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14 14 Presentation Transcript

  • Chapter 14 The Management of Working Capital © 2000 South-Western College Publishing
  • WORKING CAPITAL
    • Assets and liabilities required to operate a business on a day to day basis
    • Cash Payables
    • Receivables Accruals
    • Inventory
    • Short Term - Turn Over Continually
    • TRADITIONAL DEFINITIONS
    • Gross Working Capital = Current Assets
    • Net Working Capital = Current Assets - Current Liabilities
    • WORKING CAPITAL REQUIRES FUNDING
    • Net working capital reflects the funding required
    • to support routine operations
    • THE OBJECTIVE OF WORKING CAPITAL MANAGEMENT
    • Run the company effectively with as little money tied up
    • in the current accounts as possible.
    • Implies trade-offs because it's easier to run a business with
    • more working capital than with less
    • TM 14-1
  • PERMANENT AND TEMPORARY WORKING CAPITAL
    • Temporary Working Capital supports seasonal operations
    • and need not be maintained all year
    • $ $ Temporary
    • Working Capital
    • Permanent Permanent
    • Working Capital Working Capital
    • Fixed Assets Fixed Assets
    • Time Time
    • Stable Company Seasonal Company
    • Figure 14-3 Working Capital Needs of Different Firms
    • TM 14-4
  • FINANCING WORKING CAPITAL
    • Net Working Capital can generally be financed
    • with short-term borrowing
    • The practice is cheaper but riskier than using long-term funds
    • Leads to relatively aggressive or
    • conservative W/C financing policies
    • TM 14-5 Slide 1 of 3
    • $ Temporary
    • Working Capital Short-Term
    • Debt Financing
    • Long-Term Debt
    • Permanent and Equity
    • Working Capital Financing
    • Fixed Assets
    • Time
    • (a) Conservative Policy Using Largely Long Term Sources
    • Working Capital Financing Policies
    • Figure 14-4
    • TM 14-5 Slide 2 of 3
    • Time
    • (b) Aggressive Policy Using More Short-Term Debt
    • Working Capital Financing Policies
    • Figure 14-4
    • TM 14-5 Slide 3 of 3
    $ Temporary Working Capital Short-Term Debt Financing Permanent Working Capital Long-Term Debt and Equity Fixed Assets Financing Time
  • WORKING CAPITAL POLICY
    • How much working capital is used
    • The extent to which working capital is supported by short-
    • versus long-term financing
    • The nature/source of short-term financing used
    • How each component of working capital is managed
    • SOURCES OF SHORT TERM FINANCING
    • Spontaneous Financing
    • Unsecured Bank Loans
    • Secured Loans
    • Commercial Paper
    • TM 14-6
  • SPONTANEOUS FINANCING
    • ACCRUALS
    • Mainly wages and salaries
    • Little policy latitude
    • ACCOUNTS PAYABLE - TRADE CREDIT
    • Credit Terms
    • Terms of Sale, e.g. 2/10, net 30
    • Net amount due within thirty days, a two percent prompt payment discount
    • may be taken if paid within ten days
    • The Prompt Payment Discount
    • Abuses of Trade Credit Terms
    • * Stretching payables or leaning on the trade
    • * slow payer * credit agency
    • * credit reports * credit rating
    • TM 14-7
  • BANK LOANS
    • Promissory Note
    • Commitment to repay funds according to terms
    • Line of Credit
    • Informal, cancelable agreement for maximum borrowing in a year
    • Revolving Credit Agreement
    • Binding agreement for maximum borrowing in a year
    • Requires a commitment fee on unborrowed amounts
    • TM 14-8 Slide 1 of 2
  • BANK LOANS
    • Compensating Balances
    • Part of loan must be left in bank account
    • Funds may be partly or entirely unusable
    • Raises Bank's Yield
    • minimum
    • average
    • Cleanup Requirements
    • Requires borrower to be out of short term debt for a period each year
    • Prevents funding long term projects with short term debt
    • COMMERCIAL PAPER
    • Notes issued by large, strong companies to borrow for
    • relatively short periods
    • TM 14-8 Slide 2 of 2
  • SHORT TERM CREDIT SECURED BY CURRENT ASSETS
    • RECEIVABLES FINANCING
    • A key issue is collectibility.
    • Relates to the credit worthiness of the firm's customers
    • rather than to its own
    • Pledging Accounts Receivable
    • Using cash value as collateral for a loan.
    • With and without RECOURSE
    • Receivables continue to belong to the borrowing firm,
    • which administers collection
    • TM 14-9 Slide 1 of 2
  • SHORT TERM CREDIT SECURED BY CURRENT ASSETS(cont.)
    • Factoring Receivables
    • Selling the receivable at a discount to a factor
    • Payment made directly to factor
    • Recourse
    • Interest
    • Other Services
    • Pledging and factoring tend to be expensive forms of financing
    • INVENTORY FINANCING
    • Inventory as collateral for loan
    • Major problem is tracking
    • Blanket Liens
    • Trust Receipt or Chattel Mortgage Agreement
    • Warehousing - Field, Public - Secure but expensive
    • TM 14-9 Slide 2 of 2
  • CASH MANAGEMENT
    • The Motivation for Holding Cash
    • Transactions Demand
    • Precautionary Demand
    • Speculative Demand
    • Compensating Balances
    • The Objective of Cash Management
    • Cash in the bank doesn't earn a return.
    • but
    • It is easier to run a business with more cash than with less - LIQUIDITY
    • Good cash management minimizes the amount in the bank,
    • consistent with efficient operations.
    • Marketable Securities
    • A compromise
    • Good liquidity with a modest return
    • TM 14-10
  • CHECK DISBURSEMENT AND COLLECTION PROCEDURES
    • 1. The payer writes a check on its bank, and mails it to the payee. (2-3 days)
    • 2. The payee receives the check, records it, and processes it internally for deposit.
    • 3. The payee then deposits the check in its own bank. (2 days - items 2 and 3)
    • 4. The payee's bank sends the check into the Federal Reserve's interbank clearing system at a Federal Reserve office.
    • 5. The clearing system processes the check. This transfers money from the payer's account at its bank into the payee's account at its bank. The funds are now available for the payee's use. The canceled check is returned to the payer through its bank. (2 days - items 4 and 5)
    • TM 14-11 Slide 1 of 2
    • Check in Mail
    • Process Notice of
    • Internally Available
    • Deposit Funds
    • Check
    • ( 2 days )
    • Banking System
    • ( 2 Days )
    • Check Check
    • $ $
    • Figure 14-5 The Check Clearing Process
    • FLOAT - Money tied up in the process : Mail Float - Check in the mail;
    • Processing Float - In payee's office; Transit Float - In federal reserve system
    • TM 14-11 Slide 2 of 2
    Payer Payee ( 2-3 days ) Payer’s Bank Account Fed Reserve Clearing Sys. Payee’s Bank Acct.
  • Check in Mail Notice of Available Funds Banking System ( 2 Days ) Check Check $ $ Figure 14-6 A Lock Box System in The Check Clearing Process TM 14-12 Slide 1 of 2 Payer Payee ( 1-2 days ) Payer’s Bank Account Fed Reserve Clearing Sys. Payee’s Bank Acct. Lock Box ACCELERATING CASH RECEIPTS - LOCK BOX SYSTEMS: Payee rents a post office box near its bank, orders payers to mail checks to the box; bank opens the box and deposits checks in the payee’s account. Saves two or three days.
  • OTHER CASH MANAGEMENT CONCEPTS
    • Managing Cash Outflow
    • Zero Balance Accounts (ZBA's)
    • Remote Disbursing
    • Evaluating the Cost of Cash Management Services
    • Benefit is largely the interest savings
    • on lower cash balances
    • which must exceed the cost of the system
    • TM 14-12 Slide 2 of 2
  • MANAGING ACCOUNTS RECEIVABLE
    • More Receivables => More Sales
    • But also More Carrying Cost and More Bad Debt Losses
    • Managing accounts receivable means striking a balance
    • which maximizes profitability.
    • (RECEIVABLES POLICY or CREDIT and COLLECTIONS POLICY)
    • Three broad issues are involved:
    • 1. Who should get credit, and how much should be allowed
    • 2. What terms (due dates and discounts) should be offered
    • 3. How should customers who don't pay on time be handled
    • Who Is Responsible For Receivables Policy
    • Receivables policy is a joint effort between financial
    • and sales/marketing management.
    • The Conflict With Sales Over Credit and Collections Policy
    • Credit Standards for Accepting Sales
    • Dunning
    • Collection Agencies
    • TM 14-13
  • INVENTORY
    • BENEFITS OF CARRYING INVENTORY
    • Smoother Production Operations - Delays and Idle time
    • Fewer Stockouts in Filling Orders - Lost Sales
    • COSTS OF CARRYING INVENTORY
    • Costs: Interest Losses: Shrinkage (theft)
    • Storage and Spoilage
    • Security Breakage
    • Insurance Obsolescence
    • Taxes
    • TM 14-14 Slide 1 of 2
  • INVENTORY MANAGEMENT
    • The overall way a company oversees its inventory and uses control systems to manage benefits against costs.
    • Defining an acceptable level of operating efficiency in terms of stockouts, backorders and production problems, and trying to achieve it with minimum inventory cost.
    • There is no single approach to managing inventory. Success comes from reviews, attention to detail and using a variety
    • of control systems.
    • TM 14-14 Slide 2 of 2
  • THE ECONOMIC ORDER QUANTITY (EOQ) MODEL
    • An approach to minimizing total inventory cost by recognizing the trade-off between carrying cost and ordering cost.
    • Quantity
    • on hand
    • Q
    • Avg Qty
    • Q/2 on
    • hand
    • Time
    • Figure 14-7 Inventory on Hand for a Steadily Used Item
    • TM 14-15
  • THE ECONOMIC ORDER QUANTITY (EOQ) MODEL
    • C = Yearly carrying cost per unit
    • Q = Order Quantity
    • D = Annual Demand
    • F = Cost Per Order
    • Carrying cost = C (Q/2)
    • N = D/Q
    • Ordering Cost = FN = F (D/Q)
    • TM 14-16 Slide 1 of 2
    • Costs, $
    • Total Cost Carrying
    • Cost
    • Ordering
    • Cost
    • EOQ Q ( Order Size )
    • Figure 14-8 Inventory Costs and the EOQ
    • TM 14-16 Slide 2 of 2
  • SAFETY STOCKS - REORDER POINTS - LEAD TIMES
    • Quantity
    • on Hand
    • Expected Usage
    • Q
    • Q/2 plus Avg Qty
    • Safety Stk on
    • Hand
    • Reorder
    • Point
    • Safety High Delayed
    • Stock Usage Delivery
    • Time
    • Ordering
    • Lead Time
    • Figure 14-9 Pattern of Inventory on Hand Including Safety Stock Showing Reorder Point, Lead Time, and the Effects of High Usage and Delayed Delivery
    • TM 14-17 Slide 1 of 2
  • OTHER INVENTORY CONCEPTS
    • ABC Systems
    • Recognize the relative value of pieces
    • and control each with appropriate effort/expense
    • Just In Time (JIT) Systems
    • Eliminate manufacturing inventories by requiring vendor shipments timed precisely to production schedules
    • TM 14-17 Slide 2 of 2