Anno accademico

Transcription

1 Anno accademico Corso di Laurea Magistrale in Economia Aziendale Curriculum amministrazione e governance delle aziende (ex DM 270) PRINCIPLES OF BUSINESS VALUATION

2 Cash Flow Management in the Value Creation Process Founding Managing Partner Cross Court Capital October 2018

3 THE VALUE OF A FIRM: CASH GENERATION Cash Flow Mgt. in the Value Creation Process Page 2 October 2018

4 The Cash Flow Statement The value of a company is, ultimately, directly correlated to its ability to generate cash Financial valuation methods are based on: (i) the ability of a company to generate cash and (ii) the level of its net financial debt The cash flow statement shows how much cash a company generates in a certain time period There are a different types of cash flows (from the most high-level to the most specific) Operating income (EBIT) Net operating profit after tax (NOPAT) Operating cash flow Unlevered free cash flow Free cash flow Cash flow statement EBIT 100,00 Taxes on EBIT -31,25 NOPAT 68,75 Depreciation and Amortization 10,00 Change in NWC -5,00 Operating Cash Flow 73,75 Capex -7,00 Unlevered Free Cash Flow 66,75 Interest -6,00 Taxes on interest 1,62 Free Cash Flow 62,37 Change in equity 0,00 Net Cash flow 62,37 Net cash flow Every management s aim should be, given a company s economics (i.e. income statement), to maximize cash generation Cash Flow Mgt. in the Value Creation Process Page 3 October 2018

5 Cash Flow Profile of a Company Value differentiator: cash generation capacity 2 companies... Operating in the same industry and country With identical income statements (i.e. margins)... With the same forecasted growth rate... Could command very different values if one generates more cash than the other Given certain economics, to increase cash generation (i.e. higher conversion rate), it is necessary to have: Lower working capital needs Lower capital expenditure (capex) requirements (many companies are doomed to invest significantly) Higher cash generation means:...having structurally less invested capital in the firm, hence less capital needs pay back funding providers more quickly have better credit rating/capacity (cheaper sources of capital) hold less equity (most expensive source of capital) Cash Flow Mgt. in the Value Creation Process Page 4 October 2018

6 The Drivers of Cash Flow Generation The drivers of cash flow generation originate in the income statement (i.e. in the economics) of the firm: (grow) sales (prices and volumes) (reduce) costs (increase) margins But the economics of the firm, alone, do not necessarily guarantee cash generation (hence value creation). A company must: Monetize sales Reduce capital expenditures to a minimum (without damaging the firms competitive position) The ability to monetize sales will naturally derive from: Getting paid quicker by clients (reducing receivables as a percentage of sales) Paying suppliers as late as possible (without incurring in penalties) Reducing inventory as much as possible (i.e. just in time production) WORKING CAPITAL REDUCTION Reducing capex is risky, as a company s asset base deteriorates over time (and needs renovation) and often this will penalize the quality and output of the company s production Cash Flow Mgt. in the Value Creation Process Page 5 October 2018

7 WORKING CAPITAL Cash Flow Mgt. in the Value Creation Process Page 6 October 2018

8 Operating Working Capital ( OpWC ) Operating working capital is the capital necessary to run a company s short-term (commercial) operations It includes the uses and sources of capital which derive from operating (i.e. increasing/decreasing) inventory, trade receivables or trade payables In a nut shell, it corresponds to the sum of inventory and trade receivables, less trade payables, and it gives and indication of the amount of capital that is necessary for a firm to function in its normal business operations Change in working capital, in a certain time period, represents the cash flow (positive or negative) that the OpWC absorbs or generates in a business. In general: Increases in the stock of OpWC generate a capital requirement (i.e. burn cash) Decreases in OpWC release capital (i.e. generate cash) Working capital statement Inventory 32,00 32,64 33,29 33,96 Receivables 41,00 45,10 49,61 54,57 Payables -35,00-36,75-38,59-40,52 Operating Working Capital (OpWC) 38,00 40,99 44,32 48,01 Net Change in OpWC -2,99-3,33-3,70 Cash Flow Mgt. in the Value Creation Process Page 7 October 2018

9 Other Short Term Assets and Liabilities Working Capital calculation is completed by adding and subtracting other short-term assets and liabilities The figure we arrive to is total working capital, which represents all the short term capital a company requires for its day-to-day business operations to function (both operating and nonoperating) Other short term assets could be: Tax receivables Other receivables Other short term liabilities could be: Tax payables Payables to employees Termination fund (TFR) Other liabilities Working capital statement Inventory 32,00 32,64 33,29 33,96 Receivables 41,00 45,10 49,61 54,57 Payables -35,00-36,75-38,59-40,52 Operating Working Capital (OpWC) 38,00 40,99 44,32 48,01 Net Change in OpWC -2,99-3,33-3,70 Other short-term assets 4,00 4,40 4,84 5,32 Other short-term liabilities -12,00-12,60-13,23-13,89 Net Working Capital 30,00 32,79 35,93 39,45 Net Change in Working Capital -2,79-3,14-3,52 Cash on the balance sheet is not part of working capital, except if it s trapped cash (i.e. deposits for guarantees, bid bonds, lease commitments, etc.) Cash Flow Mgt. in the Value Creation Process Page 8 October 2018

10 Trade Receivables In simplistic terms, a trade receivable is a portion of sales whose monetization is deferred in time As such, it could be viewed as the number of days worth of sales trapped in receivables Once a receivable is cashed, capital is released and cash flows into the business generating a monetary effect Usually when a company increases its sales, receivables increase and cash is absorbed in order to finance growth In some cases/industries, companies are able to immediately monetize sales at the moment of product/service transfer (optimal case) The retail industry is cash and carry (shops, supermarkets, bars, restaurants) Companies who are able get paid in advance through down-payments or collateral (residential real estate development companies) Usually payments are collected between 30 and 120 days. In some industries (i.e. healthcare in Italy) tremendous delays are the norm (280 + days) Receivables need to be analyzed and monitored both in stock-values and in specific ratios, amongst which: Receivables/Sales (%age of sales outstanding awaiting payment) Receivables/Sales*365 (days sales outstanding) Sales/Receivables (receivables turnover/rotation) Sales should be LTM (Last 12 Months) gross of VAT Cash Flow Mgt. in the Value Creation Process Page 9 October 2018

11 Inventory Inventory is stock that a company produces (or holds) which is not sold off to the market immediately Inventory could regard finished goods, semi-finished products, or raw materials Hence, it could be seen as the amount of sales tied-up in stock (un-monetized) When inventory (of finished goods) levels drop, sales increase and capital is released, generating cash Companies which do not hold stock are generally service firms Airlines, utilities, restaurants etc. Some companies operate on a build-to stock basis (as opposed to build-to-order ). These generally absorb more cash Just-in-time production methodology came about to reduce inventory to extremely low (or zero) levels Inventory needs to be analyzed and monitored both in stock-values and in specific ratios, amongst which: Inventory/Sales (%age of sales outstanding awaiting payment) or production costs if SFG or raw materials Inventory/Sales*365 (days sales outstanding) or production costs if SFG or raw materials Sales/Inventory (inventory turnover/rotation) or production costs if SFG or raw materials Sales should be LTM (Last 12 Months) net of VAT Inventory needs to be analyzed by type of stock, and could vary significantly over time Cash Flow Mgt. in the Value Creation Process Page 10 October 2018

12 Trade Payables Trade payables represent the portion of purchase costs that companies delay payment on Hence they could be viewed as the number of days worth of costs suspended in payables When a company pays a trade payable, capital is required and cash is used/absorbed Normally when a company increases purchases, payables increase Few companies pay at the moment of purchase (or in advance worst case): Commodities (spot market) Personnel or utilities (short payment terms) Companies in financial distress Payables need to be analyzed and monitored both in stock-values and in specific ratios, amongst which: Payables/COGS (%age of costs outstanding awaiting payment) Payables/COGS*365 (days costs outstanding) COGS/Payables (COGS turnover/rotation) COGS should be LTM (Last 12 Months) gross of VAT Cash Flow Mgt. in the Value Creation Process Page 11 October 2018

13 OpWC Improvement Drivers Trade receivables (get paid earlier!) Receivables collection management Select customers Make credit more expensive (incentivize early payment) Inventory (reduce stock!) Production optimization (reduce minimum economic batch) Service level reduction (understand optimal level of stock) Reduce references/product range (simplify company s offer) Shorten lead time (time-to-market) Trade payables (pay later!) Increase deferral terms by increasing volumes (supplier loyalty) Improve price terms of products (i.e. increase price) Change/select suppliers Classify and re-order suppliers, understand competitive trends and have a back-up (co-suppliers) The revision of a company s Supply Chain will create many of the above benefits THE AIM IS TO GENERATE CASH! Cash Flow Mgt. in the Value Creation Process Page 12 October 2018

14 The Supply Chain Represents all of the operations that a company needs to carry out in order to deliver a product/service to the market Estimate demand Program and schedule supply (production / procurement) Logistics (inbound / outbound) Production Stock Cash-in (collection cycle) Payment (payment cycle) Management control, through reporting systems, is fundamental (management control systems and industrial/cost accounting are necessary CFO/Head of Control /COO) Revision of the supply chain (every 5-7 years aligned with internal and external radical changes) allows for OpWC reduction (and efficiency gains leading to higher margins) Supply Chain optimization is typical of a company growing and increasing its maturity, and allows to achieve continuous improvement (i.e. value creation) which will indefinitely stay with the firm Cash Flow Mgt. in the Value Creation Process Page 13 October 2018

15 Management Incentive Program In order to generate cash, possibly by reducing working capital requirements, top and middle management will have to be adequately motivated The CEO and top level management could be motivated by having their economic interests aligned with the value creation in the company Middle management, in specific areas, could be motivated, amongst others, according to the levers of working capital they directly have an impact on such as, for example: CFO (entire OpWC: receivables/inventory/payables) COO (inventory/payables) CCO (receivables) Head of procurement (inventory & payables) Head of credit (receivables) A MIP can address and include specific targets, but also overall company targets The cost of the program will evidently need to be lower than the benefits to the firm The implementation of a MIP is the first step toward operational improvements aimed at value creation in the firm Cash Flow Mgt. in the Value Creation Process Page 14 October 2018

16 PRACTICAL EXAMPLES Cash Flow Mgt. in the Value Creation Process Page 15 October 2018

17 OpWC Analysis percentage contribution Working capital statement Inventory 32,00 32,64 33,29 33,96 Receivables 41,00 45,10 49,61 54,57 Payables -35,00-36,75-38,59-40,52 Operating Working Capital (OpWC) 38,00 40,99 44,32 48,01 Net Change in OpWC -2,99-3,33-3,70 OpWC cash burn needed to grow Key Figures Sales 400,00 420,00 450,00 500,00 COGS -200,00-210,00-220,00-230,00 Gross Margin 200,00 210,00 230,00 270,00 Operating Working Capital Analysis - Percentage Contribution Inventory 8,0% 7,8% 7,4% 6,8% Receivables (incl. 8,4% 8,8% 9,0% 8,9% Payables (incl. 14,3% 14,3% 14,4% 14,4% OpWC/Sales 9,5% 9,8% 9,8% 9,6% Cash Flow Mgt. in the Value Creation Process Page 16 October 2018

18 OpWC Analysis days outstanding Working capital statement Inventory 32,00 32,64 33,29 33,96 Receivables 41,00 45,10 49,61 54,57 Payables -35,00-36,75-38,59-40,52 Operating Working Capital (OpWC) 38,00 40,99 44,32 48,01 Net Change in OpWC -2,99-3,33-3,70 OpWC cash burn needed to grow Key Figures Sales 400,00 420,00 450,00 500,00 COGS -200,00-210,00-220,00-230,00 Gross Margin 200,00 210,00 230,00 270,00 Operating Working Capital Analysis - Days Outstanding Inventory 29,2 28,4 27,0 24,8 Receivables (incl. 30,7 32,1 33,0 32,7 Payables (incl. 52,4 52,4 52,5 52,7 OpWC/Sales 34,7 35,6 35,9 35,0 Cash Flow Mgt. in the Value Creation Process Page 17 October 2018

19 OpWC Analysis capital turn Working capital statement Inventory 32,00 32,64 33,29 33,96 Receivables 41,00 45,10 49,61 54,57 Payables -35,00-36,75-38,59-40,52 Operating Working Capital (OpWC) 38,00 40,99 44,32 48,01 Net Change in OpWC -2,99-3,33-3,70 OpWC cash burn needed to grow Key Figures Sales 400,00 420,00 450,00 500,00 COGS -200,00-210,00-220,00-230,00 Gross Margin 200,00 210,00 230,00 270,00 Operating Working Capital Analysis - Capital Turn Inventory 12,5x 12,9x 13,5x 14,7x Receivables (incl. 11,9x 11,4x 11,1x 11,2x Payables (incl. 7,0x 7,0x 7,0x 6,9x OpWC/Sales 10,5x 10,2x 10,2x 10,4x Cash Flow Mgt. in the Value Creation Process Page 18 October 2018

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