Cash flow & inventory management - Nissan
Quite in-depth, but anyone who wants to look at how a real MNC handled a liquidity problem during the 2008/9 downturn, this tells a very full story. Very useful as an example in long answer questions:
Source: http://www.nissan-global.com/EN/IR/INSIDE/INSIDE-SP/FCF/index.html
In the latter half of FY 2008, Nissan, like other global companies, faced three challenges- the financial crisis, severe economic downturn and volatile exchange rates. However, Nissan continued investing and developing its brand, products and technologies, so that the company would be prepared for the post-crisis period and future.
Nissan focused on free cash-flow management to address not only the current economic climate but also the major shifts occurring in the automotive industry, as a result of global environmental issues.
As the cash flow statement reports the usage and generation of cash, balances do not change when a sales contract is made. Figures change only when cash is actually paid or received, as shown in red below. Even if a company reports profit on the income statement, there is a possibility that it cannot survive due to insufficient levels of cash. To identify these risks, the cash flow statement is important.
The cash flow statement consists of three different activities as noted below:
- Cash provided by operations (the excess of cash receipts over payments), a company's core activities.
Cash expenditures
ex.) Payment for the purchased cost of parts used in vehicle production/ payment of employee salaries.
Cash receipts
ex.) Receiving payment from the sale of vehicles and replacement parts.
(2)Cash flow from investing activities
- Cash provided by or used in investing activities including the sale of assets.
Cash expenditures
ex.) Payment for the purchase of facilities used in vehicle production.
Cash receipts
ex.) Payment from the sale of facilities and real estates, no longer in use.
- Cash provided by or used in financing activities including debt raised and repaid for operating and investing activities.
Cash expenditures
ex.) Debt repayment/ bond redemptions / dividend payments.
Cash receipts
ex.) Increased borrowings/ fund raising from bond issuance.
Of these three activities, the combined total of "(1) Cash flow from operating activities" and "(2) Cash flow from investing activities" constitute "Free Cash Flow".
A positive free cash flow means that a company is able to raise the necessary funds for investment through its own operating activities. Furthermore, the company is able to repay debt and pay dividends with excess cash. In contrast, when free cash flow is negative, a company is unable to raise the necessary funds itself. As a result, the company may need to incur additional debt through loans or bond issuances to cover their investment needs. If free cash flow remains negative for the long term, a company's fundraising ability will be limited. Therefore, the company may have to forego necessary investments, which in turn could negatively impact its future competitiveness.
If Nissan fails to respond, as stated in Part 1, the company will have little choice but to sacrifice its future and reduce its investment in integral projects such as the environment and emerging markets. Therefore, Nissan is committed to its focus on free cash flow management, as evident in various measures.
Nissan's business is comprised of the automotive division and sales finance division. Generally, the automotive business is responsible for the manufacturing and sale of vehicles. The sales finance business generates interest income and supports automobile sales by offering consumer financing, including automobile loans and leasing, to the car buying public.
At the end of FY 2008, the asset values for the automotive division and sales finance division were approximately 5.6 trillion yen and 4.6 trillion yen, respectively. Major assets in the automotive business include manufacturing facilities, raw materials and completed products. Assets for the sales finance business consists mainly of customer loans and leased vehicles. Assets in each business differ widely.
The sales finance business is essential for the automotive industry as it assists customers purchase cars through financing. As previously explained, both businesses are considerably different in content and assets are, often times, managed separately. Therefore, the explanation on free cash flow, in the next section, is specific to Nissan's core business, the automotive business.
-Extracts from FY 2008 Financial results document (Kessan Tanshin)-
To curtail spending, Nissan reduced its labor cost. Executive compensation and annual salaries for managers were cut. Overtime was eliminated and work sharing was introduced for regular employees. Concurrently, the total number of employees decreased through retirement, the introduction of a voluntary transition program and natural attrition. In high-cost countries like Japan, North America and Europe, labor cost has been controlled by curbing new hires to the minimum.
At the beginning of FY 2009, Nissan stated that it will reduce labor costs by twenty percent in high-cost countries and fixed costs, including labor costs globally, by over 200 billion yen compared to the previous year.
In FY 2008, capital expenditures decreased to 383.6 billion yen from 516.4 billion yen in FY 2007. This was achieved by the company's decision to reduce the number of new models slated under its previous plan. The new model launch plan is now based on a streamlined product lineup. Furthermore, each project is analyzed to determine their necessity and relevance. With these continued efforts, the company will control capital expenditures below 2008 levels in FY2009.
Regardless of when products are sold, cash expenditures are inevitable, as a company pays money to suppliers for necessary parts or services and to employees for salaries and wages. Therefore, cash goes out, even when unsold products are in inventory and cash is not coming in.
Cash is necessary for maintaining inventory and when inventory increases, more cash is needed to reduce them. This falls into a vicious cycle. In contrast, if inventory is reduced, money owed to suppliers is decreased and discounts or incentives is restrained. This can contribute in the generation of positive free cash flow.
In response to the decline in global TIV in FY 2008, Nissan reviewed its production levels and sharply reduced production at its vehicle and powertrain plants all over the world. By implementing non-production days and shorter work hours, the company was able to ensure an appropriate level of inventory. Consequently, the company's global production was reduced by 20% or 772,000 units compared to the initial plan. Inventory was considerably reduced. Specifically, inventory had reached its peak of 720,000 units in November 2008 and then dropped to 470,000 units in March 2009, which was a 26% decrease compared to the end of FY 2007. This reduction in inventory improved free cash flow by 354.5 billion yen for the three month period from the end of December 2008 to the end of March 2009.
To achieve positive free cash flow, the company will continue to place strict controls on its inventory levels and optimize production and sales. However, the company also remains focused on its core business, selling vehicles. Certain markets have exhibited strong demand, such as China and those countries with government purchase subsidies. For those markets, production will be maximized, so as to not lose out on sales opportunities.
The company believes that positive free cash flow is an important driver for an increase in its credit rating and resumption of the dividend. Company-wide efforts to improve free cash flow are underway, as exhibited by a monthly free cash flow committee. This meeting is attended by those parties in the budget control division, responsible for free cash flow, for their respective regions around the world.
Source: http://www.nissan-global.com/EN/IR/INSIDE/INSIDE-SP/FCF/index.html
Nissan focused on free cash-flow management to address not only the current economic climate but also the major shifts occurring in the automotive industry, as a result of global environmental issues.
Part 1: What is Free Cash Flow?
The statement of cash flows is one of three financial statements, along with the balance sheet, the income statement. The cash flow statement reports the cash receipts and payments of a company during a period.As the cash flow statement reports the usage and generation of cash, balances do not change when a sales contract is made. Figures change only when cash is actually paid or received, as shown in red below. Even if a company reports profit on the income statement, there is a possibility that it cannot survive due to insufficient levels of cash. To identify these risks, the cash flow statement is important.
The cash flow statement consists of three different activities as noted below:
(1)Cash flow from operating activities
- Cash provided by operations (the excess of cash receipts over payments), a company's core activities.
Cash expenditures
ex.) Payment for the purchased cost of parts used in vehicle production/ payment of employee salaries.
Cash receipts
ex.) Receiving payment from the sale of vehicles and replacement parts.
(2)Cash flow from investing activities
- Cash provided by or used in investing activities including the sale of assets.
Cash expenditures
ex.) Payment for the purchase of facilities used in vehicle production.
Cash receipts
ex.) Payment from the sale of facilities and real estates, no longer in use.
(3)Cash flow from financing activities
- Cash provided by or used in financing activities including debt raised and repaid for operating and investing activities.
Cash expenditures
ex.) Debt repayment/ bond redemptions / dividend payments.
Cash receipts
ex.) Increased borrowings/ fund raising from bond issuance.
Of these three activities, the combined total of "(1) Cash flow from operating activities" and "(2) Cash flow from investing activities" constitute "Free Cash Flow".
A positive free cash flow means that a company is able to raise the necessary funds for investment through its own operating activities. Furthermore, the company is able to repay debt and pay dividends with excess cash. In contrast, when free cash flow is negative, a company is unable to raise the necessary funds itself. As a result, the company may need to incur additional debt through loans or bond issuances to cover their investment needs. If free cash flow remains negative for the long term, a company's fundraising ability will be limited. Therefore, the company may have to forego necessary investments, which in turn could negatively impact its future competitiveness.
Part 2: Nissan Focus on Free Cash Flow Management
As previously mentioned, Nissan, along with the automotive industry, faces three major challenges:- - Financial crisis
- ...Limited fundraising options, along with increased funding costs.
- - Severe economic downturn
- ... Sharp reductions in sales and average selling prices.
- - Volatile exchange rate
- ... Due to the appreciation in the Japanese yen, sales of Japanese exports in overseas markets have decreased. Furthermore, values are diminished, when profits (based in foreign currencies) from overseas subsidiaries are converted to yen.
If Nissan fails to respond, as stated in Part 1, the company will have little choice but to sacrifice its future and reduce its investment in integral projects such as the environment and emerging markets. Therefore, Nissan is committed to its focus on free cash flow management, as evident in various measures.
Nissan's business is comprised of the automotive division and sales finance division. Generally, the automotive business is responsible for the manufacturing and sale of vehicles. The sales finance business generates interest income and supports automobile sales by offering consumer financing, including automobile loans and leasing, to the car buying public.
At the end of FY 2008, the asset values for the automotive division and sales finance division were approximately 5.6 trillion yen and 4.6 trillion yen, respectively. Major assets in the automotive business include manufacturing facilities, raw materials and completed products. Assets for the sales finance business consists mainly of customer loans and leased vehicles. Assets in each business differ widely.
The sales finance business is essential for the automotive industry as it assists customers purchase cars through financing. As previously explained, both businesses are considerably different in content and assets are, often times, managed separately. Therefore, the explanation on free cash flow, in the next section, is specific to Nissan's core business, the automotive business.
-Extracts from FY 2008 Financial results document (Kessan Tanshin)-
Part 3: Nissan's Actions in FY 2008 and FY 2009
Despite the three challenges mentioned, it is possible to achieve a positive free cash flow position. This section provides detail on Nissan's actions in FY 2008 and FY 2009.(1)Expense reductions
When cash is not expected from sales and profit, it is necessary to reduce cash expenditures, particularly expenses and capital expenditures, in order to achieve positive free cash flow.To curtail spending, Nissan reduced its labor cost. Executive compensation and annual salaries for managers were cut. Overtime was eliminated and work sharing was introduced for regular employees. Concurrently, the total number of employees decreased through retirement, the introduction of a voluntary transition program and natural attrition. In high-cost countries like Japan, North America and Europe, labor cost has been controlled by curbing new hires to the minimum.
At the beginning of FY 2009, Nissan stated that it will reduce labor costs by twenty percent in high-cost countries and fixed costs, including labor costs globally, by over 200 billion yen compared to the previous year.
In FY 2008, capital expenditures decreased to 383.6 billion yen from 516.4 billion yen in FY 2007. This was achieved by the company's decision to reduce the number of new models slated under its previous plan. The new model launch plan is now based on a streamlined product lineup. Furthermore, each project is analyzed to determine their necessity and relevance. With these continued efforts, the company will control capital expenditures below 2008 levels in FY2009.
(2)Inventory reduction
Generally, a company maintains a certain level of inventory, so that it does not lose out on sales opportunities and can quickly deliver products to customers. However, if a company misreads future demand and produces more vehicles than the market needs, the company is saddled with unsold products and excess inventory. As a result, a company risks product obsolescence and deterioration in quality, as it takes longer for these products to be sold. Moreover, excess costs are incurred, as discounts and incentives are needed to move these unwanted products. As such, excessive inventory is disadvantageous for a company.Regardless of when products are sold, cash expenditures are inevitable, as a company pays money to suppliers for necessary parts or services and to employees for salaries and wages. Therefore, cash goes out, even when unsold products are in inventory and cash is not coming in.
Cash is necessary for maintaining inventory and when inventory increases, more cash is needed to reduce them. This falls into a vicious cycle. In contrast, if inventory is reduced, money owed to suppliers is decreased and discounts or incentives is restrained. This can contribute in the generation of positive free cash flow.
In response to the decline in global TIV in FY 2008, Nissan reviewed its production levels and sharply reduced production at its vehicle and powertrain plants all over the world. By implementing non-production days and shorter work hours, the company was able to ensure an appropriate level of inventory. Consequently, the company's global production was reduced by 20% or 772,000 units compared to the initial plan. Inventory was considerably reduced. Specifically, inventory had reached its peak of 720,000 units in November 2008 and then dropped to 470,000 units in March 2009, which was a 26% decrease compared to the end of FY 2007. This reduction in inventory improved free cash flow by 354.5 billion yen for the three month period from the end of December 2008 to the end of March 2009.
Part:4 Conclusion
Based on the above mentioned efforts, Nissan is focused on achieving a high-level of positive free cash flow, while continuing its investment and development of new core technologies for the future, such as the electric vehicle (EV) and global compact car. The company also aims to reduce its automotive net debt (387.9 billion at the end of FY 2008) and move to a net cash position as soon as possible. The company's business is proceeding well, as a result of the prompt, increased focus on free cash flow management in response to the downturn.The company believes that positive free cash flow is an important driver for an increase in its credit rating and resumption of the dividend. Company-wide efforts to improve free cash flow are underway, as exhibited by a monthly free cash flow committee. This meeting is attended by those parties in the budget control division, responsible for free cash flow, for their respective regions around the world.
Comments
Post a Comment