Category Archives: Finance

Working Capital in Europe is at an All Time High

But yet, so is unemployment. What’s the deal? According to this recent article over on the Financial Director site (in the UK), on how “working capital bounces back”, Europe’s biggest companies have seen the most significant revenue growth in five years. However, these same companies are hoarding their cash and, in many cases, borrowing to do so, while smaller companies remain starved for capital and unemployment remains near 10%.

This is, in a word, disgusting. As SI posted last Thursday, you get nothing for nothing, so if all your company is doing is hoarding cash instead of spending it on talent and innovation, it doesn’t, at least in SI’s view, have a very bright future. Especially given the overall state of the European economy with entire countries risking default on debt. While SI doesn’t know exactly how much cash the 1000 largest Europe-headquartered public companies are hoarding, SI is sure that it’s enough to make quite a dent in the unemployment wake and economic stability of the EU — something that would be very good for global supply chains that probably can’t afford more costly hits from economic instability and the rising prices that such instability entails.

Buy India, Sell China?

A recent article on Fortune on “Another Global Recession? Buy India, Sell China” caught my attention because, while I think China is over-hyped, I’m not sure India is ready for prime yet due to their infrastructure problems and the issues with getting freight from even a few hundred miles inland in many parts of the country. China still has problems, but they have been investing Billions to improve their infrastructure in recent years and making progress at a rapid rate whereas India, with twenty-eight states and seven union territories, and 22 languages of official status, has been slow to tackle their logistics challenges due to the very long timeframes it takes to get agreements on projects of a national scale. (It probably doesn’t help that the Republic of India is a federation with a parliamentary system that was based on that of Great Britain, where some projects take so long that they literally cross career life-spans!)

So why is the article recommending to Buy India, and Sell China? According to the authors, even though BRIC countries are growing at a rapid rate, countries like Brazil and China are doing so at the expense of other countries — primarily by supplying the global economy with raw materials and manufacturing. If major financial crises (continue to) materialize in the US and the EU, and global demand slumps significantly, these countries are going to get hit the hardest and the growth-rates of nearly 10% will be unsustainable. (And depending on which fear-monger you ask, growth could come to a screeching halt.) And this doesn’t even take into account the deep financial exposure China has to troubled regions through its massive foreign exchange reserves.

On the other hand, poorer, insulated economies like India are in much better shape to weather the storm and, in some economists’ views, even see a silver lining if major obstacles (such as nosebleed inflation rates) decline or disappear.

I have to agree, but only to a point. China is experiencing a rapid rise in its middle class at home and the local economy is booming as well. Plus it has a very aggressive five year plan, and a history of meeting those five year plans. While it will get hit hard, and probably drop down to a growth rate of 5% if a double-dip global recession hits us (just like its growth rate fell from 13% in 2007 to 6.8% in 2008), it will continue to grow and, more importantly, will likely be the first to recover when the double-dip recession ends (if it does hit us).

In other words, if you are one of the few investors left with the brains to take a long term view, don’t count China out yet. It may experience a few bumps, but it will figure out how to smooth them over as it builds its global highways. Moreover, if you’re looking to get rich quick, it will likely be another decade before India provides you with that opportunity. If you’re patient, I believe you can win with both economies.

McKinsey Just Gave Us the Best Argument for Next Practices

From a recent McKinsey Quarterly newsletter:

Spurious frameworks and torrents of data often obscure the basic principles of good strategy. To beat the market, companies must exploit imperfections that stop (or at least slow) its workings. Such competitive advantages are scarce and fleeting because markets drive a reversion to mean performance … . Good strategies therefore emphasize difference …
     From “Why best practice isn’t the best strategy”

But more importantly, an analysis of ROIC and EV/IC for top, middle, and bottom quintile companies from 2001 to 2009 shows an drop in ROIC of almost 75% (from above 15% to below 4%) and a drop of EV/IC of almost 85% (from about 3.2 to 0.5).

Best practices aren’t enough anymore. We need next practices.

As a side-note, the next Next Practices Xchange, hosted by the Mpower Group and one of the few forums dedicated to the discussion of next practices, is November 4, 2011.

Should You Be Using CEI?

Chances are, like every other organization on the block, your Finance department is tracking DSO and if the DSO metric is close to the corporate goal of, say, 30 days, declaring everything to be wonderful and right with the customer base. But is this really the case?

As a recent article over on CFO.com that points out “the trouble with DSO”, an acceptable DSO might not be acceptable at all. First of all, DSO can be manipulated. Secondly, increases in DSO can indicate a situation where a company is “forcing” sales by accepting poor receivable terms, or selling its product at a discount to create sales. (Not good at all!) Thirdly, not only will most customers not pay a net 30 day invoice early, some customers will pay on day 30 like clockwork and should probably be excluded from the DSO calculation.

According to the authors of the aforementioned article, what is really important is collections relative to accounts that have come due, not the current receivables unlikely to be paid early. In order to capture this, the authors are recommending a different metric, the Collection Effectiveness Index (CEI). In this index, 100 is a perfect score, but 100 can be exceeded if a company asks for, and gets, cash in advance. The calculation of CEI is as follows:

 

Beginning Receivables + (Credit Sales/days) – Ending Total Receivables

Beginning Receivables + (Credit Sales/days) – Ending Current Receivables

 x 100

 

It’s an interesting calculation, and I see one advantage for Procurement. During the calculation, the analyst will have to identify those customers with amounts due in “current”. If a customer shows up in this bucket month after month, they probably aren’t a good customer to have. And if a customer never shows up in this bucket, they are probably a good customer to have. This will help Procurement prioritize customer requests as the requests from good customers should get priority, as that is what can keep an organization afloat in trouble times.

Any different thoughts?

An Idea for Aligning the Non-Competing Finance and Procurement Agendas

About two weeks ago, in What Competing Agendas, SI pointed out that, where Finance and Procurement are concerned, there are no competing agendas. Furthermore, as far as the doctor is concerned, whomever said that the dynamics and sometimes competing agendas between finance and procurement are widely known doesn’t get it. At all. Remembering that the ultimate goal of any organization is to derive value for the stakeholders — employees, customers, and shareholders alike — both organizations are trying to find the right balance between cost cutting and value generation to meet the company’s goals and shareholder return. Just because Procurement is always spending while Finance is always trying to cut spend doesn’t mean that the departments are in opposition. Finance knows better than any other department that companies have to spend money to make money, as long as the money is being spent wisely, and a good Procurement organization has better spending as its ultimate goal. There is no competing agenda.

However, since Finance and Procurement sometimes speak a different language, because Procurement hasn’t learned to Speak the Language of the CFO, the agendas aren’t always aligned. And while they both plot a route to the same goal, the routes barely intersect. And any good financier as well as any good sourcerer knows that taking two planes from New York, New York to Mumbai, India with one routed through Frankfurt, Germany and the other routed through Sydney, Australia, is wasteful. Thus, the agendas have to be closely aligned for optimal performance.

But how do you align the agendas?

One idea could be to use balanced scorecards as a shared framework. Back in the early days, SI ran a post that asked if you need a Chief Strategy Management Officer. Back in 2006, CFO Research Services published a short paper that summarized the highlights of their annual executive conference in New York, New York. Part of that report was a mini-paper on aligning the finance function to strategy execution based on a presentation by Robert S. Kaplan, co-developer of the balanced scorecard and co-author of Alignment: Using the Balanced Scorecard to Create Corporate Synergies with David P. Norton.

At the conference, Kaplan discussed various approaches for aligning the finance function more strategically with the goals of business units and corporate leaders, including:

  • the use of balanced scorecards as a shared framework to run the business, guide the operating agenda, and evaluate progress against strategy
  • the use of activity-based budgeting to link the strategic planning capability of Balanced Scorecards with the operational budgeting mechanism of a time-driven ABC (activity-based costing) model

And, as I suggested in my original post, I think it’s a great idea. And I still see no idea why it can’t work for Procurement. In the process of creating a balanced scorecard, Procurement and Finance will have to agree on budgets and savings / avoidance targets, payment terms, working capital objectives, inventory turnover, and a host of other supply management issues. And by scoring themselves on the same metrics, they will have to stick to the plan to collectively succeed. Now, getting the right scorecard might not be easy, but the exercise will get the organizations to a deep alignment that will pay off in the long run if each goes in to the discussions with an open mind and a true desire to work together.