ENTREPRENEURIAL

FINANCE

Working Capital Management Chapter 8

Corporate Finance Clayman

Working Capital
Management
To

ensure that a company has

adequate ready access to the funds
necessary for day to day operating
expenses, while at the same time
making sure that the companys
assets are invested in the most
productive way.

Working Capital
Management
Encompasses

several aspects of
short term finance:
Maintaining adequate levels of
cash too much or too low not
good
Converting short term assets (AR /
Inventory) into cash
Controlling outgoing payments to
vendors, employees and others

Working Capital
Management
Effective execution:
Managing and coordinating

several tasks within the company

including
Managing short term
investment
Granting credit to customers
and its collection
Managing inventory
Managing payables
Reliable cash forecast
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Working Capital
Management
The scopes include:
Transaction: payments

for trade,
financing and investment
Maintain relation with financial
institutions and trading partner
Analyzes working capital
management activities
Focus requires on liquidity

Managing and Measuring

Liquidity
Liquidity
Is the extent

to which a
company is able to meet its
short term obligations
using assets ready to
transform to cash
Liquidity Management
The ability of an
organization to generate
cash when and where
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Managing and Measuring

Liquidity
Managing liquidity includes
developing, implementing
and maintaining a liquidity
policy

Managing and Measuring

Liquidity
Primary sources of liquidity
Ready cash balances
Short term funds trade
credit, bank lines of credit
and short term investment
portfolios
Cash flow management

Managing and Measuring

Liquidity
Secondary sources of
liquidity (this may result in a
change in the companys
financial and operating
positions)
Negotiating debt contract
Liquidating assets
Filling for bankruptcy and
reorganization

Notes: using this source as a signal of financial health problem

Drag and Pull on

Liquidity

A drag on liquidity
When receipts lag,

creating

pressure from the

decreased available fund
A pull on liquidity
When disbursement are
paid too quickly or trade
credit availability is limited

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Drag and Pull on

Liquidity

Major

drag on
receipts:
Uncollected
receivable
Obsolete inventory
Tight credit
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Creditworthiness
Is

the perceived ability of the

borrower to pay what is owed
on the borrowing in a timely
manner and represents the
ability of a company to
withstand adverse impact on
its cash flow
Contributed from companys
liquidity
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Creditworthiness
Allows

the company to
borrow at lower costs and
better terms for trade
credit and contributes to
the companys investment
flexibility for more
profitable opportunities
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Creditworthiness
The

less liquid the

company, the greater
the risk it will suffer
financial distress
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Financial Ratios To Measure

Creditworthiness

Current Ratio
Quick Ratio
Accounts Receivable Turnover
Inventory Turnover
Number of Days Receivable
Number of Days Inventory
Number of Days of Payables

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Financial Ratios To Measure

Creditworthiness

Financial ratios tell how the

company manage its liquidity
To do analysis, should arrange
each ratio in trend to know the
companys performance
Or else, do comparison with
industry ratios or other
competitor in the same industry

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Financial Ratios Trend Comparison

Liquidity Analysis of Wal Mart Stores

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Financial Ratios Trend Comparison

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Financial Ratios Trend Comparison

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Managing The Cash

Position
Forecasting

short term cash flows

Minimum cash balance

Identifying typical cash flows
Cash forecasting systems

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Managing The Cash

Position

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Managing The Cash

Position

Examples of Cash Forecasting Aspects Over Different Forecast H

Data frequency
Format
Techniques
Accuracy
Reliability
Uses

Short Term
Daily / weekly for 4 6
weeks
Receipts and
disbursement
Simple projections

MediumTerm
Monthly for one year

Receipts and
disbursement
Projection models and
averages
Very high
Moderate
Very high
Fairly high
Daily cash management Planning financial
transactions

LongTerm
Annually for 3 5 years
Projected Financial
Statements
Statistical model
Lowest
Not as high
Long range financial
positions

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Monitoring Cash Uses

and Levels
Managing

cash position in the bank

on virtually a real time basis
The minimum level of cash available
is estimated in advance as a target
balance
Most companies, manage cash by
the assistance of short term
investment and borrowings

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Investing Short Term

Fund
As

a temporary store of excess fund

Normally invest it in marketable
securities

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Managing Accounts
Receivable
Three

major activities in managing

AR:
Granting credit and processing

transactions
Monitoring credit balances
Measuring performances of the credit
function

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Managing Accounts
Receivable
Monitoring

the outstanding AR:

Regular reporting of outstanding receivable

balances
Notifying the collection managers of past due
AR

Measuring

the performance of credit

function by:

Developing performance measurement reports

AR aging schedule
Days sales outstanding report

Collaboration

between the credit manager,

treasury manager and accounting manager
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Managing Accounts
Receivable
Goals

of AR management system:

Efficient processing and maintaining

accurate and up to date record

Control of AR and assuring that AR record is
not accessible by unauthorized person
Collection on accounts and coordination with
the treasury management
Coordination and notification with credit
manager
Preparation of regular performance
measurement report
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Managing Accounts
Receivable
Components of Credit
Policy
Terms of sale
Credit period
Cash discount and discount period
Type of credit instrument

Credit

analysis distinguishing between

good customers that will pay and bad
customers that will default
Collection policy effort expended on
collecting receivables
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Terms of Sale
Basic

Form: 2/10 net 45

2% discount if paid in 10 days

Total amount due in 45 days if

discount not taken

Buy

$500 worth of merchandise

with the credit terms given
above
Pay $500(1 - .02) = $490 if you pay

in 10 days
Pay $500 if you pay in 45 days
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Example: Cash
Discounts

Finding

the implied interest rate when

customers do not take the discount

Credit

terms of 2/10 net 45

Periodic rate = 2 / 98 = 2.0408%

Period = (45 10) = 35 days
365 / 35 = 10.4286 periods per year

APR

= periodic rate x number of

periods per year
= 2.0408% x 10.4286 = 21.28%

EAR

= (1.020408)10.4286 1 = 23.45%
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Example: Cash
Discounts
APR Periodic rate x No of periods per year
Discount
365

x
1 Discount Days taken Discount period

APR Periodic rate x No of periods per year

Discount
365

x
1 Discount Days taken Discount period

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Five Cs of Credit
Character

willingness to meet
financial obligations
Capacity ability to meet financial
obligations out of operating cash
flows
Capital financial reserves
Collateral assets pledged as
security
Conditions general economic
conditions related to customers
business

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Evaluating AR
Management

AR Aging Schedule
The Number of Days Receivable (AR Turnover and Day of AR

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Managing Inventory
To

maintain the level of inventory so

that production management and
sales management can make and
sell the companys product without
more than necessary invested in this
asset

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Inventory
Created

by purchasing, paid by accounts

payable and funded by treasury

Does

not produce cash until sold or

disposed

The

more it is on hand, the greater the

potential for obsolete inventory, which
can be sold of but at a discount

Shortage

of inventory -> loss of sales

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Managing Accounts
Payable
Accounts

payable happened due to

purchasing of goods and services not
yet paid
Arise from trade credit

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Managing Accounts
Payable
Important

as if not:

Result in opportunity costs from

payments made too early

Lost opportunities to take advantage of
trade discounts
Inefficiencies may arise in managing
purchasing, inventory and payables if
each area is not organized and not
efficiently linked between each other.

The

term is similar as in AR policy,

but it is from the supplier side.

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END

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