Case 2 : Carrefour, S.A.

Working Capital Management

Course : Financial Management, MMUGM Sby AP 7

Instructor : Dr. Erni Ekawati, MBA, MSA

Group member :
1. Yuli Rosiana
2. Hidayat Akman
3. I Ketut Widya N.
4. Robby S. Irawan
5. Yogik H. Wijayanto

KEY ISSUES :

- Carrefour had been maintaining a negative net working capital that is considered as a
risky financial strategy. A negative net working capital that a company currently is
unable to meet its short-term liabilities with its current assets (cash, accounts receivable
and inventory). In case of temporary recession occur during payment of short term debt,
the firm may unable to pay the debt.

- Its Debt-to-Equity (D/E) ratio showed an increasing number over a period of time and it
was relatively higher than other competitors. A higher debt-to-equity ratio means that the
more debt that is used and the greater risk that the entity might be forced to liquidate and
go out of business. Carrefour financed its capital mostly by using a non-interest bearing
trade note. Consequently, Carrefour indeed should find a way to make a slightly higher
net working capital and reduce its debt-to-equity ratio.

- Maintaining a short Cash Conversion Cycle (CCC) was a good thing for Carrefour;
however, having a negative Free Cash Flow (FCF) might not be good. Some investors
believe that FCF gives a much clearer view of the ability of the company to generate cash
(and thus profits). On the other hand, a negative FCF also shows that this company was
doing large investments. If these investments earn a high return, the strategy would be a
worth for a company to provide a potential to pay off in the long run. Moreover,
Carrefour’s current ratio (liquidity and risk ratio) seems to look awkward in which that its
number is less than 1.0 while other competitors maintained a number greater ratio.

- As a rapidly growing company, Carrefour had great opportunities to be accepted by its

customers excitedly as a convenient and one-stop shopping center with its cheaper price
compare to other available stores. This lead to a number of 40% of other small retail
shops or approximately 80,000 stores had closed down in 1971. In order to solve this
issue, French government to some extend decided to make tighter regulations to slow
down the significant enlargement of hypermarket, such as Carrefour by limiting the
number of new opening store each year (maximum of two stores per year). Another way

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 to approach the issue broadly was increasing the tax to hypermarket and subsidized the
tax income for small shopkeepers that could not maintain their sustainability.

- While Carrefour was trying to manage its capital management, Carrefour created two
type of businesses besides its wholly owned stores. This was accomplished in order to
work out their capital shortages. Some stores were in form of joint ventures and the
others were in a franchise type of businesses. Each type of business generated different
net income in which joint ventures gave Carrefour a profit between 10-50% of the
ownership, while franchises provided a fee of 0.2% of total store sales. The strategy was
quite successful by means that Carrefour’s investments and advances to affiliates had
grown up to F 19 million. The main concern of Carrefour was to create maximum returns
and minimize risks as low as possible by combining these three type of businesses.

- Carrefour was facing an increased competition in France and the future growth was
beginning to look limited. It was estimated that 50% of market saturation had already
been taken. Furthermore, it was expected in the next few years, the market for
hypermarket stores would be completely saturated at current growth rates. Therefore,
Carrefour considered expanding their strategy by investing in others countries. As a
result, Carrefour needed to observe several possible ways to set up stores outside France.

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ANALYSIS :

Working capital represents operating liquidity available to a business. It’s usually

calculated by subtracting the current asset with current liabilities. Decisions relating to working
capital and short term financing are referred to as working capital management. The goal of
working capital management is to ensure that the firm is able to continue its operations and that
it has sufficient cash flow to satisfy both maturing short-term debt and upcoming operational
expenses. Working capital management entails short term decisions based on cash flow and
profitability. Cash flow could be measured by cash conversion cycle, meanwhile profitability
usually measured by ROC (Return on Capital) or ROE (Return on Equity). Firm in managing
their working capital use combination of policies and techniques in cash management, inventory
management, debt management, and short term financing, such that cash flow and risk and return
are acceptable.

Carrefour main strategy was to generate high sales volume by maintaining a very small
margin. From the Re-arranged Operating Statement (Exhibit 1), Carrefour net profit margin was
averagely 2% which means that each dollar sale give 2 cents return. It was lined up with
Carrefour’s low price strategy. The percentage incremental of both EBIT and Net Income
averagely returned a positive value (60% and 62%). These values are majorly affected by Sales
(Net), purchase and operating expense. Figure 1.5 shows increasing amount in operating expense
followed by an increment in net sales over the past seven years. On average, the net sales each
year was increasing around 53% which was considered to be a great number. The company grew
at least by half of its company size every year. The short table below gives a quick picture of the
net income percentage within seven years :
In millions of Avera
France 1965 1966 1967 1968 1969 1970 1971 ge
Net Sales (net
VAT) 153 215 332 513 878 1,250 1,936
Net Income 3 3 7 10 16 23 44
1.96 1.40 2.11 1.95 1.82 1.84 2.27 1.91
% Net Income % % % % % % % %

Although this percentage of net income was relatively low, Carrefour should observe at
how its profitable investment was being financed. Exhibit 2 shows that the composition between
investment activities and financing activities. The composition between these two activities was
mismatching. Carrefour’s fund was more than enough to support their operating activity. Mostly
its fund was covered by short-term debt from external parties. Ideally, a short-term investment
should be supported by a short-term debt. However, from the balance sheet, Carrefour kept
increasing its net fixed asset, which was assumed to be an investment in land and buildings. The
investment in net fixed asset was financed mostly by non-interest bearing note (short-term debt).
Net fixed asset is again categorized as a long-term investment. This is where Carrefour had a
mismatching between a long-term investment and a short-term financing.

One important thing to note is that using a non-interest bearing note gave Carrefour an
advantage financial performance since it did not force the company to pay the interest which
considered as a cost that could more reduce its net margin.

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 Carrefour was maintaining a positive Net Operating Working Capital (Net Working
Asset) within 7 years. The NOWC had increased starting from 1965 – 1968 and dropped in 1969
– 1970. This was due to an increase in the amount of account payables.

From the Carrefour’s Financial Performance (exhibit 5), Carrefour’s spread was still in a
positive value. This was a great thing which means the company maintained a growing stage.
However, one major problem was that the Debt-to-Equity ratio kept increasing and it showed a
2.2 ratio at the end of 1965. The debt was double compare to its equity. However, the
composition of the debt mostly consisted of short-term debt. This could cause a problem for
Carrefour since its equity would not cover its debt in case of debt maturity. This resulted in a
negative Net Working Capital which has been stated above on the key issues.

Free cash flow is another thing to look at. Free cash flow represents the cash that a
company is able to generate after laying out the money required to maintain or expand its asset
base. Free cash flow is generated by subtracting investment in operating capital from operating
cash flow. Carrefour’s negative free cash flow results in high long-term investments.

According to Carrefour’s Balance Sheet, the net fixed asset, which was growing in 1965
– 1971, resulted in using the short-term debt instead of its long-term debt. The negative free cash
flow could reduce in the value of the company. In this case, external investors might start to
think twice in order to put their investments in Carrefour. (Please refer to Figure 1.1 - Free Cash
Flow and Weighted Average Cost of Capital)

Carrefour’s Return on Earning (ROE) was greater than Return on Invested Capital
(ROIC) which means that Carrefour’s financing strategy was more provided externally. Note that
its Turnover, which is calculated by dividing Sales by Total Capital, showed a number greater
than 1, means that sales covered more than enough compare to its total capital. This is closely
related to its Cash Conversion Cycle which will be explained on Exhibit 11. Moreover, this
strategy still correlated with Carrefour strategy by making huge sales revenues and maintaining
small margins.

Carrefour’s cash conversion cycle had generated a fast cash. Please refer to Figure 1.3 for
Carrefour’s cash conversion cycle diagram. Cash conversion cycle represents the net time
interval between the collection of cash receipts from sales and the cash payments for the various
resources used by the firm. The cash conversion cycle, which Carrefour had on average, was
around 13 days (Exhibit 11). This means that Carrefour would have to finance the buying-selling
cost for a 13-day period. It might be better if later Carrefour could shorten its cash conversion
cycle without hurting its operations. On the other hand, Carrefour’s current ratio (one type of
liquidity ratios) shows a small number, less than 1.0. The low current ratio is due to the fact that
as a retail store, Carrefour has to maintain high inventory levels which mean that most of its
funds is tied in inventory. This, however, is not a bad sign since Carrefour enjoyed a small
inventory turnover ratio, average of 0.06 times, which means that the company is effectively
managing its inventory. Moreover, in terms of Carrefour’s low current ratio, with the quick cash
conversion cycle could still fund its operations.

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RECOMMENDATIONS

Based on the analysis above, we observe two main factors that raised several issues in its
working capital management as below :

1. Maintaining a negative net working capital

2. High Debt-to-Equity ratio

These two conditions above are considered as a risky financial management. Negative net
working capital could be a sign for a company facing a bankruptcy or serious financial problem.
This is due to the higher current liabilities (or debts) compare to its current assets. If Carrefour in
some situation cannot generate a fast cash conversion cycle, it will end up with having lots of
debts that cannot be covered by its assets.

Our team propose a better net working capital. Carrefour should adjust its negative net
working capital by reducing its current liabilities. Based on our balance sheet projections in 1972
(exhibit 9), we have made two scenarios to compare which one of Carrefour’s capital structure
suits the best for Carrefour.

Prior to arranging the two scenarios, our team decided to project Carrefour’s sales
performance in 1972. We found that the average percentage growth of net sales was 79% (about
F 3,485 million). In addition, we made several calculations to support our projected income
statement and balance sheet in order to project the financial statement that results in a positive
net working capital.

Knowing that Carrefour’s negative net working capital was being affected by its high short-
term debt, our team propose a better composition between the short-term debt and the long-term
debt that will lead to a positive net working capital. To meet Carrefour capabilities in fulfilling
the investment activities, we suggest Carrefour to increase their equity by releasing some new
stocks (shares) to the market. This will later finance its growth in a better way. Consequently,
this low total debt and increase in equity will lower the Debt-to-Equity ratio.

Since in 1972 Carrefour was planning to open 15 new stores, with three different type of
business units, it appears that wholly owned will give a higher return based on our forecasting
(please refer to exhibit 13 and figure 1.6) ; however, since the French government limited a
number of new opening stores (maximum 2 stores each year) under the same company, the
chance for Carrefour to grow rapidly would be constrained. As a result, Carrefour can only open
a maximum number of 2 new stores in a year. This will leave 13 new stores with two types of
ownership.

Comparing the return between the two types of ownership, it is obvious that Carrefour
would prefer to choose a joint venture. However, we tried to look over its business risk. Based on
our risk calculations (exhibit 12), we started to forecast the rate of return for each type of

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ownership. We found that wholly owned stores placed a 54% rate of return, where joint ventures
occupied 18% and franchise was 28%. Comparing with Carrefour’s plan in 1972 to open 2 new
wholly owned stores, 7 joint ventures and 6 franchise company, our team decided to leave the
composition. We support our detail analysis from the risk and return (exhibit 12) that shows a
number of standard deviation 11.54%. Comparing with Carrefour successful way in adding its
joint businesses within 1969 – 1971 in order to increase its Investments and advances to affiliates
(current assets), this risk can be assumed as low risk and high return.

The hypermarket competition in France started to increase that would later slow down the
future growth. According to the Carrefour’s management observation, there had a bigger
potential market that could be explored outside France. Carrefour’s winning strategy by lowering
cost could be done, for example in Belgium. However, Carrefour needs to open either a joint
venture or franchise ownership, for example with SA Innovation. The reason was that initial
entry in other countries could be difficult for foreign company. Besides, Carrefour might lack of
knowledge and experience in expanding the territory outside France. Carrefour, however, could
later do the tactical acquisitions of smaller competitors and emerged to be one of the giant
hypermarket all over Europe.

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IMPLEMENTATION CONSIDERATIONS

Our team founded an article about Wal-Mart in which that they could manage a shorter
cash conversion cycle in which it had a negative number in 2006. Therefore, it will be better for
Carrefour to shorten its cash conversion cycle from 13-day period becomes to a lower number.

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Appendix A – Detail Company Description

I. Company Profile
Carrefour’s Mission Statement :
Carrefour is totally focused on meeting the expectations of its customers. Our
mission is to be the benchmark in modern retailing in each of our markets. As a global
retailer, Carrefour is committed to enabling as many people as possible to purchase
consumer goods, in accordance with the principles of fair trade and sustainable
development.

Business sectors : Retail

Founded in : 1959
Headquarters : France
Operating in : 29 countries
Employees : 430,000

Carrefour started to open a retail food store in 1960 with its single supermarket in France.
The idea was to open a one-stop food shopping area were costumers could find any foods they
wanted to buy conveniently and inexpensively. French consumers were enthusiastically in
accepting the self-service shopping at discounted rates. Looking at how this company grew,
Carrefour tried to expand its product variances by adding non-food items in 1963.

II. Company Growth

Carrefour had been maintaining its growth at 50% rate per year and becoming a giant
hypermarket in expanding its assets not only locally but also globally. By 1971, Carrefour had
built 16 hypermarket stores, operated 5 stores as joint ventures and had franchise agreements
with 7 additional stores. For a joint venture, Carrefour invested an ownership interest of 10-50%,
while for franchising, Carrefour only received a fee of 0.2% from total store sales.

As a cheap-retail store, Carrefour managed to open several stores outside towns which
had a closely access to highways. Carrefour maintained its low-cost strategy by not only buying
land in that suburb area that was much cheaper than in the central town, but also constructing
inexpensively. The total investment per square meter of selling space in a fully equipped store
costs about 30% lower than those of traditional supermarkets and department stores.

Carrefour also did a decentralized management which gave a more power for its
managers to have a freedom in decision making. This lead to a faster profit creation in each
Carrefour’s store. However, a good empowerment system resulted in higher operating expense.
Carrefour preferred to hire a well-experience store manager and offered them a high salary so
that it could later generate the a more efficient process (and generated more profit). The
increasing salary is shown below in detail:
1965 : 8 millions of France

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 1966 : 11 millions of France (increased 37.5% from 1965)
1967 : 16 millions of France (increased 45.45% from 1966)
1968 : 26 millions of France (increased 62.50% from 1967)
1969 : 56 millions of France (increased 115.28% from 1968 – the highest)
1970 : 82 millions of France (increased 46.43% from 1969)
1971 : 119 millions of France (increased 45.12% from 1971)
Averagely the increased salary each year was around 59%.

III. Company Barriers

Looking at how Carrefour managed its growth both inside and outside of France, many
traditional retail stores started to collapse. There were about 80,000 traditionally running-retail
stores that operated in 1961 were disappeared in 1971. French government urged this problem
by creating a strict regulations in order to pursue a slower growth. One way was to make a
complexity in order to obtain construction permits to build large new retail stores. Also, each
new opened hypermarket must provide a leasing to at most 40 independent shopkeepers.

Moreover, Carrefour was facing numerous number of direct competitors such as Au

Printemps, Casino, Docks Remois and Galeries Lafayette. According to some industry analysts,
the French consumer needs for stores would be satisfied half of it by mid of 1972. As a result,
Carrefour needed to avoid this tight competition by looking at other market outside France.

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Appendix B – Computations / Calculations

Exhibit 1 : Carrefour’s Operating Statement (Rearranged Form) for Years Ending

1965 – 1971
Exhibit 2 : Carrefour’s Balance Sheet (Rearranged Form) for Years Ending 1965 –
1971
Exhibit 3 : Carrefour’s Weight Percentage Changes over Net Sales in Operating
Statements
Exhibit 4 : Carrefour’s Weight Percentage Changes over Net Sales in Balance
Sheet
Exhibit 5 : Carrefour’s Components of Financial Performance from 1965 - 1971
Exhibit 6 : Carrefour’s Cash Flow Statements based on Change in Sales from 1965
- 1971
Exhibit 7 : Carrefour’s Turnover based on Changing in days of Net Sales from
1965 - 1971
Exhibit 8 : Carrefour’s Projected Operating Statement in 1972
Exhibit 9 : Carrefour’s Projected Balance Sheet in 1972
Exhibit 10 : Carrefour’s Sensitivity Analysis based on the Forecast
Exhibit 11 : Carrefour’s Cash Conversion Cycle from 1965 – 1971
Exhibit 12 : Carrefour’s Risk and Return based on performance in 1965 – 1971
Exhibit 13 : Carrefour’s Forecast 1972, based on Net Sales, EBIT and Net Margin in
1965 - 1971
Exhibit 14 : Carrefour’s Financial Ratio
Exhibit 15 : Financial Data for Large Retail Firms in Europe, 1967 - 1971

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Appendix C – Diagrams / Graphics

Figure 1.1 – Free Cash Flow and Weighed Average Cost of Capital
Figure 1.2 – Cash Conversion Cycle Formula Diagram
Figure 1.3 – Carrefour Cash Conversion Cycle
Figure 1.4 – Carrefour Changes in Operating Assets
Figure 1.5 – Trend in Carrefour’s growth in Revenues vs. Purchases vs. Operating
Expense
Figure 1.6 - Carrefour’s Net Margin Between Each Different Type of Ownership

Operating Required
Sales Financing Interest
Costs and Investments in Firm Risk Market Risk
Revenues Decisions Rates
Taxes Operations

Weighted Average Cost of Capital

Free Cash Flows (FCF)
(WACC)

FCF1 FCF2 FCF3 FCF∞

Value = ------------------- + ------------------ + ------------------ + ….. + ------------------
(1+WACC)1 (1+WACC) 2 (1+WACC)3 (1 +WACC) ∞

Figure 1.1 Free Cash Flows and Weighted Average Cost of Capital

Cash Conversion Cycle (CCC) = Inventory Conversion Period (ICP) + Receivables Collection Period (RCP) – Payables Deferral Period (PDP)

Inventory Receivables Payables

ICP = --------------------- RCP = --------------------- PDP = ----------------------------
Sales per day Sales / 365 Purchase per day

Payables
PDP = ---------------------------------
Cosf of Good Sold/ 365

Figure 1.2 CCC Formula Diagram

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 Finish Goods and
CASH CONVERSION CYCLE – Carrefour , S,A. Sell Them

Inventory Receivables
Conversion Collection
Period (avg. 21 days) Period (avg. 1 day)

Cash
Payables Conversion
Deferral Cycle
Period (avg. 9 days) (avg. 13 days)

days

Pay Cash for Collect Accounts

Purchased Receivable
Materials
Figure 1.3 Carrefour’s Cash Conversion Cycle (CCC) Diagram

Figure 1.4 Carrefour’s Changes in Operating Asset

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Figure 1.5 Trend in Carrefour’s growth – Revenues vs. Purchases vs. Operating Expense

Figure 1.6 Carrefour’s Net Margin Between Each Different Type of Ownership

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 Bibliography

1. Brigham, Huston, “Essential of Financial Management”, Thomson, 2007.

2. Brigham, Ehrhardt. “Financial Management : Theory and Practice”, Thomsom, 2005
3. http://www.investopedia.com
4. http://www.wikipedia.org/

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