
VBM in action: taking the long-term view
One of the largest divisions of a money center bank, the retail bank, had been pursuing a "harvest" strategy. It had been underinvesting and taking cash out of the business. Unfortunately, it had also been losing market share, albeit slowly over a long period.
The new chief operating officer wanted to spend roughly $100 million on a plan to recapture market share by refurbishing branch facilities, installing new automatic teller machines, training tellers to improve customer satisfaction, and launching a new advertising campaign. This alternative was called the "aggressive growth" strategy. It was designed to win back market share at the same slow rate at which it had been lost—a fairly conservative approach.
Exhibit 9
The crucial measure for this program was return on equity (ROE) projected over the next three years, as shown in Exhibit 9. The ROE for the aggressive growth strategy was lower than the harvest strategy for the first year, about the same in the second year, and only slightly higher in the third year. When these results were shown to the bank's CEO, he at first could not understand how the aggressive growth strategy could be better, but he realized the answer when he saw its value creation potential. It resulted in a 124 percent increase in value over the harvest strategy, worth more than $450 million.
Why did the return on equity and the value creation performance metrics give such different answers? The reason is that most of the value creation potential was outside the three-year time frame that was used for making ROE comparisons at the bank. Valuation requires a longer view, because the value of a strategy cannot be estimated without forecasting the cash flows over the long run.
Value drivers must be defined at a level of detail consistent with the decision variables that are directly under the control of line management. Generic value drivers, such as sales growth, operating margins, and capital turns, might apply to most business units, but they lack specificity and cannot be used well at the grass roots level. Exhibit 3 shows that value drivers can be useful at three levels: generic, where operating margins and invested capital are combined to compute ROIC; business unit, where variables such as customer mix are particularly relevant; and grass roots, where value drivers are precisely defined and tied to specific decisions that front-line managers have under their control.
Exhibit 3
Exhibit 4 illustrates value drivers for the customer servicing function of a telecommunications company. Value driver trees like this one are usually linked into ROIC trees, which are in turn linked into multiperiod cash flows and valuation of the business unit. Total customer service expense, on the left-hand side of the tree, was an expense-line item in the income statement of several business units. Improving efficiency in this key function would therefore affect the value of many parts of the company.
Exhibit 4
It took five levels of detail to reach useful operational value drivers. The "span of control," for example, was defined as the ratio of supervisors to workers. A small improvement here had a big impact on the value of the company without affecting the quality of customer service. Percent occupancy is the fraction of total work hours that are spent at an operator station. Relatively minor changes here also have a major impact on value.
What is important is that these key value drivers, although only a small part of the total business system, have a significant impact on value, are measurable from month to month, and are clearly under the control of line management.
Exhibit 5
To see how the numbers might work, consider the list of value drivers for a hard goods retailer shown in Exhibit 5. The value of the company derives partly from gross margin, warehouse costs, and delivery costs. Gross margin, in turn, is determined by gross margin per transaction and the number of transactions (which can be themselves further disaggregated if necessary). Warehouse costs are a function of the number of retail stores per warehouse and the cost per warehouse. Finally, delivery costs are determined by the number of trips per transaction, the cost per trip, and the number of transactions.
Analysis of these variables showed that the number of stores per warehouse significantly affected the cost per transaction: the more stores that could be served by a single warehouse, the lower the warehouse costs relative to revenues. The scale economies were substantial enough to support a strategy of growth through metropolitan concentration, rather than a shot-gun approach of scattering new stores over a wide area. The number of stores per warehouse thus became a strategic value driver.
Further analysis revealed that the number of delivery trips per transaction was very high. Whenever there were errors in an order or goods proved defective, multiple deliveries had to be made to a single customer. The retailer found that it was making an average of 1.5 trips per transaction, compared with a theoretical minimum of 1.0. Management believed this was high for the industry and thought it should be reduced to 1.2. Attaining this performance would increase value by 10 percent. So trips per transaction became an operating value driver as the company began to monitor its monthly performance.
Key value drivers are not static; they must be regularly reviewed. Once the retailer reaches its goal of 1.2 delivery trips per transaction, for example, it may need to shift its focus to cost per trip (while continuing to monitor trips per transaction to make sure it stays on target).
Identifying key value drivers can be difficult because it requires an organization to think about its processes in a different way. Often, too, existing reporting systems are not equipped to supply the necessary information. Mechanical approaches based on available information and purely financial measures rarely succeed. What is needed instead is a creative process involving much trial and error.
Nor can value drivers be considered in isolation from each other. A price increase might, taken alone, boost value—but not if it results in substantial loss of market share. In seeking to understand the interrelationships among value drivers, scenario analysis is a valuable tool. It is a way of assessing the impact of different sets of mutually consistent assumptions on the value of a company or its business units. Typical scenarios include what might happen if there is a price war, or if additional capacity comes on line in another country? Thinking about such issues helps management avoid getting caught off guard and brings to life the relationship between strategy and value.
Management processes
Adopting a value-based mindset and finding the value drivers gets you only halfway home. Managers must also establish processes that bring this mindset to life in the daily activities of the company. Line managers must embrace value-based thinking as an improved way of making decisions. And for VBM to stick, it must eventually involve every decision maker in the company.
There are four essential management processes that collectively govern the adoption of VBM. First, a company or business unit develops a strategy to maximize value. Second, it translates this strategy into short- and long-term performance targets defined in terms of the key value drivers. Third, it develops action plans and budgets to define the steps that will be taken over the next year or so to achieve these targets. Finally, it puts performance measurement and incentive systems in place to monitor performance against targets and to encourage employees to meet their goals.
These four processes are linked across the company at the corporate, business-unit, and functional levels. Clearly, strategies and performance targets must be consistent right through the organization if it is to achieve its value creation goals.
Strategy development
Though the strategy development process must always be based on maximizing value, implementation will vary by organizational level.
At the corporate level, strategy is primarily about deciding what businesses to be in, how to exploit potential synergies across business units, and how to allocate resources across businesses. In a VBM context, senior management devises a corporate strategy that explicitly maximizes the overall value of the company, including buying and selling business units as appropriate. That strategy should be built on a thorough understanding of business-unit strategies.
At the business-unit level, strategy development generally entails identifying alternative strategies, valuing them, and choosing the one with the highest value. The chosen strategy should spell out how the business unit will achieve a competitive advantage that will permit it to create value. This explanation should be grounded in a thorough analysis of the market, the competitors, and the unit's assets and skills. The VBM elements of the strategy then come into play. They include:
Assessing the results of the valuation and the key assumptions driving the value of the strategy. These assumptions can then be analyzed and challenged in discussions with senior management.
Weighing the value of the alternative strategies that were discarded, along with the reasons for rejecting them.
Stating resource requirements. VBM often focuses business-unit managers on the balance sheet for the first time. Human resource requirements should also be specified.
Summarizing the strategic plan projections, focusing on the key value drivers. These should be supplemented by an analysis of the return on invested capital over time and relative to competitors.
Analyzing alternative scenarios to assess the effect of competitive threats or opportunities.
Developing business-unit strategy does not have to become a bureaucratic time sink; indeed, the time and costs associated with planning can even be reduced if VBM is introduced simultaneously with a reengineering of the planning process.
Target setting
Once strategies for maximizing value are agreed, they must be translated into specific targets. Target setting is highly subjective, yet its importance cannot be overstated. Targets are the way management communicates what it expects to achieve. Without targets, organizations do not know where to go. Set targets too low, and they may be met, but performance will be mediocre. Set them at unattainable levels, and they will fail to provide any motivation.
In applying VBM to target setting, several general principles are helpful: Base your targets on key value drivers, and include both financial and nonfinancial targets. The latter serve to prevent "gaming" of short-term financial targets. An R&D-intensive company, for example, might be able to improve its short-term financial performance by deferring R&D expenditures, but this would detract from its ability to remain competitive in the long run. One solution is to set a nonfinancial goal, such as progress toward specific R&D objectives, that supplements the financial targets. Tailor the targets to the different levels within an organization. Senior business-unit managers should have targets for overall financial performance and unit-wide nonfinancial objectives. Functional managers need functional targets, such as cost per unit and quality. Link short-term targets to long-term ones. An approach we particularly like is to set linked performance targets for ten years, three years, and one year. The ten-year targets express a company's aspirations; the three-year targets define how much progress it has to make within that time in order to meet its ten-year aspirations; and the one-year target is a working budget for managers. Ideally, you should always set targets in terms of value, but since value is always based on long-term future cash flows and depends on an assessment of the future, short-term targets need a more immediate measure derived from actual performance over a single year. Economic profit is a short-term financial performance measure that is tightly linked to value creation. It is defined as: Economic profit = Invested capital × (Return on invested capital—Weighted average cost of capital)
Economic profit measures the gap between what a company earns during a period and the minimum it must earn to satisfy its investors. Maximizing economic profit over time will also maximize company value.
Action plans and budgets
Action plans translate strategy into the specific steps an organization will take to achieve its targets, particularly in the short term. The plans must identify the actions that the organization will take so that it can pursue its goals in a methodical manner.
Performance measurement
Performance measurement and incentive systems track progress in achieving targets and encourage managers and other employees to achieve them. Rarely do front-line supervisors and employees have clear performance measures that are linked to their company's long-term strategy; indeed, many have none at all.
VBM may force a company to modify its traditional approach to these systems. In particular, it shifts performance measurement from being accounting driven to being management driven. All the same, developing a performance measurement system is relatively straightforward for a company that understands its key value drivers and has set its short- and long-term targets. Key principles include: 1. Tailor performance measurement to the business unit. Each business unit should have its own performance measures—measures it can influence. Many multibusiness companies try to use generic measures. They end up with purely financial measures that may not tell senior management what is really going on or allow for valid comparisons across business units. One unit might be capital intensive and have high margins, while another consumes little capital but has low margins. Comparing the two on the basis of margins alone does not tell the full story. 2. Link performance measurement to a unit's short- and long-term targets. This may seem obvious, but performance measurement systems are often based almost exclusively on accounting results. 3. Combine financial and operating performance in the measurement. Too often, financial performance is reported separately from operating performance, whereas an integrated report would better serve managers' needs. 4. Identify performance measures that serve as early warning indicators. Financial indicators can only measure what has already happened, when it may be too late to take corrective action. Early warning indicators might be simple items such as market share or sales trends, or more sophisticated pointers such as the results of focus group interviews.
Once performance measurements are an established part of corporate culture and managers are familiar with them, it is time to revise the compensation system. Changes in compensation should follow, not lead, the implementation of a value-based management system.
Exhibit 6
Compensation design
The first principle in compensation design is that it should provide the incentive to create value at all levels within an organization. Compensation for the chief executive officer—though a popular topic in the press—is something of a red herring. Managers' performance should be evaluated by a combination of metrics that reflects their organizational responsibilities and control over resources (Exhibit 6).
At the chief executive level in a publicly-held company, increases in stock prices are directly observable, and therefore a CEO's bonus can take the form of stock options or stock appreciation rights. Even so, many stock price changes result from factors outside the CEO's control, such as falls in interest rates. Stock appreciation plans can, however, be adjusted to remove such general market influences so that they focus on the aspects of company performance that are directly attributable to the skill of top management.
Discounted cash flow (DCF) is not one of the performance metrics in Exhibit 6 for good reasons. DCF is the present value of forecasted cash flows. If compensation relied on DCF, it would be based on projections, not results.
However, we do recommend using DCF in conjunction with economic profit to establish benchmarks and reward performance at the business-unit level. The long-term perspective provided by DCF can balance the short-term, accounting-based metric of economic profit. The latter is often negative in, for example, start-up or turnaround projects, even though value is being created. The role of DCF is to act as a corrective so that compensation can be calculated appropriately at the business-unit level.
At the front line of management, where financial information is rarely an adequate guide, operating value drivers are the key. They must be sufficiently detailed to be tied to the everyday operating decisions that managers have under their control.
Exhibit 7
Implementing VBM successfully
Although putting a VBM system in place is a long and complex process, successful efforts share a number of common features (see Exhibit 7). Most of these points have already been discussed, and others are self-explanatory, but the first feature is worth elaborating.
As with any major program of organizational change, it is vital for top management to understand and support the implementation of VBM. At one company, the CEO and CFO made a video for their employees in which they pledged their support for the initiative, declared that the basis of compensation would shift at the end of the year from earnings to economic profit, and gave examples of what VBM meant. All business units, for instance, would be expected to earn their cost of capital. "If our cost of capital is 12 percent," the CEO said, "a 12 percent rate of return on the capital that we have invested is not good enough. An 11 percent return destroys value, and a 13 percent return creates value. But a 14 percent rate of return creates twice as much value as a 13 percent return."
Most managers had not thought about their business in these terms. The video caught their attention and showed them that top management supported the change that was under way.
Though active top management support is a necessary condition for the successful implementation of VBM, it is not sufficient in itself. Value-based management, as we have suggested, must permeate the entire organization. Not until line managers embrace VBM and use it on a daily basis for making better decisions can it achieve its full impact as an aid to the long-term maximization of value.
XXX . V0000000 PayPal Working Capital Reviews
General Background About PayPal Working Capital
If you operate an online business, you already know how challenging it can be to get access to the working capital you need to grow your business. Few traditional lenders are willing to make a loan for an online business as they lack specialized knowledge of the industry. There are a growing number of small business loan marketplaces that cater to online businesses although choosing the right lender for your business can still be a challenge.
Many small business owners are now turning to PayPal to help fund their online business. PayPal has been used by online merchants since 1998 with a proven track record as one of the world’s leading online payment systems. The company recently branched out to offer merchants easier access to capital with flat rate loans. This PayPal Working Capital review will help you understand the PayPal Working Capital program, one of the most common online lending programs for merchants.
What Exactly Is PayPal Working Capital?
The PayPal Working Capital program was launched in 2013 amid tight bank credit standards. The program began by offering 90,000 PayPal merchants the chance to borrow up to 8% of their annual PayPal volume up to $20,000 with a fee repaid automatically as a 10-30% deduction of the merchant’s incoming receipts. PayPal began the program by targeting existing customers who already established strong cash flow and opened the program to all PayPal users in 2014.
Overview of the PayPal Working Capital Program
PayPal Working Capital gives business owners fast access to capital that is deposited directly into a PayPal account. PayPal loans do not require a personal guarantee and the loan terms are somewhat flexible as merchants can choose the repayment plan that works best for their cash flow. After being approved for a loan, you will pay a single fixed fee rather than an interest rate. The loan can be funded almost instantly and deposited into your PayPal account.
PayPal loans have a single fixed fee based on your loan amount, repayment percentage, and PayPal sales history. You can choose for 10-30% of your sales to go toward repaying your PayPal loan. The lower the withholding amount, the higher the loan fee. For example, on a $8,000 loan, you may pay a total of $949 in loan fees if you choose a 10% withholding amount. Increase withholding to 30% and the loan fees drop to $294.
The loan will be repaid automatically as a percentage of sales. Whenever payment is deposited into your PayPal account, a specific amount will be deducted and credited toward your loan. Payments toward the advance will happen automatically whenever you have sales, but you will not pay anything on days you do not have sales. You can reapply for another PayPal loan once the balance is paid in full.
Minimum payment is required every 90 days Must continue to use PayPal until advance and fee is paid in full
PayPal Working Capital vs. Merchant Cash Advances
PayPal Working Capital (PPWC) loans work like traditional merchant cash advances in many ways. There are a few differences to be aware of, however. Many businesses, even online merchants, use PayPal as a secondary payment method. This means receipts into a PayPal account are not always reliable. For the first 18 months of the loan, you will need to have paid a minimum of 10% of the advance and fee back every 90 days. If this does not happen, the remaining balance will be due at the 90-day mark.
Because a PayPal advance is tied to your PayPal account, you are required to continue using PayPal. If you stop processing payments through PayPal or raise suspicions that you are avoiding paying the advance, PayPal has the right to impose restrictions on your PayPal account until the advance and fees are paid as a lump sum.
PayPal Payday Advance Loan Vs. PayPal Working Capital (credit) Loan
If you conduct business online, you are probably familiar with PayPal. You may accept some or all of your business payments through the site. From time to time, online merchants need some extra cash to cover operational expenses or to expand their inventory. A loan is a safer way to come up with the funds rather than putting off bills or trying to restructure current financial obligations. An instant PayPal cash loan may be the answer.
When you search online for an instant PayPal cash loan, you will see two main options. The first and worst option is a cash advance loan, and the second and better option is a working capital loan that is based on your PayPal business income.A payday business loan that is based on your PayPal income is not an ideal option. It may sound great to be able to get money quickly without a credit check. However, you wind up paying much more than what you actually borrow. If you are struggling to get through a dry spell in sales that you know will end at a certain point in the near future, it may sound tempting to take this easy but expensive option.
The problem is that you will still be paying so much in interest and fees that it will impact your bottom line and strain you financially even when the dry spell is over. Imagine a worst-case scenario where the dry spell does not end or sales do not increase as much as they should. You will now be drowning in debt, your credit will suffer and you will have a hard time finding the funds to get out of this new financial pit.
The better option for a PayPal instant cash loan is a working capital loan. With this type of funding, your payments are aligned with your income. Since payday business loans must be repaid in specific amounts regardless of your monthly, weekly or daily income, they are difficult to repay when you have slow days or weeks. Working capital loan payments are based on the amount of money brought in every day. If you do not make much for a few months, your payments are lower. When you start making more after a dry spell ends, your payments increase to match your increased income.
Understanding Paypal Working Capital Fees
Prospective borrowers should carefully weigh the financial advantages and disadvantages of using Paypal working capital because the service uses a unique fee structure. With ordinary loans, borrowers usually pay nothing upfront unless a down payment is required. Banks also ordinarily impose a lending fee, and this is almost always charged by adding it to the outstanding principal balance on the account. The lending fee is added to the borrower’s account in addition to regular interest charges and other fees associated with a loan. Unlike traditional banking services, Paypal charges no interest on outstanding balances. The difference, however, is that Paypal charges a single fixed fee instead of ordinary interest. You probably like the idea of not having to pay interest, but Paypal’s fee structure can actually be more expensive in some situations. With ordinary revolving credit accounts, businesses normally do not have to pay a fee that is proportional to the amount borrowed. Instead, a fixed fee is usually charged to open the account, and this fee is usually very low. With Paypal, however, lending fees increase as borrowers raise the amount that they borrow. Furthermore, Paypal does not offer any discounts for early repayment. Borrowers with access to credit, therefore, can sometimes save a significant amount of money on short-term borrowing through traditional credit services. In contrast, borrowers who plan to maintain an outstanding credit balance for several months can often save money by paying Paypal’s fees instead of high interest rates. The advantage of Paypal’s fixed fees, however, is that the initial fee really does cover all costs associated with the loan. There are no late fees for failing to make a monthly payment, and Paypal does not charge an early repayment fee. Furthermore, Paypal does not vary its fee structure based on a borrower’s credit, so money can sometimes be saved through a lower interest rate at a traditional financial institution. However, it is critical for borrowers to carefully consider their own situation and needs before taking out a Paypal working credit loan. Depending on your circumstances, Paypal’s fees can vary on a sliding scale from approximately 3 to 20 percent of a loan’s principal balance. Due to such high variation in Paypal’s fee structure, borrowers have to fill out Paypal’s online application to know exactly how high financing fees associated with this service will be.
Effective Interest Rates with Paypal
Traditional creditors ordinarily charge interest, and this is usually computed as an annual percentage rate. While Paypal working capital does not have an interest rate, its fee structure means that it has an effective APR. Since Paypal is required to estimate and disclose its APR under federal law, this provider has devised a method of calculating its APR in the absence of interest. The stated APR value is found by first taking the inverse of the average percentage of a year that businesses ordinarily take to pay back their Paypal working capital loan, then multiplying this value by Paypal’s fixed fee as a percentage of the loan’s principal balance. In most instances, therefore, Paypal’s effective APR ends up being between 15 and 30 percent. Due to the relatively subjective way that Paypal calculates the APR of its loans, borrowers must use their own judgement to determine the true costs they will have to pay. Paypal working credit loans that are held for a longer period of time have a lower effective interest rate than the stated APR. Likewise, loans that are repaid in a very short period of time, such as one month, have a much higher rate of effective interest. Understanding how Paypal calculates the cost of its loans is critical for borrowers because this information can be used to determine whether a Paypal working credit loan is less expensive than an ordinary loan. Paypal varies its APR depending on a borrower’s history and the percentage of sales that a borrower is willing to commit for repayment. Borrowers can view their effective APR before taking out a loan by signing up for the program .
XXX . V000000 How to Calculate Net Working Capital: Definition & Formula
Have you ever wondered how a company manages its money and pays its bills? Working capital management is how companies are able to manage finances and continue operations.
What Is Working Capital Management?
Working capital management is the way a company manages the relationship between assets and liabilities in the short term. Simply put, working capital management is how a company manages its money for day to day operations as well as any immediate debt obligations. When managing working capital, the company has to manage accounts receivable, accounts payable, inventory, and cash. The goal of working capital management is to have adequate cash flow for continued operations and have the most productive usage of resources.
There are a few calculations we have to discuss in regards to working capital management. To calculate working capital, a company would take current assets and subtract current liabilities.
Working capital efficiency is determined by calculating the working capital ratio. This ratio is a key indicator in the company's financial health. The working capital efficiency is calculated by taking current assets divided by current liabilities. If the result of the calculation is less than 1.0, then it is taken as a sign that the company's having financial issues. If the result of the calculation is greater than 1.0 but less than 2.0, then the company is in good financial health. If the calculation yields a result greater than 2.0, then company may not be making an effective use of its assets.
The next calculation we need to understand is receivables turnover. This is a calculation of how many times an account is created and collected during the reporting period. Receivables turnover is calculated by dividing the total revenue by average receivables. That was a long way to say how many times orders are being created and invoiced during the reporting period.
The last calculation we need to understand for working capital management is the inventory turnover ratio. The inventory turnover ratio is calculated by costs of goods sold divided by the average inventory costs. If the results are less than 1.0 then the company is not moving enough inventory.
Working Capital Management in Action
John is the CEO of Wookie Inc. and he is trying to determine what his working capital is to see if he can invest in a new technology. Wookie Incorporated has current assets totaling 8.9M, and their current liabilities are 7.6M. John takes 8.9 minus 7.6 and the result is 1.3M. John feels good about having 1.3M of available capital. He takes his calculations a little further to determine what the working capital effect is for Wookie Inc. He takes 8.9 divided by 7.6 to get a ratio of 1.17. With the calculations, John determines that the company is in good financial health, and he can invest in new technology.
Ralph is the inventory manager for Lightsaber Incorporated. Ralph wants to determine his inventory turnover. Cost of goods sold is 300M, and the average inventory is 600M. The inventory turnover is .5. Ralph determines that the company is holding too much inventory and scales back production.
Steve is the finance manager for Link Meats, and he is trying to determine receivable turnover. The company has total revenue of 4M and are has average receivables of 4M. The company's receivable turnover ratio is 1.0, which is good for the company.
To operate effectively, businesses must be able to pay their bills as they become due. The best way to determine a business' ability to pay its bills is to calculate its net working capital. Learn what net working capital is and how to calculate it in this lesson.
What Is Net Working Capital?
The success or failure of a business is heavily dependent on that business' ability to use its assets effectively. An asset is an item that a business owns, such as cash in a bank account, amounts due from customers, and equipment. When a business uses its assets effectively, it is able to produce income to further increase its assets and pay its liabilities. A liability is an item that a business owes, such as an outstanding bill from a vendor or a mortgage or loan. A business can determine its ability to pay its liabilities as they become due by calculating net working capital. Net working capital is a financial measure that determines if a business has enough liquid assets to pay its bills that are due in one year or less. Assets are liquid if they can quickly be converted to cash. Examples include cash, amounts due from customers, short-term investments and marketable securities, and inventory.
Calculating Net Working Capital
Net working capital is calculated by subtracting total current liabilities from total current assets. Assets and liabilities are considered current if they are expected to be used or paid within one year. Current assets include all of the liquid assets discussed previously. Current liabilities include outstanding bills, payments on mortgages and loans due in the next year, and amounts due to others that are not yet payable, such as wages and interest.
Net working capital is presented as a dollar amount and can be positive or negative. A positive result means that there will be liquid assets remaining after all current liabilities are paid and that assets are being used effectively. On the other hand, a negative result means that there are not currently enough liquid assets to pay all of the current liabilities and that a business may be headed towards bankruptcy.
Examples
Now let's look at a couple of examples.
Example 1
Nelson & Associates is a small, family-owned business. William Nelson has recently taken over the business from his father and is concerned there will not be enough funds to run the business for the next year. He has come to you to calculate the business' net working capital. The business has $100,000 in the bank, $200,000 due from customers, and $50,000 of inventory. The business owes $225,000 to vendors and has a $500,000 mortgage, of which $50,000 is due in the next year.
The business' net working capital ratio would be calculated like this:
100,000 cash + 200,000 due from customers + 50,000 inventory = 350,000 current assets
225,000 due to vendors + 50,000 current portion of mortgage = 275,000 current liabilities
350,000 current assets - 275,000 current liabilities = 75,000 net working capital
After performing the calculation, you will be able to tell William that the business will have $75,000 in liquid assets remaining after the current liabilities are paid.
All of the following accounting terms have precise definitions when used in business:
• Sales or revenue • Cost of goods sold • Expenses • Gross profit • Fixed assets • Current assets • Current liabilities • Working capital • Liquidity • Debtor • Creditor • Bad Debt • Depreciation • Accrual Accounting
Even though you may be familiar with some of them, it is important to know their exact meanings otherwise you may find yourself becoming confused.
For example, you may hear the terms 'revenues' and 'receipts' used interchangeably in casual office conversation. However, as far as business accounting is concerned they are different things and you need to appreciate the difference.
Read the following definitions carefully and make sure that you understand exactly what is meant by each of these accounting terms. This Accounting Terminology Checklist outlines the terminology, concepts and conventions that are accepted within the accounting profession. Sales or Revenue Revenue is the income that flows into an organization, and it is often used almost synonymously with sales. In government and nonprofit organizations it includes taxes and grants.
Don't confuse revenues with receipts. Under the accrual basis of accounting, revenues are shown in the period they are earned, not in the period when the cash is collected. Revenues occur when money is earned; receipts occur when cash is received. Cost of Goods Sold This is the purchase cost of the merchandise that was subsequently sold to customers. Expenses Refers to the other costs that are not matched with sales as part of the cost of goods sold. They may be matched with a specific time, usually monthly, quarterly, or annually or they may also be one-off payments. Expenses include: staff wages, rent, utility bills, insurance, equipment, etc. Gross Profit Refers to what is left after you subtract the cost of goods sold from the sales. It is also called gross margin. For example, if an organization buys in an item for $50 and sells it for $75 (plus sales tax), then the gross profit will be $25. Fixed Assets This refers to all of those things that the business owns which will have a value to the business over a long period. This is usually understood to be any time longer than one year. It includes freehold property, plant, machinery, computers, motor vehicles, and so on. Current Assets This refers to assets with the value available entirely in the short term. This is usually understood to be a period of less than a year. This is either because they are what the business sells or because they are money or can quickly be turned into money. Examples of assets include inventory/stock, money owing by customers, money in the bank, or other short-term investments. Current Liabilities This refers to those things that the business could be called upon to pay in the short term - within the year. Examples include bank overdrafts and money owing to suppliers. Working Capital This is the difference between current assets and current liabilities. An organization without sufficient working capital cannot pay its debts as they fall due. In this situation it may have to stop trading even if it is profitable. Liquidity This is the ability to meet current obligations with cash or other assets that can be quickly converted into cash in order to pay bills as they become due. In other words the organization has enough cash or assets that will become cash so that it is able to write checks without running out of money. Debtor A debtor is a person owing money to the business, for example a customer for goods delivered. Creditor A creditor is a person to whom the business owes money, for example a supplier, landlord, or utility organization. Bad Debt All reasonable means to collect a debt have been tried and have failed so the amount owed is written off as a loss and becomes categorized as an expense on an income statement. This results in net income being reduced. Depreciation Assets have a certain length of time in which they operate efficiently, referred to as 'an asset's useful life.' During this period the value of that asset depreciates due to age, wear and tear, or obsolescence. The loss in value is recorded in accounts as a non-cash expense, which reduces earnings whilst raising cash flow. Accrual Accounting Accrual accounting relies on two principles, which have already been alluded to: The revenue recognition principle states that revenues are recognized when they are realized or realizable, and are earned (usually when goods are transferred or services rendered), no matter when the payment is received.
The matching principle states that expenses are recognized when goods are transferred or services rendered, and offset against recognized revenues, which were generated from those expenses, no matter when the cash is paid out .
XXX . V00000000 IMPLEMENTING A ELECTRONIC MONEY C PLAN BENEFIT WORKING CAPITAL MANAGEMENT
Recently, banks and enterprises are gradually involved in B2B electronic money C Plan abbreviated as electronic money. However, few articles have related e-commerce to the financial area. The main purpose of this study is to investigate the relationship between financial characteristics and implementing electronic money by e-commerce, and whether implementing electronic money will affect the firm value and working capital management. The important results are described as follows: 1.We find that the companies with trouble in cash flow will stress on electronic money due to the negative relationship between cash flow and implementing electronic money. 2. Implementing electronic money will raise the turnover ratio of inventory
value added of electronic money is regulated by the Electronic Money Regulations 2011 (“EMR”) which implement the second EU Electronic Money Directive (“2EMD”), which was adopted by the European Parliament and the Council of the European Union in September 2009. Skrill Ltd. is authorised by the Financial Conduct Authority (FCA) under the Electronic Money Regulations 2011 for the issuing of electronic money, Register No. 900001.
Key features of the regulation include:
Capital requirements & liquidity — Our business is required to maintain minimum levels of capital. There is an initial and continuous threshold of € 350,000 own funds. We must also hold sufficiently liquid assets to be able to redeem all e-money issued and to meet our working capital requirements.
Float Management — There is a clear set of regulations on how we have to safeguard our customers funds and how we can invest the funds received in exchange for the issue of e-money. In particular the EMR and 2EMD require authorised e-money issuers to safeguard funds received from customers for e-money so that, if there is an insolvency event, the e-money issued would be protected from other creditors’ claims and can be repaid to customers.
Management & Vetting at Entry — The FCA must be satisfied that all individuals who are responsible for the management of the e-money and payment service are of good repute and possess appropriate knowledge and experience. The FCA performs a " fit and proper test " on each member of Skrill Limited senior management considering honesty, integrity, reputation, competence, capability and financial soundness.
Systems & Controls — We must maintain organisational arrangements that are sufficient to minimise the risk of the loss or reduction of our customers funds or assets through fraud, misuse, negligence or poor administration. In addition we are required to have effective risk management procedures, adequate internal control mechanisms and to maintain relevant records.
Financial Crime — We must comply with legal requirements to deter and detect financial crime, which includes money laundering and terrorist financing. Relevant legislation includes the financial crime provisions in the EMRs, section 21A of the Terrorism Act 2000, the Proceeds of Crime Act 2002, the Money Laundering Regulations 2007, the EC wire transfer regulation21 and Schedule 7 to the Counter-Terrorism Act 2008. Electronic money issuers are also subject to the various pieces of legislation that implement the UK’s financial sanctions regime.
The Money Laundering Regulations 2007 require firms to put preventative measures in place. They require firms to ensure that they know their customers (including conducting customer identification and verification and undertake ongoing monitoring where applicable), to keep records of identity and to train their staff on the requirements of the Regulations. A senior member of staff needs to be appointed to oversee appropriate policies and procedures.
XXX . V000000000 New Ways to Make the Most of Working Capital
The secret to surviving this Great Recession may turn out to be how you manage working capital--the difference between the money you've been paid and the cash you owe.
The good news is that clever startups are coming to market with big new ideas intended not only to change the way small businesses handle money, but in some cases to also cut out big, bad, TARP-grabbing traditional banks altogether.
"The market is beginning to understand how much value there is in unlocking what is not working in the financial infrastructure," says Aaron Patzer, vice president of the Personal Finance Group at Intuit and founder of Mint.com, the online personal finance site Intuit purchased last year.
Here then, is how to get the most out of next-gen working capital. 1. Put future sales to work The old-school small-business dynamic of paying a bill by the agreed-upon due date or face usurious late fees is disappearing. BillFloat, based in San Francisco, is launching micro-credit for small business. Using investment and tech backing from online giant PayPal, BillFloat will provide as much as $1,000 of unsecured credit for 30 days to pay any bill.
BillFloat charges a flat rate for each micro loan. Fees during the current beta period, for example, are $4.99 per bill for a $50 loan and as much as $14.06 to pay a $225 bill. This fee combines a 3 percent monthly interest rate and a flat service charge per bill. Lendees have 30 days to repay and can extend terms as long as they notify BillFloat. Interest continues to accrue while the balance is outstanding.
Traditional banks also are morphing into financing innovators. Capital Access Network has created a product called AdvanceMe that provides working capital based on a company's estimated future credit card transactions. The outfit also reviews other factors--including whether a company has a minimum monthly credit volume of $5,000--before agreeing to provide a lump sum. The Scarsdale, N.Y., company says the approach lets firms with lower credit scores qualify for loans.
Clearly, new financing options like these will strain some small businesses. For example, as low-cost as BillFloat might be compared with charges for bounced checks, 3 percent per month works out to a near-Sopranos level of 36 percent annually. And financing tools like those offered from Capital Access Network require sophisticated accounting because, technically, the cash is not a loan, but a form of accelerated sale. Companies will need to think through options to be sure these deals make business sense.
2. Get your money faster Considering all the innovation in digital technology and the web, small-business billing is still almost ludicrously old-fashioned snail-mail paper bills and paper checks or fast but pricey web-based billing and payment services. Now third parties are offering new ways to expedite inbound cash.
3. Lose the payroll, the paper and even the branch BankSimple is angling to offer all the services of a bank without the actual building. The Brooklyn, N.Y., firm is establishing a web-based financial system that will offer free ATMs, automated money management, smartphone bank deposits and free online bill payment with what the firm claims are no hidden fees and far lower costs than traditional banks.
New banking hybrids are springing up fast. Austin, Texas-based MPOWER Ventures, through its prepaid debit card brand Mango Financial, recently opened its first "Mango Store" in Austin. A lower-cost alternative to high-priced check cashing, Mango's new retail location provides prepaid MasterCards, mobile money transfers and free alternatives to many financial transactions. The service gives small businesses not only new payroll options, but also lets their employees cash checks less expensively. Mango will offer payment options for small businesses looking to pay employees in cash. It hopes to open stores across the country on a march to become the Starbucks of next-gen banking.
PayNearMe is looking to do away not only with paper checks, but paper money, too. The Mountain View, Calif., company has pioneered the use of bar-coded vouchers, which any desktop imaging device can produce and which can be used to pay for anything from goods at 7-Eleven stores to rental cars from firms like Avis.
There are risks for these services. Fees are higher for working through third-party ATMs, and the tax implications are significant. The IRS likes to know where your money is. 4. Smarter point-of-sale For sheer innovation, it's tough to beat the changes coming at the point-of-sale. One of the most cutting-edge is Palo Alto-based Bling Nation, which is trying to deploy a system that lets small firms create on-the-fly loyalty programs. The cash-back and points system works through BlingTag, a fob that attaches to the back of any mobile device--no cash or credit card needed. The BlingTag lets merchants track purchases, reward customers and offer discounts almost automatically.
Best Practices for Payments & Working Capital Optimization
Companies are seeking new ways to effectively address complex global payment and cash management issues. Comprehensive and flexible payment hubs will soon become the “dominant architecture in the payments industry,” and new strategies are required to optimize the use of this emerging business model.
Today’s Payment Challenges
Managing enterprise payments has become increasingly complex and demanding. Businesses now face a host of challenges that did not exist a decade ago when the world was undergoing a boom period and credit was plentiful. We live in a world where credit is tight and the macroeconomic environment is risky and fragile. As a result, an organization’s inefficiencies have the potential to make the difference between survival and failure.
Enterprises are also now operating in a truly global economy. Ten to fifteen years ago, the supply chain for most corporations was primarily domestic and managed by a central organization. Now, the supply chain has become international and the financial systems to support it have become much more complex. Globalization has led to new markets, operations, suppliers, customers, banks, and new sources and uses of cash. Most legacy back-office systems cannot efficiently manage these new relationships leading many companies to adopt regionalized treasury and accounting strategies far different from the centralized control that previously dominated.
Finally, increased mergers and acquisitions have led to financial and operating complexities including multiple:
• Divisions and business sites, often with different operating procedures and business processes
• Legacy and back-office systems, including banking, enterprise resource planning (ERP) and line-of-business applications
• Accounts and banking relationships to manage cash, disbursements and collections
The removal of the unlimited-credit safety net, the addition of complex requirements for international commerce, and complications brought on by mergers and acquisitions have led many organizations to seek innovative new approaches. Businesses need integrated solutions that will address all the multifaceted processes surrounding global payments and cash management.
Enterprise Payment Hubs Unify Payment Operations
Many high-performing organizations are deploying a payment hub to streamline and standardize their payments processing across all enterprise applications, payment types and banks. Acting as a single payment gateway, a payment hub helps increase efficiency, improve control over funds, mitigate risk and increase visibility.
Unlike transaction-based, siloed systems that are dedicated to specific payment types, a payment hub manages the interface between all back-office systems, treasury workstations and other systems associated with payment and cash management.
Implemented properly, a payment hub can:
• Support global payment and remittance standards
• Seamlessly manage electronic and paper payments
• Consolidate inquiry, reporting and control capabilities
• Provide scalability and high availability
• Manage the complete payments lifecycle
• Reduce exposure to operational risk
This article examines three key areas that a payment hub must address and recommends best practices to ensure you execute the business process changes required to minimize risk and improve cash management.
1. Managing Domestic Payments The Paper Chase
Great inefficiencies plague the domestic accounts payable (AP) process, and the number one culprit is paper. Industry analysts estimate that more than 60% of business-to-business (B2B) payments remain paper-based in the U.S. The effect of this is increased cost, inefficiency and risk.
Processing a paper check can cost up to $17 and take up to 28 days. Compare that to Automated Clearing House (ACH) payments, where the average cost is $1.66 and it takes 1.5 to 3 days for payment issuance. Beyond the escalating cost and support requirements, paying by check also leaves your organization more vulnerable to risks such as check fraud, duplicate checks and failure to meet escheatment-process requirements.
Industry Best Practice
Best-in-class companies are eliminating checks for payments to their strategic vendors and are automating processing for their remaining AP check requirements. Using a payment hub, they receive payment data from back-office systems for multiple payment types in a single file. The payment hub discerns what type of payment is being requested, processes it in whatever format is received, and automatically generates the type of payment required.
Your payment hub must meet the following requirements:
• ACH. Create files for payments that can be released based on the corporate requirements for cash-flow management. Payments must be formatted to meet the organization’s ACH clearinghouse requirements and provide remittance in whatever format the vendor requires. Providing these capabilities eliminates the check-float and remittance concerns raised as objections to adopting ACH.
• Wires. Automate and standardize the management of the workflow and data associated with wire payments. This includes meeting internal and external compliance requirements and automatically executing the wire transfer in whatever format is required for domestic and international Realtime Gross Settlement (RTGS) payments.
• Paper Checks. Automate the entire check processing workflow, including local and distributed issuing/printing of checks and remittance information in whatever format is required. The payment hub must also manage the post-check process, including risk mitigation and reconciliation to help eliminate internal and external fraud.
2. Managing International Payments Current Situation
Most payment challenges facing U.S. companies doing business globally center on electronic funds transfers:
• ACH. Most countries outside the U.S. have their own ACH structures which require extensive knowledge of local requirements. ACH payments in the United Kingdom pose an additional challenge. The Bankers Automated Clearing Service (Bacs), the electronic ACH system used in the UK, is “conversational,” requiring authentication for each message. This necessitates a messaging conversation between the receiving Bacs service center and the service sending the payment. Many legacy systems are not capable of handling this requirement.
• International Wire Payments. Wires (or RTGS payments) are often required for international payments and pose a set of idiosyncratic challenges. Individual banks often have their own rules for wire formats, which can complicate transactions. This has led many organizations to rely on multiple, bank-specific workstations, which increases both operational and support complexity.
• Checks. Checks are much less prevalent for international payments because their use is rapidly declining, especially in Europe. When making cross-border payments by check, the biggest hurdle is often translating the payment line into the language of the receiving country.
Industry Best Practice
Best-in-class companies are implementing a single payments solution capable of automatically configuring their international payments to whatever format is required. Success requires a payment hub that can:
• Automatically manage the specific ACH format of the countries to which you are making the payment, including the outbound and associated confirmation aspects of the UK’s Bacs system
• Support standards such as the Society for Worldwide Interbank Financial Telecommunications (SWIFT) message format, and leverage a library of bank-specific adapters to satisfy the unique formatting needs of individual banks around the globe
• Handle the translation of check amounts and MICR lines into whatever format and language is required
3. Improving Visibility and Reporting Current Situation
Most organizations do not have the real-time visibility and control they need to optimize working capital. The combination of globalization and mergers and acquisitions has led to an expansion of domestic and international banking relationships that further fragments process and control.
Reporting across multiple internal systems and banks is extremely challenging for most enterprises. It requires time-consuming, often manual, data compilation from multiple sources and is prone to errors and inconsistencies. In addition, the information is often “stale”, which means financial executives are often making cash management decisions based on outdated information.
Companies require both global and real-time visibility. It is no longer viable to operate on partial or out-of-date information. Accurate, timely and complete accounts payable and banking information is critical for overall corporate success.
Industry Best Practice
Best-in-class companies are adopting an integrated solution that provides real-time global access to transactional information and account balances. This can be achieved by implementing an enterprise payment architecture that consolidates payments and cash management positions in a single database by:
• Using industry standards (i.e. SWIFT, BAI) for connectivity and message formats to ensure visibility and management of activities within all of the enterprise’s banks and accounts
• Interfacing with back-office AP and AR systems to integrate inbound and outgoing funds on a daily basis to provide more accurate forecasts
This centralization of immediately accessible information allows you to:
• Streamline the consolidation of financial information
• View and control balances on all accounts across multiple banks
• Receive up-to-date information for better visibility and control over cash positions
• Forecast cash flow needs on a short-term basis and ensure liquidity for upcoming disbursements
• Access reports consolidated by organizational reporting structure
• Better manage liquidity by transforming data into actionable intelligence
The solution should also provide the flexibility needed to easily organize report information, including multilevel drill-down capabilities and support of industry-standard reporting tools such as Microsoft Excel.
Summary
Thriving in today’s demanding financial environment requires new strategies. The current macroeconomic situation and the increasing demands of a global supply chain and economy mean that you must become more efficient in your payments and cash management processes. By adopting a state-of-the-art enterprise payments hub and proven best practices, finance managers can streamline their business and payment processes, achieve new levels of efficiency and control, and improve profitability.
===== MA THEREFORE ACTION WORKING CAPITAL WITH E-MONEY MATIC =====
