Solutions To Reduce Cash Conversion Cycle At Thm., Ltd Company.pdf

UNIVERSITY OF ECONOMICS HO CHI MINH CITY International School of Business Nguyen Thi Kim Hue SOLUTION TO REDUCE CASH CONVERSION CYCLE AT THM , LTD COMPANY ID 22130025 MASTER OF BUSINESS ADMINISTRATION[.]

UNIVERSITY OF ECONOMICS HO CHI MINH CITY

International School of Business

-

Nguyen Thi Kim Hue

Special thanks to members of THM Company for cooperating, supporting and providing necessary information regarding this thesis

My thanks and appreciations also go to my group mates who have cooperated with me to complete this thesis and classmates who have willingly helped me out with their abilities

Finally, I must express my very profound gratitude to my parents and to my spouse, for providing me with unfailing support and continuous encouragement throughout my years of study and through the process of researching and writing this thesis This accomplishment would not have been possible without them

CONTENT

INTRODUCTION 1

EXECUTIVE SUMMARY 4

1 PROBLEM IDENTIFICATION 5

1.1 Problem Symptom 5

1.2 Tentative Problem 7

1.2.1 First tentative problem 7

1.2.2 The second tentative problem 13

1.1.3 The third tentative problem 19

1.2.4 Ratio analysis and Dupont Model 25

2 ALTERNATIVE ANALYSIS AND CHOICE OF ALTERNATIVES 34

3 ACTION PLAN 41

4 SUPPORTING INFORMATION 46

REFFERENCE 49

APPENDIX 53

List of tables

Table 1: THM ROA and ROE

Table 2: Customer response about slow payment Table 3: Overall THM account receivable

Table 4: Receivable Turnover ratio

Table 5: Payable turnover ratio

Table 6: THM inventories classify

Table 7: THM inventories consolidated

Table 8: Inventories turnover

Table 9: THM sale revenue

Table 10: THM cash conversion cycle

Table 11: THM current ratio/quick ratio

Table 12: THM Asset turnover

Table 13: THM financial leverage ratio

Table 14: THM profit

Table 15: The solution assessment procedure

INTRODUCTION

These days, the economic difficulty has affected significantly to development and profitability of Viet Nam companies In a competitive market with hundreds company were born each day, with the same service, products, maintaining sales and innovating product to satisfy customers play an important role in the development process of entrepreneur Besides, company financial management decision has affected significantly to their performance that working capital management is an important component of this

THM., Ltd company is running business as a 1st level agent of paint firm Dulux and Jotune, distributing the paint products to main customers, those are departments and the 2nd level painting agencies in HCM City

 Company name: Cong ty TNHH Thuong mai va xay dung The He Moi

THM capacity: 4.000.000.000 VND

Staffs: 1 general director, 1 accountant, 1 warehouse manager, 1 sale leader and 20 staffs

Company structure:

(THM,2014)

In 2011, revenue of company achieved nearly 84 billion with 2 types of above clients From the starting of 2012, the painting firms wanted THM., Ltd focus to develop distributing toward only departments with the expect return 1000 billion revenues each year for this segment, so THM trended to cut the distribution for the

2nd level agencies in HCM city Unfortunately, the freeze of real estate affected significantly to the business of THM., Ltd, sale went down dramatically and create a bad prospective, inventories increase for department segment and lack of the product for agency revenue decreased accompany with profitability through fiscal years until

now In addition, the account receivable ware also high so THM had lack of money

to generate and pay to supplier

The board of director faced too many difficulties to find out the way that can improve THM situation, achieving the target sale that paint firm appointed 50 billion revenues per year instead of 26 billion at current The sale growth also needs to be increased 30% per year, according to Dulux and Jotune put target to THM So in order to achieve requirement

of these 2 big firms, THM have to face hardest dilemma to maintain the sale and control profitability since they have to pay quite high cost inventories

The results of previous study revealed that firms with shorter cash conversion cycles (CCCs) seem to outperform the other firms included in their sample in terms

of profitability In recent years, the cash conversion cycle has become an increasingly popular tool for analyzing a firm’s cash management According to Haskin, 2013, cash conversion cycle for a manufacturing company can be defined as a function of [days of accounts receivable + days of inventory – days of accounts payable] The length of cash conversion cycle is used to measure the impact of accounts receivable, inventories and payments to supplier on the firm’s profitability, cash conversion cycle assist in measuring the performance and current assets management of the firm’s (Uyar, 2009)

Since it represents the number of days a firm's cash remains tied up within the operations of the business at THM, we have recognized that CCC is also a powerful tool for assessing how well THM is managing its working capital and the lower the cash conversion cycle, the much healthy finance a company generally become

Studies on this relationship have consistently found that more efficient cash conversion cycles lead to higher small firms (Garcia Teurel and Martinez Solano, 2007) These findings lend credence to cash conversion cycle as an important management tool that warrants further investigation, especially at the small firm level Understanding the important of cash conversion cycle that affected by account receivable, inventories and sale revenue were reasons of decrease profitability, we have selected THM Company for our result since THM is a kind of small company with simple managing structure

EXECUTIVE SUMMARY

This study target to analyze factors influence the profitability of THM by using the existing relevant study theories and information from in-depth interview to suggest feasible ways to help to enhance and control the profitability

After interviewing the directors of THM and executives in other painting enterprises, we found out some key factors could influence the THM profitability that are relation to the cash conversion cycle, an effective tool to measure working capital management in organization The information will be supporting by ratio inventories turnover, account receivable, account payable, sales trend analysis, and assess THM situation by comparison with the previous year to validate the result from interview

The next step should be explored ratio analysis and Dupont model, we mention some other ratio to validate the situation of THM with more comprehensive assessment and finding was assessed relevant and match up with the finding from in depth- interview above

After receiving the finding from in depth- interview and ratio analysis from secondary data of Financial department, three main causes were assessed to be relevant to long cash conversion cycle that make profitability decrease over fiscal year: account receivable policy, the planning to manage inventories and the strategy

to increase sale in short- time and long- term and solution for THM are the ways to reduce cash conversion cycle based on 3 that main incident

Solution was suggested based on the basically recommendation from previous relevant theories, the ratio analysis in comparison average industry ratio combined with recommendation from THM stakeholder The first are how much shortening the account receivable turnover should be and the way to collect them efficiently Secondly, how much balance inventories turnover should be and the way to manage them more exactly and finally are some recommendation to boost sales revenue that

is proper with THM capacity

1 PROBLEM IDENTIFICATION

1.1 Problem Symptom

Profitability is the primary goal of all business ventures All companies need

to get more profit and develop sustainable in competitive environment Profitability

is measured by a few accounting ratios, such as return on equity (ROE), return on capital employed (ROA) (Kay 1976 and 1986) And here we also suggest using 2 these ratios to measure the company’s profitability of THM., Ltd

Looking back at the balance sheet and income statement in 4 fiscal years from

2011 to 2014, we found out the net income and revenue of THM have decreased

dramatically, from nearly 84 billion VND down to nearly 26,5 billion VND ROA and ROE of the firm was extremely low in comparison to the industry of construction materials In 2014, although the industry ROA and ROE ratio recovered and increased to 3% and 10%, respectively, THM’s ratios still felt sharply This situation has made THM managers try to research a best way to enhance their profit and cut loss as soon as possible

The ROA and ROE became negative below over 4 years as below:

Table 1: THM ROA and ROE

Here are some potential causes that directly affect from decrease to negative of

profitability The approach to study the problem is most likely based on qualitative

method especially in-depth interview and ratio analysis combined with Dupont model from the secondary data of the income statement of Finance Departments Sample of

5 people who are managers and experienced employees at THM was target for in-

depth interview and ratio analysis combined with Dupont model will be executed

1.2 Tentative Problem

1.2.1 First tentative problem

According to Ms Nguyet, general director of THM, she said that “THM

Company had not enough cash to operating business, the cash receivable collected was not enough to give payment to supplier each month” We always have a gap from cash account receivable and account payable, since customer mostly intended to delay them whereas Dulux and Jotune still keep their payment policy” If increase credit, we can get risk to collect account receivable, if reduce it, we can decrease sale target that firm appointed, so hard to make decision” Ms Nguyet also complain that

the account receivable increase dramatically so she tended to limit the credit for their clients

When was asked about this problem, Ms Ngan, financial controller believed that the account receivable affected to the cash conversion cycle of company, this

lead to the profitability consolidated decreased each fiscal year “Customer frequently

pay debit note us very slow and we are facing hard to collect account receivable”

When was asked about the policy to create debit note, she said that “THM has no

their own clearly policy, we just based on the belief at frequent customer and we had

no plan to verify them before selling as a bank, the belief is based on debt history of each customer, who pay enough in the past will be acceptable to debit for the upcoming period Some customer has debt up to 6 months to 12 months and cannot make payment on time

Following with this problem, we have a small survey with 3 large customers

of THM and THM manager to clarify some potential causes to explore the reason why they pay slowly as below:

Table 2: Customer response about slow payment

Green Land

Extend time intentionally although they have capacity to pay

Face difficulty of business, department cannot sell out

Sai Gon Topaz

Not frequently press customer pay debit on time and customer delayed payment

The settlement discount is not attractive Since company has many departments so they need more time to check, confirm and assess all invoices before make payment

(Survey, 2015)

So there are subjective and object reasons relation to the schedule pay cash of THM’s customer Actually, mostly general customers want to delay their debit note

so they can use that money to generate their business as well as THM also need to pay slower to Dulux and Jotune although THM will have a settlement discount about 1% total payment from the seller whereas the seller (paint firm) consist debit note of THM, that’s 30 days from the days they sign the sale contract and THM still always pay it within 30days

Actually, a research of manufacturing of 4226 manufacturing SMEs

companies in Italia of Muscettola, 2014 showed that the positive relationship

between accounts receivables and firm’s profitability So the more account

receivable balance, the low profitability becomes

Refer to the account receivable ratio below over 4 years, ratio AR/Sales on credit increase significantly has been calculated:

Table 3: Overall THM account receivable

(THM’s Financial Statement from 2011-2014)

- The account receivable ratio analysis

Leahy (2012) sees debtors’ turnover ratio as accounts receivable variable that measures the impact of a company’s credit function on profitability This impact

includes the risk associated with extending credit He adds that the higher the ratio of accounts receivable to sales, the greater the manufacturer’s profitability Otherwise, there would be no reason for the company to provide this function

Nweze (2011) argues that debtor’s ratio consist of debtors turnover and the collection period The debtor’s turnover gives the number of times debts are collected during the years The turnover is found by dividing net credit sales (if not available, then total sales) by the average debtors Average debtors are found by adding the beginning debtors to the ending debtors and dividing by two The higher the debtor’s turnover, the better company is collecting quickly from customers These funds can then be invested for a return The drop in the debtor’s turnover ratio is significant, indicating a serious problem in collecting from customers Therefore, a careful analysis of the company’s credit policy is required

The average collection period, or the number of days sales remain with debtors

is found by dividing the debtor’s turnover into 365 days The higher collection period indicates a danger that customers’ balances may become uncollectible Perhaps the company selling to highly marginal customers - a customer whose credit worthiness

is very much in doubt Chandra (2008) says that debtors’ turnover ratio shows how many times sundry debtors (accounts receivable) turnover during the year

This ratio indicated us the way THM controlling credit sale, this is low reflect not good for company Accounts receivable is short-term amounts due from buyers

to a seller who have purchased goods or services from the seller on credit

THM days of accounts receivable over fiscal year, from 2011 to 2014 can be calculated as following:

Table 4: Receivable Turnover ratio

This ratio indicate that account receivable transfer from 4.32 in 2011 to 2.1 in

2014 means that average 84.4 days company can collect account receivable, this number is based on credit policy of THM, the circle low reflex an ineffective capital use is tie-up much, the circle high reduce competition and affect to revenue

Compare with the previous year, THM faced harder and harder to collect debit note from customer

In comparison with another companies in the same industry in website cophieu56.com consolidated 2014, this number is around 50-60days, this showed that THM need to urgently reduce day account payable as soon as possible

Account payable

The payment period to Dulux and Jotune depends on their credit policy, and it fluctuates from 30 to 45 days, and THM always expect to expand this time period as long as possible

Leahy (2012) argues that creditors’ velocity is designed to capture the effect

of borrowing on the profitability of a company It also measures the manufacturer’s ability to negotiate the term of purchases The impact of this variable on profitability depends upon how the business in financed If the manufacturer has to borrow to make up for accounts payable, then the higher the ratio of accounts payable to cost of goods sold, the lower the expected profitability If, on the other hand, the business is financed through retained earnings, then the higher the ratio of accounts payable to cost of goods sold, the higher the expected profitability if the cost of using retained earnings is less than the cost of borrowing

Account Payable ratio

Ms Nga- Accountant said that “We have not negotiated with firm to request

any delay payment since we thought that they will not accept us Moreover, I think that is consistent for every agent”

Okwuosa (2005) says account payable day is average number of times creditors’ turnover is paid within a year High creditors’ turnover ratio indicates that the company is not taking advantage of credit facility and this may result in loss of profit as a result of interest on borrowed funds or bank overdraft needed to meet up

On the other hands low creditors’ turnover ratio indicates that the company is not taking advantage of any discount associated with prompt payment and this may lead

to increase in their cost of sales and consequently decrease in their profit Therefore,

a company should ensure that its creditors’ turnover ratio is neither too high nor too

low The creditors’ turnover is calculated by dividing Credit purchases by Average creditors

THM Accounts receivable is listed as a current asset on the seller's balance sheet

Table 5: Payable turnover ratio

This circle 2014 is 1.12 matched up with 319 days to make a circle whereas this number in 2011 is 4.07 correlatives with 87.49 days in 2014, the number in 2011

is quite good since THM can delay time to make payment for firm This number is suggested to enlarge so that can achieve like 2013, according to Ms Yen, financial controller of THM

To sum up, high account receivable turnover and decrease payable turnover can be one of main reasons lead to cash conversion circle longer than usual which is make profit decrease And the factor affect to account receivable is relation to credit policy that relevant to the time and skill collection planning, verify customer procedure to make debit note of THM so THM need to balance at a suitable number with the suitable action Besides, the time to pay supplier also consider to negotiating

1.2.2 The second tentative problem

The THM operation director, Mr Tuan shared that the THM inventories is so

high at current, they faced difficulty to boost they out the stock “Some product is on

storage even 3 months and cannot put out since have no order although company has discounted to pay” Another staff who is in charge with managing inventories said

that that “we are holding so much paint can with old label and it seen that the label

change quickly depends on the season” The inventories cost will increase in fiscal

year Since asked about this problem, he revealed that “At THM We had no plan to

classify product and forecast the quantity for the upcoming season since we have not enough staffs to handle the stock activities and therefore me and 1 current staff sometime have over workload and cannot cover all the necessary working” This lead

to sometimes we there’s lack of a product line to sale”

Actually, the inventories for each product line as below:

Table 6: THM inventories classify

(THM, 2015)

Actually, THM is in the excess inventories situation and they have been facing

to find out the way to push the inventories until now The table below indicated the status of inventories over 4 years:

Table 7: THM inventories consolidated

Inventory 15,055,117,494 13,112,068,742 24,176,924,545 24,448,027,340

COGS 25,605,589,897 32,742,950,564 48,110,417,764 79,584,299,862

(THM’s Financial Statement from 2010-2014)

In general, efficient or inefficient management of inventories is only one factor that may influence firm performance - Koumanakos, D P (2008) And THM need to balance a suitable inventory to keep going business, Mr Tuan considering The question of how much inventory a firm should keep has been extensively studied but there is dichotomy in the views given that inventory is both an asset and a liability Too much inventory consumes physical space, creates a financial burden, and increases the possibility of damage, spoilage and loss Further, excessive inventory frequently compensates for sloppy and inefficient management, poor forecasting, haphazard scheduling, and inadequate attention to process and procedures In this context the lean production principle pioneered by Womack et al (1990) has been linked with reduced level of inventories (Rajagopalan and Kumar, 1994; Herer et al., 2002; Wickramatillake et al., 2006) even if volatility of demand may limit the application of this principle On the other hand, too little inventory often disrupts manufacturing operations, and increases the likelihood of poor customer service In many cases good customers may become irate and take their business elsewhere if the desired product is not immediately available Nearly all the literature on optimal inventory management uses criteria of cost minimization or profit maximization An inventory managers’ goal for example, is modeled as minimizing cost or maximizing profit while satisfying customers’ demands

- The inventories turnover ratio analysis