Category Archives: Finance

I Hope You’re Not Paying a Wealth Investment Advisor!

Because if you are, the only person getting wealthy out of the deal is the investment advisor on your money! Especially when your LOLCat can do a better job, and will work for temptations and catnip!

As per this recent article in the The Observer, a ginger tabby named Orlando beat a team of professionals and a group of students in a year-long stock-picking experiment summarized in a recent article on how Orlando is the cat’s whiskers of stock picking. The cat, who selected stocks by throwing his favourite toy mouse on a grid of numbers allocated to different companies, beat Justin Urquhart Stewart of Seven Investment Management, Paul Kavanagh of Killick & Co, and Andy Brough of Schroders who had decdes of investment knowledge.

So if you really want to beat the market, replace your stock analysts with cats who are just as accurate (and don’t put much faith into predictive analytics no matter how much big data you have).

The Essence of Good Working Capital Management

In yesterday’s post we noted that playing games with working capital only costs the organization in the end; specifically, for every 10% of working capital an organization messes with, it loses 1% of total working capital (or 10% of the working capital messed with). Not a good deal, any way one wants to look at it.

Working Capital doesn’t have to be hard to manage. While an expert can get quite sophisticated about it, all one really has to do is:

  1. Get a good grip on receivables
    What is the organization expecting from sales and when; what reimbursements is the organization entitled to and when; what tax rebates is the organization expecting and when.
  2. Get a clear picture on fixed payables
    What is the average monthly payroll, the average monthly overhead (rent, utilities, etc), and regular non-monthly expenses that are projected over the next year.
  3. Get a good estimate of average disruption costs
    When a receivables disruption has occurred — regardless of if it was due to a late payment, lost customer, lost sales from a competitive product, or market delay due to a supply chain disruption — how much has it cost on average and how long has it persisted. This is the contingency fund that is required (and can be amortized monthly over the next twelve months).

Once this is known, the organization knows how much cash it has to work with every month. Only then can it truly begin working capital management and determine when it should pay early to take advantage of an early payment discount, borrow to pay on time to prevent costs from rising (as the supplier’s cost of capital is much higher than the organization’s), pay late and pay the penalty (as the organization’s cost of capital is higher and/or the supplier is able to bear the burden of payment late more than the organization is able to bear the burden of paying on time), or get innovative and work with the supplier to reduce costs across the supply chain. Without a solid understanding of cash flow, working capital management can’t even begin. And good working capital management definitely doesn’t involve booking revenue early, paying suppliers late, or other quarter and year end games to present a rosier picture than reality, because these games always get discovered and the organization always loses, in hard dollars, in the end.

You Can’t Buy Anything for a Quarter, So Why Do We Still Care About Them?

And more importantly, besides the fact that quarterly reporting pretty much became mandatory in North America with the Securities Exchange Act of 1934, why did we ever?

For those of you that are lost, I’m referring to the fact that when you focus on a quarterly number, you often screw up the year, or, as demonstrated in some recent research by the REL Consultancy, a Hackett Group Company, the next year. As summarized in this recent Industry Week article on how It’s All in the Game When It Comes to Year-End Cash Management (among others), attempts to game the system and post good fourth quarter results by delaying payment, manipulating receivables, or offering deep customer discounts just to book last-minute sales always lead to first quarter losses in the subsequent year that exceed the gains in the fourth quarter.

Specifically, the research indicated that while working-capital performance improved by 10% in 2011 Q4, it dropped by 11% in 2012 Q1. In other words, the loss exceeded the gain by 1%!

We’ve become way too focussed on the short term and the year end. What’s important is the long term. Given the choice between a 5% gain today and a 15% gain in a year and a 10% gain today with a guaranteed loss of 5% in a year, a company should always choose the first option as it gives the greatest combined gain over two years. But today, most public companies will choose the 10% gain today, turn a blind eye to the impending loss, and, if pressured, mumble that “we’ll figure it out later”. The problem is, if the gain comes at the expense of a deep discount on maintenance and labour rates are skyrocketing, at the expense of putting off needed upgrades to energy hogging equipment when energy costs are skyrocketing or delaying payables when interest costs are mounting, there’s no way to figure it out later. Cost are going to go up and losses are going to mount.

Not only do companies have to start managing working capital on a year-round basis, as the article notes, but they have to start managing growth on a long-term basis and re-instate the five and ten year plans as one to two year plans just aren’t enough. If this means they have to f*ck Wall Street and go private, so be it. Until we abandon this success today at all costs mindset, we’re never going to take supply chains to the next level.

If America is Going to Be Number One Oil Producer By 2020, Will Canada Be Number Two?

According to this recent Economist Article on Energy to Spare, America is on track to produce all the energy it needs at home. Considering that Americans burn three and a half times as much energy as the average Chinese person, and hasn’t been able to meet its energy needs in over half a century, this seems like a tall order. Especially since, demand has more than doubled since America was last able to satisfy its energy needs from domestic sources.

However, the International Energy Agency is forecasting that America could become the world’s largest oil producer by 2020, when it could be churning out 11.1 Million barrels a day, and be energy self-sufficient by 2035. Coupled with the fact that demand is waning due to increased fuel efficiency, the prediction is that rising production and falling demand will equal out in 2035.

It’s an interesting prediction, but so is the prediction about the Athabasca Oil Sands north of the American border. Right now, production is about 1.3M barrels per day, but estimates are that production can get to 5.1M barrels per day. As per this article in the Economist, on The Sands of Grime, Canada’s oil sands contain over 170 Billion Barrels of oil that can be recovered economically with today’s technology. With the third largest proven oil reserves in the world, it’s quite likely that production can ramp up to make Canada at least fourth in oil production by 2020, with third place a strong possibility. Right now, Venezuelan production for 2020 is estimated at 6.5M barrels per day and Saudi Arabia, at close to 10M barrels per day, expects it can get to 11 M barrels per day (Source). With the difference between Canadian production estimates and Venezuelan production estimates for 2020 less than 30%, it would only take a 15% increase in Canadian production and a 15% decrease in Venezuelan production for Canada to edge in third.

Unless Saudi Arabian reserves are less than estimated, or Canadian production ramps up exponentially beyond expectations, we probably won’t make number two, but number three is a strong possibility.

Is Your Supply Chain OCF? Part II

In Part I, we asked if your supply chain was OCF, and by OCF we meant Operating Cash Flow and not Obsessive Compulsive Finance, although you have to be the latter in order to achieve the former. We explained that, at least from a working capital management viewpoint, it is a better measure of financial health than other financial measures. We finished with a question – How Do You Impact It?

First, let’s look at one detailed formula:

  1. revenue as reported
  2. – (increase in) operating trade receivables
  3. – investment income
  4. – other income that is non cash and/or non sales related
  5. – costs of sales
  6. – all other expenses
  7. + (increase in) operating trade payables
  8. + non cash expense items
  9. + financing expenses

Based on this formula, supply chain can impact:

  • 1. Revenue as Reported
    by creating new value-added services, creating enhanced versions of a product that can be sold at a premium, etc.
  • 2. Receivables
    by creating agreements that allow for faster collection, by factoring, etc.
  • 5. Cost of Sales
    by reducing product and service costs, reducing inventory costs, reducing transport costs, etc.
  • 6. All Other Expenses
    by reducing indirect costs, SG&A overheads, etc.
  • 7. Payables
    by taking advantage of early payment discounting, by reducing amounts owed through reciprocal trade agreement, etc.
  • 9. Finance Expenses
    by taking advantage of market knowledge to obtain best rates, by selecting appropriate currencies (to hedge against), etc.

And the impact can be measured as follows:

Supply Chain Contribution to OCF / OCF

where Supply Chain Contribution is, technically (where all projections are without Supply Chain Contribution):

  • Actual Revenue – Projected Revenue +
  • Projected Receivables – Actual Receivables +
  • Projected Cost of Sales – Actual Cost of Sales +
  • Projected Other Expenses – Actual Other Expenses +
  • Actual Payables – Projected Payables** +
  • Projected Finance Expenses – Actual Finance Expenses

** while this is technically correct from a Finance view who want the organization to hold onto cash longer, from a Supply Chain view it’s usually stupid, as SI has argued for years, because your cost of capital is often lower than that of a supplier and the goal is to lower overall supply chain costs. In other words, the improvement in payables is probably coming at a cost of a greater improvement in cost of sales.

In other words, if Supply Chain Contribution to OCF was 400K and the OCF was 2M, then supply chain contributed 20% and that’s proof in the pudding that supply chain has value.