Professional Documents
Culture Documents
Learning Goals
1. Understand short-term financial management, net working capital, and the related trade-off between profitability and risk. 2. Describe the cash conversion cycle, its funding requirements, and the key strategies for managing it. 3. Discuss inventory management: differing views, common techniques, and international concerns.
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low return
Long-Term Debt
high return
high cost
Fixed Assets
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Equity
highest cost
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Current Assets
low cost
high return
Long-Term Debt
Fixed Assets
Equity
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- It shows the amount of time a firms resources are tied up (iaitu OC-APP).
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Calculating the Cash Conversion Cycle (cont.) Both the OC and CCC may be computed as shown below.
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Obviously, reducing AAI or ACP or lengthening APP will reduce the cash conversion cycle, thus reducing the amount of resources the firm must commit to support operations.
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Funding Requirements of the CCC (cont.) Permanent vs. Seasonal Funding Needs
In contrast, Semper Pump Company, which produces bicycle pumps, has seasonal funding needs. Semper has seasonal sales, with its peak sales driven by purchases of bicycle pumps. Semper holds, at minimum, $25,000 in cash and marketable securities, $100,000 in inventory, and $60,000 in accounts receivable. At peak times, Sempers inventory increases to $750,000 and its accounts receivable increase to $400,000. To capture production efficiencies, Semper produces pumps at a constant rate throughout the year. Thus, accounts payable remain at
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Funding Requirements of the CCC (cont.) Permanent vs. Seasonal Funding Needs
$50,000 throughout the year. Accordingly, Semper has a permanent funding requirement for its minimum level of operating assets of $135,000 ($25,000 + $100,000 + $60,000 - $50,000) and peak seasonal funding requirements of $990,000(in excess of its permanent need) ($25,000 + $750,000 + $400,000 - $50,000) $135,000]. Sempers total funding requirements for operating assets vary from a minimum of $135,000 (permanent) to a a seasonal peak of $1,125,000 ($135,000 + $990,000) as shown in Figure 14.2.
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and long term funds at 8%, and can earn 5% on any invested surplus,
then the annual cost of the aggressive strategy would be:
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The conservative strategy avoids these risks through the locked-in interest rate and long-term financing, but is more costly. Thus the final decision is left to management.
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2. Collect accounts receivable as quickly as possible without losing sales from high-pressure collection techniques. 3. Manage, mail, processing, and clearing time to reduce them when collecting from customers and to increase them when paying suppliers.
4. Pay accounts payable as slowly as possible without damaging the firms credit rating.
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$1
The EOQ can be used to evaluate the total cost of inventory as shown on the following slides.
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Daily usage = 1,600/360 = 4.44 units/day Reorder point = 10 x 4.44 = 44.44 or 45 units
Thus, when RIBs inventory level reaches 45 units, it should place an order for 400 units. However, if RIB wishes to maintain safety stock to protect against stock outs, they would order before inventory reached 45 units.
Copyright 2009 Pearson Prentice Hall. All rights reserved.
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Techniques for Managing Inventory (cont.) Computerized Systems for Resource Control
MRP systems are used to determine what to order, when to order, and what priorities to assign to ordering materials. MRP uses EOQ concepts to determine how much to order using computer software. It simulates each products bill of materials structure all of the products parts), inventory status, and manufacturing process.
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ERP electronically integrates all of a firms departments so that, for example, production can call up sales information and immediately know how much must be produced to fill certain customer orders.
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Accounts Receivable Management: Credit Scoring Credit scoring is a procedure resulting in a score that measures an applicants overall credit strength, derived as a weighted-average of scores of various credit characteristics. The procedure results in a score that measures the applicants overall credit strength, and the score is used to make the accept/reject decision for granting the applicant credit.
Copyright 2009 Pearson Prentice Hall. All rights reserved.
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Accounts Receivable Management: Credit Scoring (cont.) The purpose of credit scoring is to make a relatively informed credit decision quickly and inexpensively. For a demonstration of credit scoring, including the use of a spreadsheet for that purpose, see the books Web site at www.prenhall.com/gitman.
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Dodd Tool, a manufacturer of lathe tools, is currently selling a product for $10/unit. Sales (all on credit) for last year were 60,000 units. The variable cost per unit is $6. The firms total fixed costs are $120,000. Dodd is currently contemplating a relaxation of credit standards that is anticipated to increase sales 5% to 63,000 units. It is also anticipated that the ACP will increase from 30 to 45 days, and that bad debt expenses will increase from 1% of sales to 2% of sales. The opportunity cost of tying funds up in receivables is 15%. Given this information, should Dodd relax its credit standards?
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$ 12,000
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For example, with credit terms of 2/10 net 30, the discount is 2%, the discount period is 10 days, and the credit period is 30 days.
Copyright 2009 Pearson Prentice Hall. All rights reserved.
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Credit Monitoring
Credit monitoring is the ongoing review of a firms accounts receivable to determine whether customers are paying according to the stated credit terms. Slow payments are costly to a firm because they lengthen the average collection period and increase the firms investment in accounts receivable. Two frequently used techniques for credit monitoring are the average collection period and aging of accounts receivable.
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Collection Policy
Table 14.4 Popular Collection Techniques
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Controlled Disbursing
Controlled Disbursing involves the strategic use of mailing points and bank accounts to lengthen the mail float and clearing float respectively.
This approach should be used carefully, however, because longer payment periods may strain supplier relations.
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Zero-balance accounts (ZBAs) are disbursement accounts that always have an endof-day balance of zero. The purpose is to eliminate non-earning cash balances in corporate checking accounts. A ZBA works well as a disbursement account under a cash concentration system.
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