Methods of Working Capital Optimization of Global Petroleum Companies Before and After Economic Crisis on the Example of ExxonMobil and Chevron

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GOVERNMENT OF THE RUSSIAN FEDERATION

NATIONAL RESEARCH UNIVERSITY

HIGHER SCHOOL OF ECONOMICS

FACULTY OF WORLD ECONOMY AND INTERNATIONAL AFFAIRS

MASTER OF INTERNATIONAL BUSINESS PROGRAM

MASTER THESIS

Topic: “Methods of Working Capital Optimization of Global Petroleum Companies Before and After Economic Crisis on the Example of ExxonMobil and Chevron”

Moscow 2019



Introduction

Working capital is a very important business management tool, which shows the effectiveness of the operating activities of the company and its short-term financial health. The term working capital has been discussed mane times in the wide variety of literature, but still there would be a lot of explanations.

Nowadays it is essential to understand a vital role of working capital for all the business organizations and future entrepreneurs in order to make wise decisions on short-term financial needs of the business.

In the upcoming pages of this master thesis, working capital would be discussed both in theoretical and practical ways. Several previously done articles by different researches would explain the term Working capital, its types and significance.

The main interest and motivation to study this topic are to understand what kind of methods of working capital optimization are more appropriate regarding different periods of economic environment (before, during and after economic crisis). We live in the conditions of market economy, which changes from year to year and it is essential to know how to react and adapt to these changes and be aware how to overcome them.

Object of this thesis is working capital optimization of Global companies.

Subject of this thesis is working capital optimization of Global Petroleum companies.

The goal of the following master thesis is to find out which methods of working capital optimization are better to use before and after economic crisis for Global Petroleum companies.

Hypothesis 1: Before the economic crisis, Global Petroleum companies mostly use such methods of working capital optimization as account receivables management.

Hypothesis 2: After the economic crisis, Global Petroleum companies mostly use such methods of working capital optimization as account payables management.

There were some questions, to which the upcoming research attempts to answer:

Which methods of working capital optimization are commonly used by Global Petroleum companies before the economic crisis?

Do Global Petroleum companies use the same methods after the economic crisis?

Why it is essential to use different methods before, during and after economic crisis?

How the Global Petroleum companies overcome the period of economic crisis and recover from that?

In order to reach the goal of the master thesis it was essential to perform the following tasks:

Analyse the existing literature about the topic of research;

Collect the needed data for the case studies;

Calculate the relevant financial ratios;

Compare the results based on two corporations in the perspective of different periods of economic environment;

Make conclusions based on the completed research.

Research methodology. The following research was based on the public information provided by the different resources, such as electronic libraries, open sources, articles, et cetera. The theoretical chapter has in its basis only the previous works of the researches. Different annual reports, published financial statements provided the information for the analytical research. As a case studies, there were taken two large corporations from the public sector, founded in the United States of America. All the financial information of the companies is available in the open sources. Microsoft excel was used to analyze the data and prepare different tables and graphs in order to represent the analysis.

Period of the upcoming study represents the environment before economic crisis, during economic crisis and after economic crisis, and more specifically the recent accounting years from 2011 to 2017.

All the businesses meet their day-to-day requirements of the working capital to maintain their operation activities, for example in wages, advertising, rent rates and many others. That is why it is so important to manage the working capital and maintain it at the effective level, especially in the conditions of changing economic environment in the global petroleum industry.



1. Theoretical aspects of working capital optimization of global petroleum companies

1.1 Working capital optimization of global companies in the previous research

The appropriate management of working capital is indispensable to a company's principal financial health and success as a business. The working capital is a daily necessity, because every business needs some cash to maintain its operations from day to day (for instance, business concerns have to purchase raw materials, pay rents and wages, spend on advertising, invest to grow, et cetera). Moreover, the working capital shows how stable the company is in a short-term.

First of all, to explain the importance of working capital for a company and how it can affect on the finances it would be appropriate to explain what it is. There are a lot of disagreements in the thick of numerous financial jurisdictions (finance, accounting, economy, etc.) as to explicit meaning of the term working capital.

In the most of papers related to working capital, it equals the difference between current assets and current liabilities. Anyway, there are several definitions of the term. For example, in Cambridge Advanced Learner's Dictionary & Thesaurus working capital means the money belonging to a company which is immediately available for a business rather than money it has in investments or property. Mead, Baker and Malott consider that “working capital means current assets”. According to John Stuart Mill “working capital refers to a firm's investment in short term assets, such as cash amounts receivables, inventories, etc.” (Nair, 2011).

The most frequently the working capital is characterized as “the excess of current assets over current liabilities and provisions” (Hoffelder, 2012). At the same time the accounting terminology defines the working capital as the difference among the inflows and the outflows of the funds.

Working capital is a complicated concept. Sometimes it is difficult to apply the standard definition, which you could find in a textbook, to real-life cases (mostly some managers or firm owners face with this problem). The reason of this could be that the definition does not guide people to think in a deep way about the concept. In existence, it is not enough to subtract the liabilities, this precise representation of the equation could not explain the necessity for practitioners to complete correctly their finance tasks.

Also, the term “working capital” might be known as a circulating or revolving capital and short - term capital. It is typically used to stand for those assets, which are converted with a corresponding speed from cash to raw materials, for instance, and then changing into work-in-progress, after that to the finished product, which is selling for the customers and end up with cash from debtors for realization (L.A. Preve, 2010).

Traditionally working capital provides with the information how much of the short-term current liabilities (imposed with cash preconditions) would be satisfied by the available liquid assets (or cash). According to the accounting standards, current assets and current liabilities are treated as the short - term concepts. Consequently, the working capital likewise is considered as a short - term concept.

There are several approaches to classify the working capital based on both balance sheet view and operating cycle view. The operating cycle essentially poses the time needed to convert the raw materials into cash. The mail classification includes concept based working capital and time based working capital.

Regarding the concept based working capital, the quantitative and qualitative concepts can be emphasized, at the same time the others study two concepts of working capital as a gross concept and a net concept.

The quantitative concept includes the part of working capital, which belongs to the current assets. In the other words, the total current assets in the balance sheet are acknowledged as a “gross working capital” in this concept (Ismail, 2017). The great disadvantage of this theory is unpredictability. It is too complicated to determine the moment, when each asset is converted. It is referred to the appearance of the liabilities, which do not wait the time of asset's realization.

The qualitative concept is different from the previous one by the deep observation of the idea about the source of the financing capital. Conforming to the concept, the working capital is defined as an exuberance of current assets over the current liabilities.

The surplus of the total current assets over the total current liabilities is known as a “net working capital”. This term has been using frequently. In the “net working capital” concept, it is shown the exact amount of the current assets, which company would have after paying all of the current liabilities. In other words, this concept also should be explained as the amount of the current assets, which are financed by long-term liabilities.

Both the “gross working capital” concept and “net working capital concept” must be exist with their own advantages. For example, when it is necessary to evaluate the size of the used assets - the gross concept is applicable. In the other situation with analyzing of liquidity position, it is more preferred to use net working capital concept.

Sometimes the situation appears when current assets are less than current liabilities; it is called negative working capital. In these conditions, the financial crisis can come out right away, because it is risky enough. On the other hand, there are some advantages, such as the absence of need to borrow money from the banks and other credit organizations (A. Kumar Panigraphi, January - March 2015). Moreover, there is no need to involve retained profit to cover the current assets. The concept represents the situation, in which company collects its accounts receivables quicker than paying their vendors.

Recently, many managers of the leading companies aim to maintain the business activities with the zero working capital. Proponents of this concept believe that achieving the zero working capital speeds up production and generates cash more efficiently.

Zero working capital concept proposes another definition of working capital, in which it exists in the following way: Inventories + Receivables - Payables. The idea is that sales are generating from the receivables and inventories, when inventories are financed by the account payables. In this concept companies try to avoid the generating of the exuberance of the current assets over the current liabilities.

The other approach is time-based working capital. First of all, we can divide working capital into permanent or fixed category and temporary or variable one.

Permanent working capital indicates with the minimum obligatory amount of working capital, which must constantly be invested to carry out the least possible level of operation activities. Usually this type of working capital is called “Core current assets”. Tandon Committee introduced the term in the report on working capital in August 1975. Typically, it is a locked in consolidation of cash, stock and accounts receivables. Long-term liabilities finance investing in all the types of current assets the basic daily operations to maintain the business activities effectively. The basic characteristics of permanent or fixed working capital are below: working capital payables management

It consists only from long-term liabilities;

Permanent working capital positively correlates with the size of the business (if the business becomes greater, working capital will proportionally increase);

The value of the fixed working capital is a Constanta, but the value of its components can vary

Permanent working capital can be divided into two sub-types: reserve working capital and regular working capital.

Reserve working capital in other words is called as Cushion working capital. It belongs to the short - term financial adjustments, which could be made by different business units to fit with uncertainties. In the business, there are several risks, which could appear unexpectedly. Sometimes they are controllable, in the other cases - not. Reserve capital is also needed to maintain the business at the situations, when uncontrollable risks take place. It is working capital, which is available above the regular working capital. The companies keep it for the unexpected exigency.

The other part of permanent working capital is regular. It is possessed as a fixed minimum amount of working capital to be sustained continuously. Generally, the regular working capital is a requirement for the normal flowing working capital cycle.

Regarding the temporary working capital, the definition of this term is the amount of that kind of working capital, which fluctuates from time to time due to different requirements of the business. In other words, it means supplementary current assets needed during the operating year. Temporary working capital is typically financed from the short-term funds (Dr. Ahmed Arbab, June, 2011).

There is a great correlation between temporary working capital and the level of sales. During the year, the level of production and sales varies, that influences on the amount of needed working capital. Simply, the temporary working capital is a surplus between working capital and permanent working capital. Moreover, there is no opportunity to forecast the temporary working capital.

Temporary working capital also has two sub - groups as seasonal working capital and special working capital.

Considering the seasonal working capital, it refers mostly to the production of goods with seasonal demand. In other words, this kind of working capital is obliged to meet the periodic demand of the product. According to the season, to which the business is belong to, the amount of working capital temporary increases. It is appropriate to the businesses, which are periodically influenced by the seasons.

For example, ice - skaters are in a high demand in winter, so the required amount of the working capital of ice - skater's producers would increase during the winter season. The sales become extra high in winter and that is the reason of additional working capital, which would decrease when the spring would come.

Concerning the special working capital, it is associated with the special companies' programs. For example, it could be different promo actions, new advertising channels, development of the new product et cetera. In other words, the special working capital is an amount of working capital, which sustains the business in the expenses on the special company's programs.

Special working capital is an increase in temporary working capital, which appears due to unsuspected special events. Those special events are not concerned as normal regular activities and occur rarely.

Structure of working capital refers to the study of working capital cycle. Otherwise, it could be said that working capital structure shows the main elements of the current assets videlicet inventory, accounts receivable, cash and more other liquid resources, which could be converted into cash shortly, for example, short - term investments. Current liabilities regularly include short -term credits (such as bank borrowings or trade credits), unpaid dividends et cetera.

In the working capital structure, there are elements, which belongs to current assets: inventories, accounts receivable, cash holdings, accrued income, temporary investments, and to current liabilities: account payables, provision for taxation, proposed dividends, short - term loans (Fred Weston and F. Eugene Brigham, 1975).

Inventory represents as the main component of the current assets. Regarding the inventories, they consist from the different parts: raw - materials, work - in - progress, finished goods. The management of all of them is one of the most important factors of the liquidity in the short term and profitability of the company in general in the long term.

Raw material inventories are very important for the unstable demand of the finished goods or for the future changes in it. The increasing demand and the costs of accommodating production can cause the additional need of the raw materials. In the situation when there is no such inventory, the company would have to incur the different transaction costs of regular raw materials to meet the increased demand with the finished goods. The mentioned costs could be extremely large if demand changes frequently. In addition, the supplementary costs could appear, for example, for quick delivery for the needed extra raw materials. Because all of that company cannot respond to the demand changes without high costs. This kind of the costs should be reduced by holding the clearly stated level of the raw materials (Ismail, 2017).

Work - in - process inventory refers to the production cycle. It means the space of time, which is taken to convert the raw materials into the finished goods. The work - in - process inventory should be maintained during the whole production cycle.

Demand of the finished goods is uncertain as the demand of raw materials. For this reason, the amount of the finished goods should be hold at the definite level to meet unexpected high demand. If the company has not reserve finished goods it would face the additional costs to produce additional finished products at the time of the increasing demand. It is cheaper to sustain such an amount of finished goods instead of loss of sales, because the urgent production of extra good could not be available immediately.

Account receivables present the credits provided to the customers for a specified period of days to pay their invoices. The receivables balance increases when the products are already delivered to the customers, but not paid. After that, when the company starts to collect the payments for goods, this receivables balance turns to decrease. Generally, this balance shows the multiplier of the daily sales and the period, which customer takes to pay the invoices according to the contracts. It can be concluded, that working capital depends on the level of sales, because it increases with the growth of company sales and with increase in collection period of payments from the customers.

Cash holdings has a function of maintaining the business at the certain effective operation level. Usually companies require the definite amount of cash to satisfy some needs in cash during their production operations not to increase the costs in some cases. Cash holdings significance is similar to inventory.

Account payables is an opposite term from the account receivables. It presents the credits provided by the company suppliers to pay the purchased products. Generally, the level of purchases depends on level of sales, because they show the need of raw materials for production. Account payables increases with the delivery of the orders of raw materials and so on and it correspondingly decreases with the payments of the invoices. To sum up, the account payables presents the average daily purchases of the company multiplied by the periods of the credits allowed by suppliers.

Generally speaking, all the increases in account receivables, inventory and cash holdings, along with the decrease in account payables will cause the growth of working capital.

Success of organization is an important part of company management. Working capital optimization is one of the responsibilities of high-level management. Administrative accounting strategy has in its focus sustentation of the efficiency of working capital; especially current assets and current liabilities, to maintain business activities. The other object to optimize working capital is to minimize the costs of using funds.

According to the Working Capital Survey made by The Hackett Group in 2018 a lot of US companies improved their working capital performance and, as a result, they showed their best performance since 2008 (The Hackett Group, Inc, 2018). This situation could happen only with a wise management of working capital. In other words, companies optimized their working capital using different methods.

To begin with, it is important to understand how the performance of the company compares to the main competitors in order to facilitate further improvements. For this purpose, it is better to use the following metrics: cash conversion cycle (CCC); Days Sales Outstanding (DSO); Pays Payables Outstanding (DPO); Days Inventory Outstanding (DIO).

Cash Conversion Cycle could be defined as a result of time which was taken by a company to collect their accounts receivables and time which is required to convert their raw materials into the finished goods after subtracting the time which is taken to pay company's accounts payables. (Deloof, 2003) This metric shows how efficiently the working capital is used.

In order to calculate the cash conversion cycle, it is needed firstly to calculate the number of days which are the conversion period for inventory (DIO), receivables (DSO) and payables (DPO) with the use of the following formulas:

It should be mentioned that cash conversion cycle has in its focus management of four key elements, which help to improve the company's performance: cash, receivables, payables and inventory. Consequently, there are four main methods of working capital optimization:

Cash management;

Account receivables management;

Inventory management;

Account Payables management.

As it is written in The Hackett's report (The Hackett Group, Inc, 2018), in 2017 a lot of companies showed the improvements in their payables conversion period, and it happened by the reason of successful extension of the payment terms and the increasing use of supply chain finance. In other words, it could be concluded that during the mentioned period companies used method of working capital optimization such as account payables management effectively, but supply chain finance is not the only one existing solution, the other underlying processes should be also in the focus of optimization.

Regarding account receivables, there is a trend of deterioration during the period of 2015 and 2017 because of customers, which started to focus on the optimization of Days Payables Outstanding with the help of payment term extension. As far as customers extend their terms, companies feel a great pressure on their Days Sales Outstanding. In order to optimize them it is necessary to focus on encouraging correct on-time payments and another way could be to increase digitalization and use more automate processes.

Moreover, with the view of Account Receivables optimization it is important to pay attention for five main points such as (Palmer, 2011), (Caparon, 2015):

Account Receivables Accuracy (knowledge of exact amount of A/R which would be collect the next day, in 30 or 60 days and of responsible person for each action; easiness to provide the report with all of the mentioned information);

Account Receivables Metrics (assurance that all the calculations such as days sales outstanding, days past term, days past due, days deduction outstanding for each customer are accurate and easily accessible);

Account Receivables Touches (assurance that there is a continual contact with each customer every cycle of thirty days to ensure in-time payments);

Payment behavior (control over the payment customer's behavior and corresponding risks, for example such as broken promises late or short payments, et cetera);

Deductions or Disputes (if deductions and disputes occur it is important to react on them rapidly and solve the issue, then put corrective analytics in order to improve the continuous process).

Considering the inventory management, it is a great opportunity to generate cash. First of all, companies could reduce their surplus of buffers and turn to the modern supply chains, which include digitalization and automotive processes (Urbasch, 2018). Advanced block chain technologies are one of the ways for inventory optimization.

The effective management of financial supply chain may lead to the decrease in operating costs with the help of good optimization of accounts receivables and accounts payables, because the last-mentioned part of working capital constitutes the biggest drain in the working capital optimization (Sherman, 2012). If company improve the processes and have an opportunity to free cash easily, that means that working capital is used more productive.

According to the cross-industry analyses, researchers consider that aggressive strategy of working capital management could be applied effectively with the help of shorten inventory and account receivables cycles and at the same time increased account payables cycle. Generally, management of working capital should be referred to the factors of economic environment (Marttonen, Monto, & Karri, 2013).

In the context of multinational companies, the key issues which occur regarding working capital optimization are profitability, taxes, volatility of consolidated earnings, exchange rates, et cetera (Edmunds, 1983). For example, the purchased inventory should be financed and if the return from holding them is less than costs for carrying them, the management of working capital should be reviewed.

Working capital optimization is very important for firms, because it has a great influence on profitability, risks and in consequence on the company's value (Smith, 1980). Moreover, when the working capital requirements are not managed in a proper way and there is a surplus of them, this lead to the loss of benefits from the short-term investments. In the situation with the lack of working capital there could be a short-term liquidity crisis and some opportunities for profitable investments could be missed (Mian Sajid Nazir, 2009).

1.2 Methods of working capital optimization in the global petroleum industry in the literature overview

Working capital management of Global Petroleum industry differs from the other industries due to its uniqueness, which is represented by legal aspects, logistics, supply chain, et cetera.

Optimization of working capital is very important in the global petroleum industry. It is necessary to maintain the definite level of working capital to provide oil companies with wealthy opportunity to drill and refine the oil. Petroleum producers pay attention to balanced growth of their production and working capital not to have the excessive cash, which would cause the additional costs for managing it and not to have the lack of the assets during the operation cycle.

Working capital management or optimization could be defined as a process of controlling over the short - term assets and short - term liabilities. (Havoutis) Working capital optimization is one of the crucial parts of effective budgeting of the business.

Another objective of working capital management is an importance of maintaining the operating cycle of working capital, which represents the production line from the raw materials to the finished good and its delivery to the ended customers.

Regarding the costs of capital, the process of minimizing them defines one more objective of the working capital optimization. The cost of capital is the amount of funds, which company spends on maintaining the working capital on the effective level of use.

Worth to mention the maximization of return on investments on current assets (ROI) as one of the objectives. The indicator value should be more than WACC figure (weighted average cost of capital) to confirm the maximization.

Working capital optimization refers to improvement of the company's financial statements for the sake of meeting the operating costs and short - term debts. To manage working capital efficiently, it is necessary to use different tool and technics of management.

Working capital has a great influence on the profitability of a company. In order to increase profits, it is important to shorten the cash conversion cycle. Minimization of cycle length consists of faster conversion of receivables and inventory into cash. Raw materials should be converted into finished goods quicker and then delivered to customers on time. After that it is needed to collect receivables fast. (Hassan, 2017)

A lot of the companies stay capital intensive, show the high level of different inventories and turnover of account payables, low turnover of accounts receivable side. All of this benefit with the tool of cash flow management of working capital.

1.2.1 Cash Management

One of the key aspects of working capital optimization is a cash management. The importance of this tool consists in the fact that cash is the most liquid asset. Also, accounts receivable and inventory refers to liquid assets in the broad point of view, because they can be converted into cash in the course of time, but cash is a denominator.

In the cash management cash is used in two reasonable ways (Kytonen, 2004). The first one includes coins, currency, deposits in the bank, the other one includes marketable securities or time deposits in the bank, and sometimes they can be called near cash assets for the reason of readiness to be converted into cash as well.

Cash is the least profitable asset, but the reason of its importance is that it helps to generate the cash flows by the other assets. Also, each company should have an adequate amount of cash for unexpected situations to maintain healthy business activities.

There are certain strategies of cash management as the following:

Projection of cash flows and planning;

Determining optimal level of cash holding in the company;

Strategy for economizing cash.

Projection of cash flows and planning strategy belongs to the cash budget. The goal of this is to organize controllable use of cash, which represents cash inflows and outflows from period to period of business activities.

Determining optimal level of cash holding in the company aims to sustain the optimum level of cash balances to meet the current liabilities of the company. There are some motives, which encourage companies to hold some cash for transaction reasons: speculative, precautionary and compensative. The cash budget helps finance managers to predict cash inflows and outflows and to regulate the company's cash requirements. There are several models to determine the optimum level of the cash balances:

Inventory EOQ model;

Stochastic model;

Probability model;

The BAT Model.

The Economic Order Quantity (EOQ) model was introduced by Ford W. Harris in 1915, when he was undergraduate student. Dave Piasecki states that in modern life companies do not take the advantages of the inventory model, because managers do not understand how it works (Piasecki, 2001). James S. Cargal in his article “the EOQ Inventory Formula” clearly explained how the model worked and meanings of each of variables in it (Cargal):

Where Q - is the order quantity to optimize,

D - the rate of the annual demand of the product per unit,

S - the product order cost,

C - the unit cost,

H - a holding per unit as a part of the product cost.

The model determines the optimal level of cash to balance the order and holding costs, and to minimize the total costs at the same time.

The stochastic model was developed to prevent the disadvantages of the EOQ model by Miller and Orr in 1966 (Miller MH, 1966). In this model cash balances are considered as irregular, in other words they change in any way (size, form, direction, et cetera). The model has two limits - the upper and lower one. When the cash balance reaches the first one, it is a signal to financial manager to invest cash in the marketable securities. When the situation is opposite and the balance touches the lower limit, a huge portion of invested portfolio must be liquidated to return the cash balance to the optimal level. To determine the optimal level Miller and Orr introduced the following formula:

Where O - optimal cash balance,

T - fixed cost of security transactions,

V - variance of net cash flow per day,

I - daily interest on marketable securities.

William Beranek's probability model determines that cash flow are neither predictable nor irregular. Cash demand depends on the possible distribution of the future outcomes. According to the model, cash can be predicted within the range. Based on the previous experience, the financial manager should forecast the net cash flows. In other words he decides what would be the cash operating balance, and predicts the net cash flow at the end of the exact period with the probability of its occurrence.

The Baumol-Allais-Tobin (BAT) model (Tobin, 1956) analyses the classical cash management problems. It takes for granted the exactly the same outflows of cash every day, so the model illustrates what would happen if this were not case. To calculate the optimum level of cash the formula is the following (Baumol):

Where F - fixed costs of a transaction,

T - the requirement of cash for the definite period,

I - interest rate on marketable securities.

Strategy for the economizing cash determines the fact that since the cash flows forecast were made, the financial manager should cut the excessive cash. There are two ways of reaching this purpose:

Strategy towards accelerating cash inflows;

Strategy towards decelerating cash outflows.

The first strategy considers the reduction of the time lag in case of movement payments and redeployment of the funds by the company. In the second strategy, the financial manages forced to slow down the payments, for example, by delaying outward payment.

When the required amount of cash is determined and if it is needed, company could raise short-term funds correspondent to the decisions, which are made by Board of Directors. (Jain) For this purpose, the following sources could be used: Cash Credit/Over Draft; Inter-corporate borrowings; Commercial papers; Certificate of deposit.

1.2.2 Account receivables management

Account receivables represent the trade credits, provided by companies to their clients. Nowadays account receivables take the large part of company assets in common practice. Even small firms provide the commercial credits to their clients, although less than large corporations.

For the better understanding of account receivables management in Global Petroleum industry, it is important to list the elements, which are united under the title “account receivables”:

Aviation;

Bitumen producers;

Chemical producers;

Energy and power generation companies,

Lubricant refineries;

Transportation, mining, manufacturing industries;

Marine operation companies;

Different companies, which use their own logistics;

Other petroleum companies et cetera.

To optimize the account receivables there are five activities, which helps to strengthen the working capital:

Customer credit approval

Customer master data

Invoicing

Cash application process

Collection process

Regarding the customer credit approval, company should have a clear policy of issuing trade credits and getting back debts in time (Brian Stewien, Strategies for optimizing your accounts receivable, part of the Deloitte working capital series). First of all, the sales should provide with the information from the market realities. The manager need to understand which credit limits to establish and at what period of time it is better to place account on hold. Moreover, it is important to understand which customers are fair and have the ability to pay invoices on time, because of that there is a need of pre-approvals of trade credits. If a new customer starts purchasing large volumes, it would be appropriate to check its credit history. In addition, it is worth to make regular reviews of the approvals of the credit process by the reason of changes in industry and risk profiles. For example, in the situation when the customer is suffering from the economic environment, the company would be better to review the credit limits of this customer.

Customer master data in your collection system indicates all the credit conditions, payment and other relevant terms of your client. Different mistakes in the system could lead to the late payments. The customer's data must be updated according to any changes in your client's profile. Including addresses, bank details, special discounts et cetera. Finance department should approve all the changes due to their forecasts of the cash flows.

Invoicing process also plays a huge role. Every mistake on the invoice (wrong price, volume, account details et cetera) can lead to slow down the payment process. To avoid this situation the invoice process should be improved. Automation reduces the human errors, usual reports provide the information of completeness of the invoices, and delivery time could be reduced by the electronic documentation.

Cash application process refers to problems occurred during the paying process. All the payments have to contain the right descriptions in order not to be lost. To avoid incorrect cash applications, company needs to allocate the payments, which belongs to definite invoices instead of crediting customers in simple way. The information in the system should be accurate and updated at the moment of receiving the payment. To simplify this process, it is better to have the limited methods of receiving the payments.

Collection process refers to examination of the timely collection of the payments. The lack of the reports about collectible amounts could lead to difficulties with determination of the late payments or even those, which would never be paid.

1.2.3 Inventory management

Company's inventory includes different forms: raw materials, unfinished and finished goods. Investment in inventory is one the most important operating investment, because inventories help to balance variety in demand the same way as variation of raw materials.

In the Global Petroleum industry inventory plays a huge role because of imbalance between production and consumption on the market. One of the most important goal of inventory management is a stabilization on the market. In case if production is higher the consumption, companies accumulate the excessive inventories to drawn them down when consumption would be over production. (Weerawich Roekchamnong, 2014)

As long as storage of oil in gas per unit is higher than its value, it is more reasonable to maintain the additional production capacity. In the case if company hold excessive inventories it could be by the speculative reasons when companies are expecting the change in the prices. Nevertheless, as there is an uncertainty on the oil and gas market, the maintenance of buffer stock or additional production capacity could be very costly. (Amy Myers Jaffe, 2002)

Since 1970 oil price shock some countries, which import the sources of energy, decided to adapt a new policy of holding “strategic reserves”. These reserves were referred to help oil suppliers to overcome the tough times, when the disruptions in supply would occur.

Regarding the inventory of Global Petroleum companies, they consist of:

Crude oil;

Petroleum products;

Chemical products;

Gas/other;

Materials and supplies.

Some types of inventory are less liquid than cash. This happen by the reason that it is easier to convert raw materials into cash, than finished goods, which sometimes could not be sold without a respectful discount.

In the petroleum industry inventory carries an important role of a guide in the supply chain. For example, it tales pert in production, transportation, refining, distribution and even marketing. In the petroleum industry inventories include: tank bottoms, pipelines, working inventory and others, and are necessary for operation process. A lot of the companies use effectively their physical inventory to make better their economic performance.

Inventory management mission is to maximize the benefits of inventory use and at the same time to reduce costs of holding that inventory. In other words, the inventory management indicates the optimum level of investments in the inventory. Excess investments could influence unprofitably on the business blocking the funds, the low investments could affect the production with lack of the raw materials, for example. The main goal of the inventory management is to define the optimum level of investments in the inventory.

There are different technics to manage the inventory effectively. One of them, which is the best known, was mentioned above in the paragraph 1.2.1. about cash management approaches - Economic Ordering Quantity model. The approach refers to the minimization process of the costs connected in the mind with inventory investments.

Another approach is ABC analysis for value of items consumed (Nair, 2011).This method refers to the control over materials according to their value. The main principle states that high value items usually are more under control, than the low value items. The raw materials refer to the groups, which corresponds to their value and the frequency of usage:

Group “A” - small percentage of the total items with high value;

Group “B” - medium percentage of the items with medium value;

Group “C” - High percentage of the items with low value.

Using this approach, companies are able to better control of the group “A” items, which provide the most to the inventory value. The managers can predict whenever the demand on the group “A” items would change or decide to have closer relationships with the suppliers of the mentioned group products.

1.2.4 Account payables management

Account payables represent the trade credits provided by a supplier to the company. As companies sell their products to customers on credit, they receive the same opportunity to pay the invoices eventually.

Regarding the account payables management, it is essential to identify who are the suppliers in this industry:

Oil Field service companies;

Equipment providers;

Outsourcing companies, which provide engineers and other workers;

Other petroleum companies;

Logistic companies;

Recruiting companies;

Banks;

Energy companies;

Landowners et cetera.

Account payables take part in the working capital optimization, so it is important to understand how the company could manage it more effectively. There are six activities, which could help (Brian Stewien, Strategies for optimizing your accounts payable, part of the Deloitte working capital series):

Vendor selection process;

Supplier master data set-up process;

Contractual review process;

Procurement process;

Invoicing process;

Accounting and reporting process.

Vendor section process includes the set-up process of the main and preferred suppliers. Negotiations with them should include better payment conditions than the competitors propose. For example, longer payment periods are more attractive. Moreover, it is necessary to discuss the special discounts based on purchasing volumes of products. In addition, it is very important to organize the priorities for the negotiation process with vendors, involving the key decision makers.

Supplier master data set-up process represents the proper maintenance of the data, which was negotiated with the vendors about the terms of supply and payment. For this purpose, companies should accurately fulfill the payables system with all the appropriate information (product details, standards of quality, delivery, responsibilities of both sides, et cetera). All the documentation should be stored in accurate organized way in order to make the search information process easier.

Contractual review process refers to prevent overpayments or duplicate payments because of inappropriate vendor invoicing practice. For this purpose, it is essential to check the data and contracts for the completeness and compliance. In addition, vendor should be reviewed to make sure that supplier keep working with the contractual terms.

Procurement process ensures that all the buyers work with pre-approved vendors and know all the authorized limits on spending. To achieve this, company should discover different early payment discounts, negotiate more with new risky suppliers to make payment process longer to increase the working capital.

Invoicing process is another process, which refers to improve liquidity. Company should check all the invoices for the correct prices, volumes, bank details, et cetera. The Invoices with errors should be rejected and returned to the suppliers. Invoices must be processed with a timely basis; each of them must be stamped with a day of the receipt. Companies should avoid early payments in order not to change the relationships with the suppliers.

Accounting and reporting process helps to choose the best payment terms. All the accounting reports should be updated on the regular basis to provide the information of payable balances to ensure when and how often the company pays the invoices for suppliers.

1.3 Methods of working capital optimization of global petroleum companies before and after economic crisis in the previous experience

There are several methods of working capital optimization, which companies are able to use. The important fact is to make smart use of them. In order to manage working capital effectively, it is crucial to understand how each of method works and how to apply it in a particular setting. Besides the various industries, it is worth to mention that economic conditions make all the difference.

Regarding the economic crisis, which occurs periodically, it makes good sense to separate the following time lengths: before economic crisis, during economic crisis and after economic crisis. Correspondingly to the mentioned periods, methods of working capital management could be used in the different ways.

According to the Ernst & Young's report (Dale Nijoka, 2014), before the economic crisis in 2013 the Global Petroleum industry showed a deterioration in the working capital performance in comparison with the previous year, while cash conversion cycle increased by 2%.

In 2013 Global Petroleum Companies had in their focus strictly the working capital optimization in order to achieve the growth of their returns on capital and cash flows, which purpose was mainly to cover the investor's dividends. This happened mostly because of the high pressure from the stakeholder's side, who were aware of the volatile oil prices and uncertainty on the market.

In response to the mentioned situation before the economic crisis, most Global Petroleum companies started to implement more effective payment terms. The contracts with suppliers, customers and even partners became the centre of attention. It was essential to tighten them.

Moreover, procurement management and supply chain had to be improved, including better engineering, manufacturing and other function's communication. The same thing goes for collaboration between levels of value chain. Also, active management must be in evidence of cash and costs. All the cash measurements should be relevant.

Worth to mention, that working capital management might be different across the Global Petroleum industry in response to the core segments of each company. This contradiction happens because of differences in the focus of working capital management.

Economic environment before the economic crisis gives various of methods how to improve working capital management in the Global Petroleum industry. These opportunities could be presented by the following: management of demand; effective inventory management; improvement of payment terms; contractor management; et cetera. The initiative working capital management could lead to the additional cash flows.

Cash conversion cycle, as one of the most relevant measurements of working capital performance, mostly depends on required capital expenditures, which correspondingly relies on the business activities involving more exploration and production (E&P) projects with decrease in refining and marketing (R&M) or chemical activities. In order to improve cash flows and increase returns companies should be more selective in their developing projects.

During the economic crisis cash conversion cycle becomes weaker in response to volatility of oil prices. This situation occurs because of various factors, which include the time lag in passing all the changes of price to the ended customers, contract prices, which influence the amount of required stocks, and other decisions relied on oil prices.

For the purpose of decrease in cash conversion cycle, it is significant to show the decrease in days sales outstanding and days inventory outstanding with increase in days payables outstanding. According to the Ernst & Young report (Dale Nijoka, 2014) the increase in DPO could be caused by the increase in exploration and production expenditures. Consequently, expenditures grow in dependence on development costs of new oil or gas projects. Another influenced factor was qualified management of procurement and optimization of payables processes.

Table 1 - The core methods of working capital optimization in response to segments of Global Petroleum industry before economic crisis

Segment	Method
Exploration and Production	Account payables management; increase in capital expenditures.
Independent Refining and Marketing	Inventory management; optimization of supply chains though better logistics and distribution; involvement of new technologies.
Oil field services	Account receivables management; contract payment structure.

Source: Compiled by the author based on Ernst & Young report “Cash in the barrel: working capital management in the oil and gas industry 2014”

Regarding the different segments of Global Petroleum industry, the core methods of working capital optimization varies from each other (table 1).

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