Solutions to reduce cash conversion cycle at THM , LTD company

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 SUPERVISOR: DR PHAM PHU QUOC Ho Chi Minh City – Year 2016 ACKNOWLEDGEMENT This thesis becomes a reality with the kind support and help of many individuals I would like to extend my truthful thanks to all of them Foremost, I would like to express my gratitude and sincere thanks to my advisor, PhD Pham Phu Quoc for his guidance, imparting his knowledge and expertise my study 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 PROBLEM IDENTIFICATION .5 1.1 Problem Symptom 1.2 Tentative Problem 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 ALTERNATIVE ANALYSIS AND CHOICE OF ALTERNATIVES .34 ACTION PLAN 41 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  Tax code: 0302696827  Head office: No 229, Tan Ky Tan Quy street, Tan Son Nhi Ward, Tan Phu district, HCMC  Phone: 0835367276 Established from 1999, THM supply paint Product including: interior and exterior line, as well as primes, brushes and rollers product line Ms Nguyen Thu Nguyet is a managing director at present From time to time, THM has built up the relationship between agencies and Construction Company to meet the customer demand THM capacity: 4.000.000.000 VND Staffs: general director, accountant, warehouse manager, sale leader and 20 staffs Company structure: (THM,2014) In 2011, revenue of company achieved nearly 84 billion with 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 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 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 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 these ratios to measure the company’s profitability of THM., Ltd Looking back at the balance sheet and income statement in 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 years as below: Table 1: THM ROA and ROE 2014 2013 2012 2011 THM Net income -252,311,429 -45,377,948 26,389,069 1,185,546,709 THM ROA -0.9% -0.1% 0.1% 2.6% ROA of industry 3.0% 0.0% 2.0% 4.0% THM ROE -9.7% -1.7% 1.0% 45.6% ROE of industry 10.0% 2.0% 6.0% 13.0% Source: All of the data above is gathered from THM financial report from 2011 to 2014 and the average ratio is cited from cophieu68.vn, 2015 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 people who are managers and experienced employees at THM was target for indepth interview and ratio analysis combined with Dupont model will be executed Benefit Cost Increase sale can be recover profit, Pressure for THM as they have to hire cover cost and push quickly inventory an effective sales and training them, it New customers can help THM recovery will take time and more cost the sale targets and give THM a chance Pressure for sales to seek potential to expanding market customer with frequent order Take more cost to contribute a new channel All of three alternatives directly affect to profitability of company In fact, the EOQ model is quite complicated with THM and THM also has not enough capacity about human and technique to assess So It can be a solution in in a long- term department At present, THM need to focus on the left alternative and concentrate to planning as well as control and assess all the managing activity to ensure the god result for the upcoming year For the recovery the sale channel of THM, it is assessed not feasible since ms Nguyet thought that they’ve lost that customer at that segment for a long time, so THM will not consider this recommendation ACTION PLAN I believed that all the alternatives above are necessary for THM at current except the EOQ model should be considers in future to match up week company capacity In order to enhance the performance, THM need to set up a specific strategy 41 to achieve the goal that company set up And for each alternative, they also use a proper resource in the suitable time so that they can reduce cost and increase gross profit margin Action plan for the alternative 1: To decrease the account receivable 20% in 2015 and collecting account receivable efficiently It will take one year (from 2014 to 2015) to decrease 20% account receivable by limited the debit to customer 20% All the customer has been verified between buying product in account receivable and for customer has debt more than year will be removed The accountant staff under guidance of financial controller have to send the invoice to supplier on time, often on the end of each month and all the payment must be done after 15days from day release invoice since customer need time to check and make reference In case they cannot collect, need to consider the reason of slow payment If the payment delay over months with the objective reason, such as customer forgot or face difficulty with their client, accountant need to arrange it in a warning list If they delay more than months, the first thing THM need to reminder customer by phone per weeks with the polite attitude Offer a 2% discount rate for settle payment for each customer to encourage they accelerate to make payment This rate is higher than the 1% at present but equal with the other company with the same scale This will be reduced the profit per unit but THM can boost sale to increase the gross profit margin after then The rate 3% 42 can be considered if at that month THM achieved the sale target of paint firm, this is because the commission will increase 6% and THM can use 3% to give to customer Each months, accountant staff can call or email or visit accountant at customer’s company, this activitie is very limited at present and THM can send some gift- giving for them to maintain a good relationship In addition, THM representative, such as general director or financial controller can negotiate with a goodwill payment to expand the time to collect cash from THM It should be 90 days instead of 60days at present Some supplier still used this times to collect and they still using cash efficiently such as Dupont or Nippon, and also share the mission and strategic to develop of company in globalization period Action plan for alternative Since Ms Nguyet need to reduce inventories in next year 15% however to ensure the product out market, we recognized she need to maintain at 20% matched with increase 30% revenue 2015 For the current inventories, THM should be discount a little about 2% on sale to push the old label product This is because on this discount rate, THM still cover the cost of goods sold, and the discount rate not acceptable to excess this rate as some competition has discount more than 9% and mix some fake materials on each can THM are building relationship and build their brand with enhance the reliable so they cannot discount so much so that make customer misunderstand 43 In the long- term, the operation director – Mr Tuan need to control the suitable balance inventories by some proper activities The first step, statistic about the inventories situation from 2011 to 2014, the quantity of old label product and submit to sale department to make the plan to sale Inventories staffs also need to classify the product including new product, product with old label, kind of product, reason of long inventories to submit sale department and sale representative need to make plan to chase inventories situation This report should be issue each month in the same time with sale representative For the upcoming season, THM should balance an inventories around 10 billion VND so that they can sale and has enough product on their store to supply market These target will link with 10000 boxes that revenue and profit at that time achieved around billion VND expectedly For the next year, the balance will depend on the increase of sale target that Dulux and Jotune imposed Forecast of customer demand based on season, trend and kind of apartment should be also focus to provide a proper quantity Action plan for the alternative 3: The human resources department are in charge to contribute the sale team by hiring more sales to seek potential customer The sale should have experience in paint industry and has achieved the sale target in the past Time to recruitment is around months, training weeks and probation period months And after that time, they are required to achieve the target of increase 30% compare with 2014 From this target, we forecast each sale have to seek at least customers that can bring 44 THM a revenue equal with the current customer And hopefully THM can cut loss at this revenue THM Sale representatives also are trained monthly to improve skills, all the problem should be gather and present in monthly meeting After year, THM put higher target 30% to meet the firm requirement To enhance the competitive and attract customer: As designing displays, THM can choose engaging color, decor and stock arrangements Good displays appeal to both the head and the heart of customers CONCLUSION In conclusion, it is not well defined, finally, the relationship between aggregate cash conversion cycle and corporate profitability If THM is able to sell the inventory and collect the receivables it is all they need to get a good efficiency and corporate solvency Therefore, to recover the profitability and develop more in the upcoming year, THM clearly improve all the ratio that they are not good in comparison with the same company in paint industry 45 SUPPORTING INFORMATION Interview process (Transcript) The research takes about 15 days from time we approached THM company As interviewing about business situation, we get some feedback that they are in difficult cases More detail: I am reaching out to you for helping with my research on decrease profit incident My name is Kim Hue and I am a Master’s degree student at ISB I wish to gather information on reason of low profit of THM I would appreciate your participation in my research  Respondent: General Director – Ms Nguyet - How is THM income summary in 2014? “THM did not achieve company goal since inventories made up more than 30%, many debit note has not been collected, whereas payment period for supplier is limited Cutting sale channel (agent 2nd level) lead to not feasible of sale development from 2011 to 2014” - Did your company finance situation extremely hard? “The difficulties also come from the sale discount payment that company need to immediately pay commission for their customer, this applies for their customer is 30-40% for 2nd level agent whereas this figure is 5% for department segment whereas the condition that they have to achieve target on monthly and yearly so that they could receive sale commission from paint firm, its depend on the detail promotion program firm offer matched up week every period in year This sale discount agreement 46 among parties including THM, their customer and paint firm permanently made THM lack of a temporary part of amount cash that they have not still take it back, given this payment method THM will be deficient cash to generate business, the circle of money so fast made them fall to stuck and have to make a loan to keep going business Hence, she has been intended to narrow business and reduce the credit sale, as well as plan to make term with Dulux and Jotune expanding time to to pay their debt”  Respondent: Mr Tuan_ operation director - How about THM inventory situation? “I believed that the problem at hand show that an excess inventories, this make THM does not work as well as before To go back to the way they were, inventories kept in a balance that they can control Average monthly, THM have to pay storage fee nearly one hundreds VND per year, mostly outside product” - Comparison with from 2011 to 2013, is this different? It quite different as the number of inventories turnover is descending over year  Respondent: Mr Nam - Sale manager Responsibility: - Create a daily record of sales and receipts - Generate invoices and statements on a recurring basis - Track current and overdue balances on customer accounts “The change frequently of paint label to satisfy the predilection of clients is one of tremendous reason make inventories stagnant as customer just only interested in new 47 label and afraid of product with the old look, although the quality is the same, this problem is relevant to marketing department of company that I have to change every time per company request, Beside, the sale is based on the believe customer and have not tool for make reliable ladder to adjust ability to pay debt, so the collect face hard difficulty, more detail from 2001 to 2014”  Respondent: Ms Hang – Financial controller “I believe that they see unbalance with big gap between time to collect cash and make payment and they face difficulty to summarized all in income statement The paint firm also maintained the time to collect account payable 30 days so they have to accelerate to push debit note to finish, but it not easy It has negative effect on company profitability as they summarize every month and set up a financial plan”  Respondent: Mr Tien – general director of Nam Cuong company “When were keep going to we interview Nam Cuong painting company, the company has their own same scale with THM, he told me despite of difficult business, still high inventories but Nam Cuong redouble to push sale by expanding net-working to sale and using financial leverage that mean increasing using debt instead of equity to increasing profit”  In An Phong company, “We quite agreed with maintaining all ratio to ensure their profitability at billion/year For cash conversion circle, they suggest a negative value to maximization profit over fiscal year” 48 REFFERENCE Charitou, M., Lois, P., & Santoso, H B (2012) The 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manufacturing firms Journal of Economics and International Finance, 5(9), 373-379 Mehar, A (2005) Simultaneous determination of inventories and accounts receivable Managerial and Decision Economics, 26(4), 259 52 APPENDIX Appendix 1: Income statement of THM Unit: VND Items 2014 2013 2012 Revenue from sales and 26,441,898,754 34,229,467,209 50,348,740,377 services 11,771,663 Depreciations 2011 83,873,256,871 64,704,160 Net revenue from sales and 26,441,898,754 34,217,695,546 50,284,036,217 services 83,873,256,871 25,605,589,897 32,742,950,564 48,110,417,764 79,584,299,862 Cost of goods sold Net income from sales and services 836,308,857 1,474,744,982 2,173,618,453 4,691,687 6,353,922 13,643,320 99,534,130 299,831,043 449,712,166 584,626,898 Selling expenses 492,249,759 786,082,349 1,129,376,456 1,177,971,708 Administrative expenses 501,528,084 440,563,460 514,300,083 1,089,332,090 -252,311,429 -45,377,948 93,873,068 1,437,026,313 Revenue activities from 4,288,957,009 financial Financial expenses 10 Net income from business activities 11 Other revenues 61,886,318 12 Other expenses 13 Other net income 14 Net income before taxes 0 -61,886,318 -252,311,429 -45,377,948 31,986,750 1,437,026,313 5,597,681 251,479,604 26,389,069 1,185,546,709 15 Tax 16 Net income after taxes -252,311,429 53 -45,377,948 Appendix 2: Balance sheet of THMC Unit: VND ASSETS 2014 2013 A -Current assets 2012 2011 36,331,973,260 43,465,677,887 1,333,853,168 4,914,810,672 - - 28,399,207,109 31,104,656,317 I Cash and cash 6,680,845,994 9,143,524,331 II Short-term investment - - 6,310,737,088 8,624,257,077 9,228,399,034 12,156,451,169 6,300,090,088 8,624,257,077 9,228,399,034 12,156,451,169 - - 24,176,924,545 24,448,027,341 1,592,796,513 1,946,388,705 equivalents III Accounts receivable Accounts receivable from customers Other accounts 10,647,000 receivable Allowance for - - doubtful accounts IV Inventories V Other current assets 15,055,117,494 13,112,068,742 352,506,533 224,806,167 B - Long-term assets 520,705,069 317,050,726 Fixed assets 317,050,726 556,824,894 391,505,110 391,505,110 TOTAL ASSETS 28,716,257,835 31,496,161,427 54 520,705,069 556,824,894 36,852,678,329 44,022,502,781 LIABILITIES AND 2014 2013 2012 2011 A Liabilities 25,203,378,910 27,730,971,074 33,040,742,551 40,967,034,059 I Current liabilities 25,203,378,910 27,730,971,074 31,490,742,551 40,967,034,059 Current liabilities 1,400,000,000 1,851,864,235 5,383,846,256 1,550,000,000 Accounts payable 23,803,378,910 25,528,383,192 23,916,561,891 38,341,448,660 350,723,647 390,334,404 75,585,399 1,800,000,000 1,000,000,000 1,550,000,000 - EQUITY Taxes and payable to state budget Other current liabilities II Long-term liabilities B - Equity Paid-in capital Undistributed - - 3,512,878,925 3,765,190,353 3,811,935,778 3,055,469,722 2,600,000,000 2,600,000,000 2,600,000,000 2,600,000,000 912,878,925 1,165,190,353 1,211,935,778 455,469,722 28,716,257,835 31,496,161,427 36,852,678,329 44,022,503,781 earnings TOTAL LIABILITIES AND EQUITY 55 ... 6,3 0 0,0 9 0,0 88 8,6 2 4,2 5 7,0 77 9,2 2 8,3 9 9,0 34 1 2,1 5 6,4 5 1,1 69 Sales 2 6,4 4 1,8 9 8,7 54 3 4,2 2 9,4 6 7,2 10 5 0,3 4 8,7 4 0,3 77 8 3,8 7 3,2 5 6,8 71 Sale on credit 1 5,6 9 1,5 5 5,2 13 2 0,8 4 0,9 7 5,6 16 2 9,1 5 0,5 9 8,9 51 4 7,0 7 4,8 0 3,2 26 % AR/Sales... 7: THM inventories consolidated Year 2014 2013 2012 2011 Inventory 1 5,0 5 5,1 1 7,4 94 1 3,1 1 2,0 6 8,7 42 2 4,1 7 6,9 2 4,5 45 2 4,4 4 8,0 2 7,3 40 COGS 2 5,6 0 5,5 8 9,8 97 3 2,7 4 2,9 5 0,5 64 4 8,1 1 0,4 1 7,7 64 7 9,5 8 4,2 9 9,8 62... indicated as below: 19 Table 9: THM sale revenue 2014 2013 2012 2011 Sales 2 6,4 4 1,8 9 8,7 54 3 4,2 2 9,4 6 7,2 10 5 0,3 4 8,7 4 0,3 77 8 3,8 7 3,2 5 6,8 71 Sale on credit 1 5,6 9 1,5 5 5,2 13 2 0,8 4 0,9 7 5,6 16 2 9,1 5 0,5 9 8,9 51