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Benchmarking For Working Capital Strategies

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Benchmarking for Working Capital Strategies

Many companies seek to differentiate themselves and achieve success primarily through new technologies or unique product or service offerings. Companies that apply best practices go beyond this by gaining competitive advantage through stronger and more efficient internal business processes. The role of cash management can vary greatly from one company to the next, making an apples-to-apples benchmark comparison of how corporations collect, disburse and invest cash an arduous task. Good to excellent businesses frequently attempt to optimize their company's cash management function by incorporating best practices to reduce external financing cost, lower bank charges, minimize risk and manage long- and short-term liquidity.

These companies approach working capital management with a goal to lower costs and free up resources for investment and growth. They take full advantage of myriad opportunities to strengthen cash flow and cash budgeting, settle payments quickly, reduce working capital liabilities, negotiate favorable payment terms with suppliers, establish clear accountability in accounts payable and receivable, increase the value of collections personnel, and gather better information to support strategic decision making for long term opportunities (Murray, 2006).

Working capital optimization is inherently complex, as it touches many business processes and people within an organization. It is a balancing act, and companies must manage it carefully to ensure that they optimally employ their working capital and have the critical resources they need to do things like fund product development, produce and deliver their products, and provide high levels of customer service. The ability to impact the bottom line through working capital optimization is tremendous. For this reason, this paper will focus on key best practices for improving financial effectiveness in the realms of optimal working capital management that leading companies use today.

General Electric: Hedge and Swap Strategies reduce risk.

General Electric (GE) evolved from Thomas Edison's home laboratory into one of the largest companies in the world. With 11 main divisions located throughout the world General Electric is often adversely affected by global business and economic conditions, such as fluctuations in interest and currency rates or downturns in employment and economic conditions. To effectively manage these risks GE employs a cash-flow hedging strategy to offset the variability of expected future cash flows. For example, if GE Capital Services (GECS), the corporation's primary issuer and guarantor, borrows at a variable interest rate to fund a financial services' initiatives, and another division, GE Commercial makes a fixed rate loan to cover a planned net present value project, then GE will contractually commit to paying a fixed rate of interest to a counterparty who will pay back GE with a variable rate of interest ("GE 2004 Annual Report", 2005). Otherwise known as an interest rate swap, this instrument is widely employed at GE as a cash-flow hedge for the associated variable-rate borrowing. GE also uses interest-rate swaps as fair-value hedges to eliminate risk of changes in the fair values of assets, liabilities and certain types of firm commitments. Authors Brealey, Myers and Allen (2005) report that the market for swaps is currently in such demand that in 2003 the total notional amount of swaps outstanding was about $120 trillion in the United States and the major part of this figure consists of interest rate swaps.

GE's 2004 annual consolidated financial statement notes that the firm must meet specific criteria in order to apply various forms of hedge accounting. Although GE uses caps, floors, collars, and option contracts as an economic hedge of changes in interest rates, currency exchange rates and equity prices on certain types of assets and liabilities, the firm identified that hedge accounting is not permitted for hedged items that are marked to market through earnings ("GE 2004 Annual Report", 2005). GE only uses derivatives to hedge exposures when it makes economic sense to do so as noted in the 2004 Consolidated Report (2005).

To further mitigate credit risk, GE has entered into collateral agreements that provide the right to hold collateral when the current market value of derivative contracts exceeds an exposure threshold. Essentially, GE will arrange to receive Treasury Bills or other highly rated securities to secure the firm's exposure to counterparty default ("GE 2004 Annual Report", 2005). The most common credit derivative is known as a credit default swap and the buyer of a credit swap receives credit protection, whereas the seller of the swap guarantees the credit worthiness of the product ("Credit-Default Swap", 2006). The trend in the United States is going in the direction of credit default swaps, especially for pension funds or money managers, according to Calio (2006) who writes that CDS contracts, including notional amounts, are expected to grow to $15 trillion in 2006.

Cisco: Technology obtains best practices in working capital managemen.

Cisco has long been recognized as a pioneer in using technology for its own business practices, offering consulting services to help other organizations around the world through its Internet Business Solutions Group. Cisco utilizes their technology to optimize their capital money management.

In the 2006 fiscal year, Cisco saved US$3.1 billion by relying on their technology to provide customer support, offer employee services, sell products, provide training, and manage finances and manufacturing processes. Each year, Cisco introduces new applications, enhances existing applications, and increases adoption of these applications across the company, which results in an incremental return on investment year-after-year (Part IV, 2004).

Cisco uses its technology to manage the collection and disbursement of cash. Cisco does not waste time tracking delinquent invoices and rekeying invoice information. As a best practice Cisco leverages information systems to automate or eliminate steps in invoice processing. These systems include optical character recognition technology, imaging and workflow systems; electronic data interchange (EDI), web-based technologies, and electronic invoice-matching systems. With more reliable partners, Cisco even chooses to eliminate the invoicing process altogether by practicing evaluated receipts settlement, an agreement to pay the supplier and for their customers to pay them for products and services based on pre-approved blanket orders rather than invoices. Days sales outstanding



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