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Chapter 22 provides knowledge of working capital management. This chapter presents the following content: Alternative working capital policies; cash, inventory, and A/R management; accounts payable management; short-term financing policies; bank debt and commercial paper.
CHAPTER 22 Working Capital Management Topics in Chapter Alternative working capital policies Cash, inventory, and A/R management Accounts payable management Shortterm financing policies Bank debt and commercial paper Definitions Working capital management: Includes both establishing working capital policy and then the daytoday control of cash, inventories, receivables, accruals, and accounts payable Working capital policy: The level of each current asset How current assets are financed Cash Conversion Cycle The cash conversion cycle focuses on the time between payments made for materials and labor and payments received from sales: Cash Inventory Conversion = Conversion + Period Cycle Receivables Payables Collection - Deferral Period Period Cash Conversion Cycle (Cont.) Payables CCC = Days per year + Days sales – deferral Inv turnover outstanding period CCC = 365 + 45.6 – 30 4.82 CCC = 75.7 + 45.6 – 30 CCC = 91.3 days Cash Management: Cash doesn’t earn interest, so why hold it? Transactions: Must have some cash to pay current bills Precaution: “Safety stock.” But lessened by credit line and marketable securities Compensating balances: For loans and/or services provided Speculation: To take advantage of bargains, to take discounts, and so on. Reduced by credit line, marketable securities What’s the goal of cash management? To have sufficient cash on hand to meet the needs listed on the previous slide However, since cash is a nonearning asset, to have not one dollar more Ways to Minimize Cash Holdings Use lockboxes Insist on wire transfers from customers Synchronize inflows and outflows Use a remote disbursement account (More…) Minimizing Cash (Continued) Increase forecast accuracy to reduce the need for a cash “safety stock.” Hold marketable securities instead of a cash “safety stock.” Negotiate a line of credit (also reduces need for a “safety stock”) What are some other potential cash inflows besides collections? Proceeds from fixed asset sales Proceeds from stock and bond sales Interest earned Court settlements 10 Inventory Management: Categories of Inventory Costs Carrying Costs: Storage and handling costs, insurance, property taxes, depreciation, and obsolescence Ordering Costs: Cost of placing orders, shipping, and handling costs Costs of Running Short: Loss of sales, loss of customer goodwill, and the disruption of production schedules 11 Elements of Credit Policy Cash Discounts: Lowers price. Attracts new customers and reduces DSO Credit Period: How long to pay? Shorter period reduces DSO and average A/R, but it may discourage sales (More…) 12 Credit Policy (Continued) Credit Standards: Tighter standards reduce bad debt losses, but may reduce sales. Fewer bad debts reduces DSO Collection Policy: Tougher policy will reduce DSO, but may damage customer relationships 13 Is there a cost to accruals? Can firms control accruals? Accruals are free in that no explicit interest is charged Firms have little control over the level of accruals. Levels are influenced more by industry custom, economic factors, and tax laws 14 What is trade credit? Trade credit is credit furnished by a firm’s suppliers Trade credit is often the largest source of shortterm credit, especially for small firms Spontaneous, easy to get, but cost can be high 15 Working Capital Financing Policies Moderate: Match the maturity of the assets with the maturity of the financing Aggressive: Use shortterm financing to finance permanent assets Conservative: Use permanent capital for permanent assets and temporary assets 16 Moderate Financing Policy $ Temp NOWC } Perm NOWC S-T Loans L-T Fin: Stock & Bonds, Fixed Assets Years 17 Lower dashed line, more aggressive Conservative Financing Policy $ Marketable Securities Zero S-T debt Perm NOWC L-T Fin: Stock & Bonds Fixed Assets 18 Years What are the advantages of short term debt vs. longterm debt? Low cost yield curve usually slopes upward Can get funds relatively quickly Can repay without penalty 19 What are the disadvantages of short term debt vs. longterm debt? Higher risk. The required repayment comes quicker, and the company may have trouble rolling over loans 20 ... Working capital management: Includes both establishing working capital policy and then the daytoday control of cash, inventories, receivables, accruals, and accounts payable Working capital policy:...Topics in Chapter Alternative working capital policies Cash, inventory, and A/R management Accounts payable management Shortterm financing policies Bank debt and commercial paper... be high 15 Working Capital Financing Policies Moderate: Match the maturity of the assets with the maturity of the financing Aggressive: Use shortterm financing to finance permanent assets