TOCICO

Many organizations that are declaring significant profits can also get into severe financial problem if their cash availability is squeezed. Growth in sales, and even profits do not necessarily increase cash availability. In fact, most organizations get into cash squeeze in their attempt to increase sales and profits. No company gets closed because it is not making money. Instead it is forced to close when it runs of cash! Enron, Kingfisher, Jet Airways, Bhushan Power and Steel, Alok Industries are some of the well-known organizations that were forced to close as they did not had adequate cash to fulfil their financial commitments. Cash flow is impacted primarily by two parameters – Profit after tax (PAT), and changes in working capital. While senior management does understand the impact of sales, and costs, often they are unaware of the impact of increased working capital. In the current environment of high input material costs along with supply chain uncertainties, inventories have increased in money value very significantly for most organizations. However, companies have been declaring bankruptcy for a very long time much before the spread of COVID-19 and resultant supply chain disruptions. What could be the possible common reason for most these organizations? Ravi Gilani dares to say that the root cause for this is the erroneous assumption that profit is the correct measure of making money. In 2001, just a month before the collapse of Enron, its Chairman Kenneth Lay, CEO Jeffery Skilling, and CFO Andrew Fastow did not know that Enron will run out of cash in a matter of weeks (Conspiracy of Fools, Kurt Eichenwald). If we ask the CEO of any company what the Goal of their company is, often we get one or more of the following responses: Grow exponentially (10X in 5 years), Become world class, Become globally competitive. One common stated or unstated assumption for the above is that company must have economies of scale. It translates into increasing sales volume / market share through expanding geographical footprints, or through introduction of new products and services etc. Another common assumption is that the company must source additional capital from outside sources for investing in new plant, & machinery, adding new product lines, developing new markets etc. This webinar shares in detail the cause-and-effect relationship on cash squeeze for focusing exclusively on increasing profits by ignoring the increase in capital investment & working capital. The right measurement for making more & more money must fulfil the following criterion: It must be independent of accounting policies, and practices, It should be easily understandable by all the employees, Improving this measurement must ensure longevity of the organization. Current Financial Measurements for 4M: Generally accepted measures for making money are: PAT (Profit After Tax), ROCE (Return On Capital Employed), FCS (Free Cash Flow). Out of the above three financial measures, both profit and ROCE are quite dependent on the accounting policies of the company. A few examples-policy for revenue recognition, policy for valuing WIP (Working In Process), and FG (Finished Goods). FCS is comparatively more robust. Though it cannot not be influenced by the accounting policies, yet it can be increased by delaying the payments to suppliers towards the end of accounting period. FCS is impacted both by investment in plant & machinery, and changes in Working Capital (Inventory + Account Receivables less Account Payables. However investment in plant & machinery is done in a very planned and infrequently. However changes in working capital happen almost every day. A new operating parameter OFCS (Operational Free Cash Score) meets all the three criterion of making more & more money. It is defined as increase or decrease in the cash in the bank + all decrease in supplier payable. Or OFCS = Profit + Deprecation + Reduction in Accounts Receivables Reduction RM + Reduction in WIP+ Reduction in FG + Reduction Supplier Payable. Since Profit = T-OE, hence OFCS = T-OE + Depreciation + Reduction in Accounts Receivables + Reduction in RM + Reduction in WIP+ Reduction in FG + Reduction Supplier Payable. Out of the above 8 parameters, OE, and Depreciation do not vary significantly from week to week or even month to month. Hence people can focus on increasing T and reducing all other above parameters. One caution - people need to look at all the above parameters in totality and not in isolation. Harmful effects of current financial measurements, Operational Free Cash Score (OFCS), Harmful practices preventing growth for OFCS, Actions to achieve growth in OFCS.