VIEWPOINT: CORPORATE AFFAIRS

M&A:

Financing: Organisational Lifeblood

The Indian economy should gather steam over the next 12-18 months as it seeks to revv beyond 7% growth. In the long run, the India opportunity is undeniable for the size of its consumer market and the related lack of penetration. That said, rising inflation and continued volatility in global financial markets will find repercussion in India in the near term as funding and liquidity remain challenged, particularly for small and medium enterprises that are in turn, key parts of vendor eco systems.

Available resources appear huge – ranging from private equity at one end to the bond markets at the other end but the fact is that an exceeding narrow pool – the 1% of firms that are AAA-rated, and the 5% that are AA-rated – account for 86% of the bond market, and for the lion’s share of bank credit. Little capital remains for anyone else. India’s NPA-heavy banking system is very risk-averse and markets volatile. The hype of 10% GDP growth prospects is now relegated to what it is – hype - and investors today look unfavourably on over-leveraged balance sheets and the right balance is key.

At the other end of internal accruals, margins themselves are challenged both on account of a value-conscious consumer in a market that is only just beginning to add back pricing power, and on account of aggressive supply chains that seek to extract value. Cash then, remains a precious commodity and working capital an area of continued focus in any business, but most so for those with scale. Unlike previous eras of slowly returning growth, cash is indeed available with the end-consumer, but decision-making is slow, and payouts slower. Margin protection is then a function much more of very severe cost competitiveness to drive better cash flows than increasing bargaining power in the market.

Focusing on the core…

The incumbent priority of the CFO in this environment is to concentrate on the creation of healthy balance sheets, to focus the business categorically on core areas, filtering away those non-core and potential cash drags on the system. Whilst decision making on what comprises core (and therefore worthy of investment) is a result of the risk appetite of individual firms, the fact is strong financial acumen needs to marry with the ability to carry along multiple stakeholders in the journey towards financial excellence. Regulatory challenges such as fast changing norms by multiple regulators (SEBI, RBI – and now a new IBC) are a wider context that must also be borne in mind (changed FPI limits on investments in corporate bonds put at peril investments that were just being on-boarded in a number of firms recently). Once ag ain, this brings home the necessity of identifying internal areas of waste – and therefore potential accrual – that might be left on the table.

…and yet, encompassing a wider eco-system

In this operating context, the big callouts for the CFO go beyond this prioritisation of core business and ensuring its funding. CFOs will need to fund both growth and ongoing operations through a mix of external financing and internal accruals, with new, innovative modes in both. In addition, large vendor and dealer eco-systems will need to be protected as we hope for an upside risk to growth. Financing for India’s best firms includes the ability to fund both ends either directly or through standing guarantor for finance companies – or indeed, acting as bridges between them. Technology is the big game changer on this score.

Most firms that are members of IMA’s CFO Forum are already high up the value chain on financial acumen. Excellence is however a moving target and internal systems must be reviewed continually to identify areas of improvement.

Know your market

Finance office capability to understand end markets is fundamental to identifying current avenues of cash and margin and even more, those that will emerge in the future. IMA surveys suggest that most CFOs spend more than 20% of their time with customers/dealers. This needs to be expanded to the finance team at large, strongly leveraging Finance business partners and using technology to feed back both intuitive and data-based knowledge on markets and their viability. Future Group for example, closely leverages its multiple brands and price points to identify cash in systems in the immediate term, and to understand the extent of leverage – and needed funding, in the medium term. External engagement by the CFO and the Finance top team engagement is therefore key, as is the ability to use technology in order to drive medium-term strategy on the plinth of cash flows and margin.

Leverage scale…

Too often, a bane most of all, of large firms, is the inability to leverage size to advantage. This is a challenge as much of vision as it is of the lack of information availability. Topline of a certain size, for example, when visualised five years out, will appear very different, and more often than not in the case of firms in India, very powerful. Procurement and partnership teams must be able to visualise the total quantum of goods being negotiated and pricing arrived at with that context. Future Group uses scale as both a bargaining chip and a driver of internal change. Currently, the Group buys and sells goods worth Rs 750 billion (~USD 12 billion) a year, and spends Rs 10 billion on marketing and Rs 5 billion on power. By getting its people to think of themselves as the ‘captains’ of cost in each of these areas, it encourages them to negotiate better – seizing money that would otherwise get left on the table – or find new ways to cut overheads. Patience can be a key individual trait here, as businesses get co-opted into a vision of higher efficiencies and lower bottomlines.

…and synergies, both internal and external

It is equally crucial to leverage synergies both internal and external. This goes much beyond the common mantra of shared services and finds the greatest resonance in production most of all. M&M is today aligning its tractor and utility vehicle lines; and taking advantage of the fact that as much as 60-70% of the parts inside these vehicles are common – allowing for the use of common vendors. It is also consolidating its logistics and warehousing – transporting four tractors in a bigger truck, for instance, rather than two in a smaller one – and at a more micro-level, pushing up the share of fixed-term to permanent employees. Systemic improvements have a direct correlation to wealth creation. Reviewing sunk cost elements like warehousing is also key and again, the understanding of external markets and the planned growth prospects is key. The CFO is the final arbiter in many ways, and sits at a unique juncture of access to group level knowledge. That is a competitive weapon and must be wielded as such. At Future for example, the CFO has driven a consolidation of warehousing to serve both its Big Bazaar stores and the 5,000 fair-price shops in Rajasthan that it is working to upgrade, via the PPP route, in partnership with the state government.

Consolidate, and support, external (internal) eco-systems

Firm after firm in India is looking to leverage economies of scale externally, both to gain greater visibility into receivables and quicker access. To enable an ideal world of inventory backed by payables with zero receivables to ensure working capital that is off the balance sheet, risk is being concentrated in 10-12 large business partners/agents as opposed to multiple-thousand dealers by numerous firms. This is complemented by vendor consolidation already accelerated by GST in order to drive cost advantages.

Build a culture of cost accountability and capital generation

Future has, across the length and breadth of the organisation, inculcated a culture of thinking in terms of ROC, working-capital minimisation, and market-cap maximisation. Right down to the store-manager level, individual KPIs are now linked to ROC. Clearly, this must find its bedrock in the right internal structures that are a mix of empowerment and control – freedom to operate the business, but with strategic checks in the system that ensure the right balance. This is fundamental in a widely-spread business with global supply chains. Future Group for example, has an inventory of over 60,000 SKUs, 50% of which is food with a limited shelf life. A vertically aligned team in HQ manages inventory but the decision-making is highly decentralised. ‘Money taps’ are kept in check at the centre but within that overall allocation, regional managers have every freedom to take decisions.

Create the right benchmarks

CFO ability to create the right framework in the context of which business can chase growth is equally fundamental. Every line item must be reviewed and its outlook forecasted. M&M for example, seeks to identify core spend areas such as steel as input, and oil prices as driver of end demand for autombiles within defined time frames. Total purchase at a certain ratio of purchase price is then a good benchmark that operating businesses can use, but it will need the forecast, and the benchmark within which to operate. Equally, if costs are forecast upwards by a certain percentage, it becomes easier important to identify other areas that will offset the hit to the bottomline.

Use Future-focused technologies

India’s leading firms are leveraging technology hugely in order to support supply-chain finance, both to ensure vendor and dealer solvency and uninterrupted business flows. Technology is a huge enabler. Using a single portal, for example, M&M is able to do everything from tracking dealers’ inventory levels to predicting (albeit within a range) how much of what model it will sell, right down to the village level. It also knows exactly where the raw materials it requires are located at any point in time, and what stage each task is at. The moment a bill is raised, dealers are able to accept it on the portal. Banks are also linked to the portal, allowing for effective floor financing. Critically, since vendors and dealers are able to benefit from M&M’s stronger credit rating – after all, banks know that they are either supplying to, or buying from, a solid, reliable organisation – their inventory costs come down. All in all, the increased transparency of the system allows lower cost and improves supplier and dealer viability.

Free up working capital

In the view of Sandy Kemper, Chief Executive of working capital firm C2FO, businesses hold some USD 45 trillion of accounts receivable (AR) on their books at any given point globally, but there is just USD 3-4 trillion of liquidity available to fund that need. Each year, this shortfall, in terms of not being able to get capital in a timely fashion to those who need it most, is estimated to cost the world economy USD 4-6 trillion, and the Indian economy USD 100-150 billion. Regulation, including the requirement to allocate capital against risk-weighted assets, is perhaps the biggest constraint, but firms like C2FO are working to overcome this by reducing the role of financial intermediaries. Today, C2FO is the world’s largest non-bank provider of working capital, with over 200,000 customers, and over 1 billion invoices processed each month. Its aim is to enable transparency between the AP and AR sides of the equation, and allow for direct price discovery between those in the capital chain who need capital (suppliers), and those who have it (buyers).

Using such systems allows businesses to disintermediate themselves and yet not carry risk. The premise behind such a system is that, with bigger firms in particular, once an invoice gets entered into the system, it is not a question of whether, but when, the payment will get made. Average payment cycles range from 90-100 days in India and 120-180 days in China, to just 45-60 days in America. A price-discovery system allows suppliers to fund their working capital needs more cheaply, while allowing buyers to earn higher, risk-free yields on their surplus cash – all by electronically matching the two sides, and incentivising movements of capital between them. Buyers end up paying slightly less by releasing funds sooner than they otherwise would, while on the flip side, a supplier who needs money urgently accepts a slightly smaller amount. Crucially, by not requiring any third-party (banks) to underwrite the process, it strengthens supply chains. The vast pool of data generated by the system offers another crucial set of advantages: insights into the credit-worthiness of small- and mid-sized firms, which are typically outside the purview of credit ratings; and solid, forward-looking predictive indicators on their performance. In time, this can allow smaller firms to access other types of finance, at reasonable rates, to which they might otherwise have had little or no access.

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The contents of this paper are based on discussions of The India CFO Forum in Mumbai with Sandy Kemper, Global Chief Executive of C2FO, K Chandrasekar, EVP- F&A at Mahindra & Mahindra, and Sanjay Jain, Group CFO of Future Group in Mumbai in May 2018. The views expressed may not be those of IMA India. Please visit www.ima-india.com to view current papers and our full archive of content in the IMA members’ Knowledge Centre. IMA Forum members have personalised website access codes.