Chapter 7: Current Asset Management


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Chapter 7: Current Asset Management

  1. 1. Chapter 7 Current Asset Management Copyright 2006. Based on Foundations of Financial Manage-ment by Stanley B. Block and Geoffrey A. Hirt, 11 th ed. (2005), on slides prepared by and copyright by McGraw-Hill/Irwin, and on work by John Kevin Doyle.
  2. 2. Chapter 7 - Outline <ul><li>Current Asset Management. </li></ul><ul><li>Cash Management. </li></ul><ul><li>Ways to Improve Collections. </li></ul><ul><li>Marketable Securities. </li></ul><ul><li>Three Primary Variables of Credit Policy. </li></ul><ul><li>Inventory Management. </li></ul><ul><li>Level vs. Seasonal Production. </li></ul><ul><li>Economic Ordering Quantity. </li></ul>
  3. 3. <ul><li>Current Asset Management is essentially an extension of working capital management. </li></ul><ul><li>It is concerned with the current assets of a firm (cash, A/R, marketable securities, and inventory). </li></ul><ul><li>A financial manager needs to remember that the less liquid an asset is, the higher the required return. </li></ul>Current Asset Management
  4. 4. Cash Management <ul><li>The financial manager wants to keep cash balances to a minimum. </li></ul><ul><li>There are two reasons for holding cash: </li></ul><ul><ul><li>for everyday transactions (main reason). </li></ul></ul><ul><ul><li>compensating balances. </li></ul></ul><ul><ul><li>for precautionary needs (emergencies). </li></ul></ul>
  5. 5. Cash Management <ul><li>Goals are </li></ul><ul><ul><li>to speed up the inflow of cash (or improve collections) and </li></ul></ul><ul><ul><li>slow down the outflow of cash (or extend disbursements). </li></ul></ul><ul><li>Also will attempt to “play the float”. </li></ul>
  6. 6. FIGURE 7-2 Expanded cash flow cycle
  7. 7. TABLE 7-1 The use of float to provide funds
  8. 8. TABLE 7-2 Playing the float
  9. 9. Ways to Improve Collections <ul><li>Collection Center </li></ul><ul><ul><li>– speeds up collection of A/R and reduces mailing time. </li></ul></ul><ul><li>Electronic Funds Transfer (or Wire Transfer of Funds) </li></ul><ul><ul><li>– a system where payments are automatically deducted from a bank account. </li></ul></ul><ul><li>Lockbox System </li></ul><ul><ul><li>– when customers mail payment to a local post office box instead of to the firm. </li></ul></ul>
  10. 10. FIGURE 7-3 Cash management network
  11. 11. Marketable Securities <ul><li>Treasury Bills (T-Bills) and Notes. </li></ul><ul><li>Certificates of Deposit (CDs). </li></ul><ul><li>Banker’s Acceptances. </li></ul><ul><li>Eurodollar Certificates of Deposit. </li></ul><ul><li>Passbook Savings Accounts. </li></ul><ul><li>Money Market Funds. </li></ul>
  12. 12. FIGURE 7-6 An examination of yield and maturity characteristics
  13. 13. TABLE 7-3 Types of short-term investments
  14. 14. <ul><li>There are three things to consider in deciding whether to extend credit: </li></ul><ul><ul><li>Credit Standards. </li></ul></ul><ul><ul><li>Terms of Trade. </li></ul></ul><ul><ul><li>Collection Policy. Measures of efficiency: </li></ul></ul><ul><ul><ul><li>Average Collection Period. </li></ul></ul></ul><ul><ul><ul><li>Ratio of Bad Debts to Credit Sales. </li></ul></ul></ul><ul><ul><ul><li>Aging of Accounts Receivable. </li></ul></ul></ul>Three Primary Variables of Credit Policy
  15. 15. TABLE 7-4 Dun & Bradstreet report
  16. 16. Inventory Management <ul><li>Inventory is divided into three categories: </li></ul><ul><ul><li>Raw Materials. </li></ul></ul><ul><ul><li>Work in Progress (WIP) or Unfinished Goods. </li></ul></ul><ul><ul><li>Finished Goods. </li></ul></ul><ul><li>There are two basic costs associated with inventory: </li></ul><ul><ul><li>Carrying Costs. </li></ul></ul><ul><ul><li>Ordering Costs. </li></ul></ul>
  17. 17. Level vs. Seasonal Production <ul><li>Level Production: </li></ul><ul><ul><li>producing the same (equal) amount each month. </li></ul></ul><ul><ul><li>inventory costs are higher. </li></ul></ul><ul><ul><li>operating costs are lower. </li></ul></ul><ul><li>Seasonal Production: </li></ul><ul><ul><li>producing a different amount each month (based on the season). </li></ul></ul><ul><ul><li>inventory costs are lower. </li></ul></ul><ul><ul><li>operating costs are higher. </li></ul></ul>
  18. 18. FIGURE 7-9 Determining the optimum inventory level
  19. 19. Economic Ordering Quantity <ul><li>Economic Ordering Quantity (EOQ): </li></ul><ul><ul><li>the optimal (best) amount for the firm to order each time. </li></ul></ul><ul><ul><li>occurs at the low point on the total cost curve. </li></ul></ul><ul><ul><li>the order size where total carrying costs equal total ordering costs (assuming no safety stock). </li></ul></ul><ul><li>Safety Stock: </li></ul><ul><ul><li>“extra” inventory the firm keeps in stock in case of unforeseen problems. </li></ul></ul>
  20. 20. EOQ Formula <ul><li>Assumes: </li></ul><ul><ul><li>Inventory usage at a constant rate. </li></ul></ul><ul><ul><li>Order costs per order are constant. </li></ul></ul><ul><ul><li>Delivery time of orders is consistent and order arrives as inventory reaches zero. </li></ul></ul>