Posts Tagged ‘cash flow management’

Many of our clients have exposure to foreign currencies within their yearly business cycle, but do not utilize the array of foreign exchange tools that are available to manage the risk of fluctuating currency values and the profits associated with those risks. Net Exporters hope for a weak Canadian Dollar in order to maximize revenues from foreign currency sales. Net Importers hope for a strong Canadian Dollar to keep input costs low. There are even clients who need to buy fx for certain parts of the year and then sell fx for other parts of the year. Managing the foreign exchange risk can make the difference between a good and bad year for many of our clients.

The three main tools used for managing foreign exchange needs are:

1. Spot purchases
2. Forward contracts
3. No Cost Forward Collars

These tools are ranked by most often used, but not necessarily in importance. If you are not familiar with more than one type of tool, you may be adding risk and losing profits to your enterprise unnecessarily.

Spot purchases are most familiar to most Canadians. A simple example is when you are planning a trip to the USA, you first visit your local bank and buy an amount of US dollars (in cash or travellers cheques) that you will need and hope that the exchange rate is “good”. The teller looks up the exchange rate , say 1.20, applies the rate to the amount of US funds you need, and then takes your hard-earned Loonies to pay for the exchange. When you get back from your trip, you take your left-over greenbacks to the bank and exchange them back to Loonies, at a rate of say 1.15. The spread between the buy and the sell rate represents the transaction cost for you and a profit for the bank. It is a very convenient method if you have an immediate need for foreign currencies. However, for businesses, you are giving up future fx rate predictability in exchange for today’s convenience. You may be adding risk to your profits unnecessarily.

Forward contracts allow you to choose and lock in an exchange rate at some point in the future. This can be a great method for businesses to lock in profits associated with the exchange rate. Say you get a $100,000 purchase order from a US customer today for shipping in 90 days. This is a good customer who does pay within 30 days. You know that you will receive US$100,000 90-120 days from today. Instead of risking that the exchange rate will be in your favour 90-120 days from today, you can lock in a rate by purchasing a forward contract that will come due 90-120 days from today. And here’s the best part: you can use the forward contract as a risk mitigator by contracting for less than 100% of the expected revenue. You can buy a contract for (say) half the expected amount and spot purchase the other 50%, thereby reducing your fx risk and increasing your known profits today.

The down side of a forward contract is that you must purchase the amount of money by the time the contract expires, whether you need the money or not (orders do get cancelled or delayed). That is why most businesses do not forward contract for 100% of their needs.

No cost forward collars are the least known fx tool to SME businesses. To put it in simple terms (that’s how I like things, generally), it is a forward contract with an exchange range instead of a single point. Your fx broker will buy for you offsetting buy and sell contracts for the same future date that you specify. The difference between the buy and the sell now becomes your fx range. The range will generally increase the further out you get from today’s date.

At that future date there are three possible scenario:
a) The spot exchange rate is somewhere within your fx collar range. The two contracts cancel each other out (at no cost) and you purchase your fx needs at the spot rate. You have effectively managed your fx and your profits within an acceptable range.
b) The spot rate is below your low point collar. You will have to fulfill the low point contract, thereby giving up a small amount of profit vs. the spot rate, but adding a small amount of profit from what would have been the rate of a straight forward contract due on the same day.
c)The spot rate is above your high point collar. You will have to fulfill the high point contract. If you do not need the money, you can sell it back at the higher spot rate and make a trading profit. If you need the money, you will be pleased to have locked in a higher profit than what a straight forward contract would have given you.

Take a second look at your foreign exchange needs and cycles to see if you can utilize these tools to manage your profits upwards and bring your risks down.

Northbridge Consultants are here to assist you throughout the year in managing your profits through SR&ED and general business consulting.

In times of recession, many companies cut down on costs.  But unless you’re facing bankruptcy, cutting costs may come at the cost of sacrificing future sales.  For instance, to make the bottom line look better, you could always downsize R&D efforts.  This may make the current quarter look more profitable.  However, the lack of R&D may hurt you several years down the road, when you have no new products to introduce, and your existing products are nearing the end of their product life cycles.

To follow are several suggestions on how to improve the propspects of your company, and increas cash flow, WITHOUT sacrificing the future well being of your company.

1. Reduce Accounts Receivables

This is not the time to have leniant AR collection policies.  Collecting sooner will free up your AR and increase your company’s cash flow.  Offer small discounts to your debtors, to encourage them to pay sooner.

2. Reduce inventory- go lean!

Unecessary inventory can tie up the bulk of your cash flow.  The worse type of inventory is work-in-progress (WIP).  Ideally, you should aim to have ZERO WIP because not only does WIP tie up cash flow, but they also CANNOT be liquidated, because they are not a finished product.  Finish WIP products as soon as possible.  Because only finished products can be converted into cash. Secondly, order raw materials just in time, when you need them.  Having raw materials sit around costs you money!

3. Invest in operations management

As a business professor of mine once said: “Operations management is not the most exciting field of business.  However, it is the one area of business that you have complete control over.”

You will not be able to increase sales through operations management.  However, increased operational efficiency can free up cash flow by increasing throughput and reducing inventory.  The faster you can get orders out the door, the more cash you can collect.

Analyze your business process and identify bottlenecks.  Make operational changes on bottlenecks only.  If it’s not a bottleneck, then why should you care?  (changing a non-bottleneck will not improve your throughput).  Suggested reading: “The Goal” by Dr. Eliyahu M. Goldratt.

4. Take advantage of tax subsidies

The government can lend a helping hand to business, when economies go south.  The problem is, not many companies take advantage of government subsidies!  One example of a subsidy that is not well know, is the SR&ED program (i.e. Scientific Experimentation and Experimental Development).  This tax program provides companies with an opportunity to seek a reimbursement of up to 35% of their R&D costs.  This can be a huge source of cash flow for your company!

You shouldn’t be pannicking just because there is a recession.  Instead, recessions are great times to investigate improved internal efficiencies.  Now is the time to focus on investigating ways to improve your free cash flow.