Professional Documents
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Topics in Chapter
21-2
Basic Definitions
Gross working capital:
Total current assets
Net working capital (NWC):
Current assets - Current liabilities
Net operating working capital (NOWC):
Operating CA Operating CL =
(Cash + Inv. + A/R) (Accruals + A/P)
21-3
Working Capital
Management
Day-to-day control
Cash
Inventories
Accounts receivable
Accruals
Accounts payable
21-5
Inventory Conversion
Period
Average time required to convert
materials into finished goods and to
sell those goods:
Inventory
Inventory Conversion Period
Sales per day
21-6
Receivables Collection
Period
Average length of time required to
convert the firms receivables into
cash:
Receivables
Receivables Collection Period
Sales / 365
21-9
Inventory Conversion
Period
Inventory
Sales per day
$2,000,000
Inventory Conversion Period
73 days
$10,000,00 0 / 365
Inventory Conversion Period
21-10
Receivables Collection
Period
Receivables
Sales / 365
$657,534
Receivables Collection Period
24 days
$10,000,00 0 / 365
Receivables Collection Period
21-11
Payables
Purchases per Day
Payables
30 days
$8,000,000 / 365
21-12
CCC =
CCC =
67 days
(21-4)
21-13
Figure 21-1
21-14
TABLE 21.1
21-16
21-17
21-18
Cash Management:
Cash = Non-earning Asset
Transactions:
Must have some cash to pay current bills.
Precautionary balances = Safety stock
Compensating balances:
For loans and/or services provided.
Speculation:
Take advantage of bargains
Take discounts
21-19
Cash Budget:
The Primary Cash Management
Tool
Projected cash inflows, outflows, and
ending cash balances forecast loan
needs and funds available for
temporary investment
Daily, weekly, or monthly, depending
upon budgets purpose
Monthly for annual planning
Daily for actual cash management
21-20
21-22
Table 21-2
21-23
21-24
$300*20%*98% =
$250*70% =
$200*10% =
$300*70% =
21-25
21-26
Table 21-2
21-27
21-29
Cash Management
Techniques
Synchronize inflows and outflows
Billing cycle = Payment cycle
Use Float
Remote disbursement accounts (+)
Collections float (-)
Net
Float
Lockbox Plan
Payment by wire transfer or automatic debit
Reduce the need for a cash safety stock:
Increase forecast accuracy
Hold marketable securities instead of a cash
Negotiate a line of credit
21-30
Inventory Management
Goals
1. Ensure that the inventory needed to
sustain operations is available
2. Minimize the costs of ordering and
carrying inventory
Trade-off to balance goals
21-31
Inventory Management:
Categories of Inventory Costs
Carrying Costs
Inventory Management:
Categories of Inventory Costs
Ordering Costs
Cost of placing orders
Shipping
Handling costs
21-33
Inventory Management:
Categories of Inventory Costs
Costs of Running Short
Loss of sales
Loss of customer goodwill
Disruption of production schedules
21-34
Receivables Management
A/R = Credit sales/day X Collection Period
Depends on volume of credit sales
Average time from credit sale to
collection of cash
Credit policy
Receivables monitoring
21-35
Cash Discounts
Lowers price
Attracts new customers
Reduces DSO
21-36
Collection Policy
Tougher policy will reduce DSO
May damage customer relationships
21-37
Receivables Monitoring
Credit sale events:
1. Inventories reduced by COGS
2. A/R increased by sales price
3. Price COGS = Profit
Profit Retained Earnings
365
365
(21 - 6)
(21 - 7)
DSO
Receivables
Receivables
21-39
Receivables Aging
Schedule
Breaks down firms receivables by age
TABLE 21.3
21-40
Accruals
Accrued wages and accrued taxes
Increase spontaneously
Accruals are free in that no explicit
interest is charged
Firms have little control over the level of
accruals
Levels influenced by industry custom,
economic factors, and tax laws
21-41
Trade Credit
Credit furnished by a firms suppliers
Accounts Payable
Often largest source of short-term credit,
especially for small firms
Spontaneously increases
Easy to get, but cost can be high
Example: 2/10, net 30
2% discount if paid within 10 days
Due in 30 days
21-42
= 0.0204 18.25
98
20
= 0.372 = 37.2%
21-46
21-48
Trade Credit
Two components:
Free trade credit = discount period credit
Costly trade credit = cost implied by
foregone discount
Firms should always use the free credit
Use the costly credit only after careful
analysis and comparison with other sources
21-49
21-50
FIGURE 21.2
Page 751
21-51
Temp. NOWC
}
Perm NOWC
S-T
Loans
L-T Fin:
Stock &
Bonds,
Fixed Assets
Years
Lower dashed line, more aggressive.
21-52
Conservative Financing
Policy
$
Marketable Securities
Zero S-T
debt
Perm NOWC
L-T Fin:
Stock &
Bonds
Fixed Assets
Years 21-53
Short-term Investments
Marketable securities
Lower yields than operating assets
Held for same reasons as cash
Benefits:
Reduces risk and transactions costs
Wont need to issue securities or borrow as
frequently
Ready cash for opportunities = speculative
balances
Disadvantages
Low after-tax return
21-54
Short-term Financing
Advantages
Funds available relatively quickly
Lower cost
Yield curve usually upward sloping
Lower flotation costs
Short-term Financing
Disadvantages
Higher risk
Interest expense fluctuates
Required repayment comes quicker
Firm may have trouble rolling over
loans
21-56
Promissory Note
Signed when bank loan approved
Specifies:
Amount
Interest rate
Repayment schedule
Collateral
21-57
21-59
Security in Short-term
Financing
Commercial paper is never secured
Better to borrow on an unsecured basis
Lower bookkeeping costs
Collateral options:
Marketable securities
Land or buildings
Equipment
Inventory
Receivables
21-60