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
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 .........................................................................................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
 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

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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

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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.

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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.
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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
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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
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
5 people who are managers and experienced employees at THM was target for indepth interview and ratio analysis combined with Dupont model will be executed.

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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.

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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
Customer

THM response

Customer response

Extend time intentionally
Face difficulty of business,
Green Land

although they have capacity to
department cannot sell out
pay
Still not finished collecting
Pay slowly to use cash to

Viet Do

their account receivable to
continue generating their business

pay THM
The settlement discount is
not attractive. Since
company has many
Not frequently press customer
departments so they need

Sai Gon Topaz pay debit on time and customer
more time to check,
delayed payment
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

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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
2014

2013

2012

2011

Accounts receivable

6,300,090,088

8,624,257,077

9,228,399,034

12,156,451,169

Sales

26,441,898,754

34,229,467,210

50,348,740,377

83,873,256,871

Sale on credit

15,691,555,213

20,840,975,616

29,150,598,951

47,074,803,226

% AR/Sales on credit

40.1%

41.4%

31.7%

25.8%

% decrease AR

-48%

-29%

-24%

100%

% decrease sales

-68%

-59%

-40%

100%

(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
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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.

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THM days of accounts receivable over fiscal year, from 2011 to 2014 can be
calculated as following:
Table 4: Receivable Turnover ratio
2014

2013

2012

2011

2.10

2.33

2.73

4.32

169

152

131

82

Receivable Turnover
ratio
Days of accounts
receivable
(THM, 2015)

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.

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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

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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
Year

2014

2013

2012

2011

DOP

319.06

399.87

232.93

87.49

Payable turnover ratio

1.12

0.89

1.53

4.07

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

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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
Type product

2014

2013

2011

2010

Interior (can)

3500

2600

2985

1523

Exterior (can)

2126

1350

2351

1690

(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
Year

2014

2013

2012

2011

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

I/COGS

200.76

146.17

183.42

112.13

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(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

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Nweze (2011) says that inventory turnover is computed by dividing the cost of goods
sold by the average inventory. An average inventory is determined by adding the
beginning and ending inventories and dividing by two. The decline in the inventory
turnover indicates the stocking of more goods. An attempt should be made to
determine whether specific inventory categories are not selling well and the reason
for this. Emekekwue (2005) argues that stock turnover ratio seeks to identify the
length of time that stock is held as inventory before it is converted to cash. In
organizations where stocks are perishable, holding of large stock is very costly to the

business. However, if stock is not the perishable type, delays in disposing stock might
be profitable during inflationary period. It must be appreciated that sales will be
valued at cost; this is because the stock will be valued at cost. If the sales were not
valued at cost, then we shall be over stating the ratio. Moreover, one will be
comparing two incomparable i.e. the sales figures and the cost of stock. Furthermore,
the inventory turnover ratios measures the average number of days for which stock is
held. It helps to assess the efficiency of stock utilization. Various factors affect the
stock level help by the organization such as product, production-seasonal or
otherwise, demand pattern, competition, funds availability.
This measure efficiency of using inventories and control them, this is should be high
will lead to hold up product also should not be very low. The THM inventories can
be calculated as below:

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