CONTROLLING TOOLS IN THE LIGHT OF CRISIS AND SECURING OF BUSINESS FINANCIAL STABILITY THROUGH BANKING INSTRUMENTS. Pavel ŠLÉGR Hana SCHOLLEOVÁ

Transcription

1 CONTROLLING TOOLS IN THE LIGHT OF CRISIS AND SECURING OF BUSINESS FINANCIAL STABILITY THROUGH BANKING INSTRUMENTS Pavel ŠLÉGR Hana SCHOLLEOVÁ Vysoká škola ekonomická v Praze, W. Churchilla 4, Praha 3 Žižkov, slegr.pavel@gmail.com Abstract Global crisis has in the recent years shown that widely used controlling tools do not provide sufficiently valid results regarding the danger of financial instability and therefore fail to provide relevant information to the top management. This phenomenon narrows the possible managerial decisions regarding the securing of sufficient level of liquidity to usage of banking loans. In the time of crisis banks on the other hand tighten up the financial stability requirements for enterprises, which are often dependant on the financial help from them. By setting the strict loan rules, banks condemn enterprises with wrongly set controlling system, due to which they find out their financial difficulties at the last moment, to collapse as they are deemed too risky to be provided with a banking financial help. That s why it is vital for enterprises to modify their controlling tools so they provide them with accurate information about their financial health and are able to detect the threat of financial instability in advance. The main goal of the article is to create a set of recommendations, on the base of which the controlling system should be modified in order to provide the management with the valid information in the time of crisis and to be able to detect and reveal the threat of financial instability in time. During the research we have worked with the data provided from the financial institutions, scientific literature and self-made questionnaires. The obtained data are being analyzed mainly by statistical methods, benchmarking and internal and external analysis of significant factors. Key words: controlling, crisis, metal, working capital management, short term loan 1. INTRODUCTION In recent years, we have witnessed an unusually strong and coordinated global economic recession that hits much more the firms which can t react in a shorter time period, because they are strongly encumbered by high share of fixed assets and fund by greater share of debts. These three attributes are unfortunately common for metallurgical industry (according to the Czech CZ-NACE classification regards C 24.1). Fig. 1 shows a comparison of year on year growth of the industry in the CZ and clearly demonstrates a high sensitivity to fluctuations. Companies faced and still face long-term problems, which were further deepened by the recession. However, it is important to point out that recession wasn t the trigger but just the accelerator of these problems. The economic crisis has shown that deficiencies in controlling system are reflected in the market success of products that can be limited by failures in the capital market. Researches of the behaviour of Czech companies and using the controlling tools for managing business risks have shown long before the crisis that management prefers short term tools with easy application (solving wellstructured problems) and easy presentation of problems [1]. Because of simplicity the controlling focused on quantified calculations (financial analysis, short term plans controlled with the deviation analysis) rather than strategic analysis tools. These assumptions are confirmed by researches [1], [2]. Focusing on short term static tools used for long term investment decisions is confirmed by other researches [3], [4]. One of the reasons is often principal-agent problem and subsequent poor or inadequate communication between the owners and managers. Managers then use tools, which prefer their short term goals to owner s long term goals [5]. This article aims to demonstrate the idea, that absenting use of strategic controlling tools may be noticeable in the growth phase, but causes huge problems in the phase of economic downturn. The

2 elaborates on the results and outputs of the research project Analýza uplatňování controllingových nástrojů a vyhodnocení rozdílů v přístupu ke controllingu v době krize a postkrizovém řízení (Analysis of the use of controlling tools and the evaluation of different controlling approaches in crisis and after crisis) registrated at FPH VŠE in Prague, Czech republic under registration number IGA F3/26/ ,0 140,0 120,0 100,0 80,0 60,0 40,0 20,0 0, Total industry Manufacture of basic metals and fabricated metal products, foundry Manufacture of fabricated metal products, except machinery and Fig. 1 Comparison of sales in metallurgical industry (according to[6]) 2. TOOLS FOR MANAGEMENT OF LONG TERM PROSPERITY OF FIRMS The starting point are the pre-crisis researches of the use controlling tools 2.1 Pre-crisis signals Long before the economic crisis occurred, it was clear from various surveys of companies that firms are focused on short term goals. This can be documented e.g. by system of plans that are developed in various areas of business activities. As it is clear from a research carried in large Czech companies [1], repeated again in 2000 (unpublished), there are few areas of business activities, where the companies were willing to go beyond the scope of 5 years (see Fig. 2). Profit Financial Income statement Personnel R & D Stock Purchasing Production Investment Products Turnover Sales < 1 year 1-5 years > 5 years 0% 20% 40% 60% 80% 100% Fig. 2 Creation of business plans (processed according to [1] )

3 We can tolerate focusing on short term goals in some areas of management (production), but in others we are likely to miss any deeper interconnection of plans. Why then is the production planned in a longer scope than sales? It is alarming that most of the surveyed firms didn t create long term plans even for the typically long term and strategic-oriented areas (investment, finance, research and development). In the survey made by KPE FPH VŠE in 2007 [2] firms (256 large firms from CZ involved) confessed again that they tended to focus more on short term control. Only 45 % of these firms have processed a written form of their strategy, but it is shared only by management (all employees share it only in 36 % of these firms). In over 80 % of firms,the responsibility of controlling focused on checking of deviations, sub-plans, operational plans and reporting. Only 20 % of firms apply strategic tools as forecasting models, strategic balance or balanced scorecard. This pre-crisis survey confirmed short term orientation in business management. It is alarming that 69 % of firms use bank loans as a source of their long term financing and for operating financing use overdraft (50 %), but the risk management use only verbal definitions of risks (90% of firms shared their practice of merely discussing the possibility of risks without quantifying them). One could simply say that firms used the pre-crisis market potential for growth, but used inadequate controlling tools while taking risks that weren t managed nor identified. 2.2 Financing of metallurgical companies benchmarking industry leader Czech Statistical Office provided initial source of data for the analysis, but since the scope of research is so non-homogenic, individual values are eventually distorted by the ration indicators. For this reason, we tried to analyse the industry through the analysis of annual financial statements of the leaders in this industry [7]. Fig. 3 shows the development of indebtedness of the six selected major firms in Czech metallurgical industry. Fig. 3 Indebtedness of selected firms and its development in period With only minor exceptions, the indebtedness has fallen in the period However, if we apply the best known indicator of creditor risk index, i. e. Altman index (for comparison between the selected companies a version for non-public traded companies was used) [9] (see Table 1.), then the creditor s risk didn t significantly change. The critical value of Altman index is Any value greater than 2.89 signifies that the firm is considered as financially healthy.

4 Table 1 Altmann index creditor s risk of selected firms and its development in the period Altman index Arcelor Mittal 3,4 4,2 3,9 Železárny Veselí 0,6 2,3 2,0 1,5 2,3 Moravia Steel 5,5 5,8 5,7 4,0 4,6 Třinecké železárny 3,3 3,6 3,7 3,1 2,5 Vítkovice Heavy Machine 2,4 1,9 1,5 1,3 1,1 ŽĎAS 2,3 2,1 2,5 2,1 2,3 Table 1 clarifies the idea that firms have been in good or worse financial position and have stayed in the same zone for all five years. That means that level of creditor risk remains at the same level. This fact indicates that creditors do have completely different criteria in deciding on the conditions of lending. Banks denied establishing stricter lending conditions [8], their approach to lending resulted from automatically set processes of the input control. Most of the surveyed companies got worse in the monitored indicators, so they fell in stricter regime and banks monitored them more carefully. Banks, for obvious reasons, do not publish client assessment systems, but it is known that they keep an eye on firm s operating financing. This is a logical approach for creditors, because they have only short time interest (in contrast to owners). Operating financing is represented mainly by Working Capital (WC = current assets short term liabilities). It is natural that their need for working capital changes with volume of sales (higher sales require more money to be owed), that s why it is useful to focus on index WC/S (working capital/sales). Table 2. compares the development of a firm s indebtedness and WC/S index. Table 2 Correlation between indebtedness and WC/S index of selected firms Firm indicator Correlation 2010 coefficient Arcelor Mittal indebtedness 20% 12% 15% WC/S index 70% 110% 118% -0,85 Železárny Veselí indebtedness 84% 70% 66% 65% 68% WC/S index -40% -13% -3% 0% -1% -0,98 Moravia Steel indebtedness 57% 48% 43% 46% 48% WC/S index 1% 3% 4% 2% 3% -0,82 Třinecké železárny indebtedness 28% 26% 22% 20% 31% WC/S index 13% 10% 12% 14% 18% 0,38 Vítkovice Heavy Machine indebtedness 62% 60% 66% 58% 58% WC/S index 14% 24% 15% 27% 46% -0,71 ŽĎAS indebtedness 39% 44% 44% 34% 30% WC/S index 26% 29% 29% 32% 35% -0,75 If we use correlation between both time series, we can see a strong negative correlation between indebtedness and WC/S index (except for Třinecké železárny - a specific case). What complicates the interpretation of these data is the fact that WC/S index represents the period of a time, while indebtedness represents the state in time. It is difficult to say whether lower indebtedness suggests an increased need (not state of ) for WC or a better controlled need for WC is easier way to use loans. Working capital management is definitely an essential component of obtaining good credit conditions. 2.3 Controlling tools for working capital management Management of WC (as an important component of obtaining good credit conditions) makes it necessary to use appropriate controlling tools in relevant time horizon. Terms of financing must be configured in a way that corresponds to its core business. Metallurgical firms share these common attributes: - stable higher proportion of fixed assets,

5 - a stable structure of costs, - a small possibility of rapid adaptation of pruduct portfolio, - dependence on commodity markets. Small overall flexibility of core business creates higher need for solving operating financing. Financing has to be optimized for long run (not only for short run as was mentioned in the introduction of this article). If firms were to focus on optimization of need for WC, it would be necessary to concentrate on the components, which cause this need. The definition [9] of the need for WC can be expressed as follows need for WC = cash turnover cycle * average daily expenses (1) If we modify this formula, we can express it as thus need for WC = (stock+ trade receivables trade payables) * daily expenses/ daily sales (2) need for WC = needed NCWC * expenses /sales (3) From formula (3) it is clear that the need for WC can be minimized in two ways - minimizing the ratio expenses/sales, i.e. maximizing profit margin (it is a direct indicator of basic prosperity of firm) which means maximizing EBITDA, - minimizing needed NCWC, i.e. the sum of capital in a form of inventories and the net receivables and payables. Net receivables and payables should be balanced for the long term, especially in industry with dominant B2B trading. For a firm s financing it is favourable to use the so called supplier credit, i.e. superiority of payables over receivables (especially with no other fees). Table 3 illustrates that there is no stable equilibrium between payables and receivables (especially in terms of variation rate). Table 3 Equilibrium between payables and receivables before maturity Firm Variation rate Arcelor Mittal % Železárny Veselí % Moravia Steel % Třinecké železárny % Vítkovice Heavy Machine % ŽĎAS % Firms must monitor capital bound in form of inventories and its consumption or transformation into sales. Table 4 Stock/consumption ratio Firm Variation rate Arcelor Mittal 21% 20% 22% 3% Železárny Veselí 20% 16% 19% 25% 12% 23% Moravia Steel 47% 36% 34% 32% 30% 16% Třinecké železárny 19% 18% 19% 20% 22% 7% Vítkovice Heavy Machine 20% 35% 31% 45% 36% 24% ŽĎAS 47% 67% 56% 68% 59% 13%

6 The whole industry achieves much better results in the area of inventories management (see in Table 4.), the coefficients of variations are quite low in this time period. All the aforementioned facts do not mean that firms haven t excess of inventories and could not reduce its overall level. However, the deficiency in balance between payables and receivables is obvious and firms should seek tools for its management. There are few fields of interest that the firms would focus on: - tools for reducing receivables bound in firm i.e. - monitoring maturity and observance of receivables, - providing incentives for acceleration of payments (discount), but for carefully considered conditions (discount must not burden EBITDA too much), - monitoring and using of deferred payment (this must not decrease firm s credibility for suppliers), - the setting of receiving advances from customers, - continuously monitoring and evaluation of balance between payables and receivables in short and long term, i.e. - not only application of local and global manage but plans of creating operating cash flow too. 3. CONCLUSION Firms need to think in long term, because even short term financing parameters cannot be changed immediately. It is possible in normal economic situation, but it is connected with higher expenses and in time of crisis these expenses even increase. The efficiency of bound capital is monitored as a creditors index. If the working capital of management is poor, firms get under double pressure. The result is a higher bound of capital under worse financial conditions. Both increased expenses and creditors pressure limit the decisions of executives and owners, reducing the firms long term prosperity. That s why firms need to consistently and continuously use specific tools for efficient working capital management. BIBLIOGRAPHY [1] MIKOVCOVÁ, H. Controlling. Dissertation thesis. Praha: VŠE, s. [2] KISLINGEROVÁ, E. et al Nová teorie ekonomiky a managementu organizací a jejich adaptační procesy (New Theory of Economy and Management in Organizations and Their Adaptation Processes). Survey of Faculty of Business Administration, University of Economics, Prague, September s. [3] SCHOLLEOVÁ, Hana, ŠVECOVÁ, Lenka, FOTR, Jiří. Criteria for the Evaluation and Selection of Capital Projecta. Intellectual Economics, 2010, roč. 1, č. 7, pp [4] HYNEK, J., JANEČEK, V.: Rozhodování o investicích do vyspělých technologií. In: Vědecké spisy FES Univerzity Pardubice: Aktuální problémy teorie a praxe v ekonomice, Univerzita Pardubice, 2/2007, pp [5] MONKS, R.A.G, MINOW, N. Corporate governance. John Wiley and Sons, s. [6] Český statistický úřad, datasets available online at [7] Ministerstvo spravedlnosti ČR, datové soubory hospodaření metalurgických firem available online at www. justice.cz [8] available online [9] KISLINGEROVÁ, Eva, aj. Manažerské finance. 3. vyd. Praha : C.H.Beck, s.