Chapter 7

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Chapter 7

  1. 1. Current Asset Management (Chapter 7) (Chapter 6 – pages 143 – 145) <ul><li>Working Capital Management </li></ul><ul><li>Current Asset Investment Policy </li></ul><ul><li>Temporary and Permanent </li></ul><ul><li>Current Assets </li></ul><ul><li>Zero Working Capital </li></ul><ul><li>Cash Management </li></ul><ul><li>Marketable Securities </li></ul><ul><li>Accounts Receivable Management </li></ul><ul><li>Inventory Management </li></ul>
  2. 2. Working Capital Management: An Overview <ul><li>Gross Working Capital -(Current Assets) </li></ul><ul><li>New Working Capital - (Current Assets - Current Liabilities) </li></ul><ul><li>Working Capital Management </li></ul><ul><ul><li>Involves investing in current assets and financing of current assets: </li></ul></ul>
  3. 3. Current Asset Investment Policy <ul><li>Everything else remaining the same, higher levels of current assets mean lower risk and lower expected return </li></ul><ul><li>Lower Risk </li></ul><ul><ul><li>Greater ability to meet short-run obligations. </li></ul></ul><ul><li>Lower Return </li></ul><ul><ul><li>Cash and marketable securities typically yield low returns. Furthermore, when current assets are increased, additional financing costs will be incurred thereby lowering returns. </li></ul></ul><ul><li>Lower levels of current assets result in opposite effects. </li></ul>
  4. 4. Alternative Current Asset Investment Policies Current Asset (millions of $) Sales (millions of dollars) Conservative - low risk Aggressive - high risk Moderate
  5. 5. Temporary vs. Permanent Investment in Current Assets <ul><li>Temporary Investment - Commonly, firms experience short-run fluctuations in current assets. For example, retail department stores will have high levels of inventory around Thanksgiving. In January, the inventory should be low. </li></ul><ul><li>Permanent Investment - Firms always have some minimum level of investment in current assets (i.e., a permanent investment). As a firm grows over time, the level of permanent current assets also grows (e.g., a supermarket chain with 70 stores will have more permanent inventory than a chain with 4 stores). </li></ul>
  6. 6. Temporary and Permanent Current Assets Millions of dollars Time Period Temporary Fluctuations in Current Assets Permanent Current Assets
  7. 7. Cash Management: An Overview <ul><li>Beginning Cash Balance </li></ul><ul><li>+ Cash Inflows - - - Speed Up </li></ul><ul><li>- Cash Outflows - - - Slow Down </li></ul><ul><li>= Ending Cash Balance </li></ul><ul><li>- Desired Cash Balance </li></ul><ul><li>= Surplus or Shortage </li></ul><ul><li>If Surplus: Pay off short-term debt or buy marketable securities </li></ul><ul><li>If Shortage: Short-term borrowing or sell marketable securities </li></ul>
  8. 8. Desired Cash Balance: <ul><li>Precautionary Demand - Satisfy possible, but as yet indefinite cash needs. </li></ul><ul><li>Speculative Demand - Build up current cash balances in anticipation of future business costs being lower. </li></ul><ul><li>Risk Preferences </li></ul><ul><li>Compensating Balances </li></ul><ul><li>Transactions Demand - Cash needs arising in the ordinary course of doing business. </li></ul>
  9. 9. Float <ul><li>Much of cash management is oriented towards managing the float. </li></ul><ul><li>Mail Float </li></ul><ul><ul><li>Time lapse from the moment a customer mails a remittance check until the firm begins to process it. </li></ul></ul><ul><li>Processing Float </li></ul><ul><ul><li>Time required for the firm to process remittance checks before they can be deposited in the bank. </li></ul></ul>
  10. 10. Float (Continued) <ul><li>Transit Float </li></ul><ul><ul><li>Time necessary for a deposited check to clear through the commercial banking system and become usable funds to the company. </li></ul></ul><ul><li>Disbursing Float </li></ul><ul><ul><li>Funds available in the firm’s bank account until its payment check has cleared through the system. </li></ul></ul>
  11. 11. Electronic Funds Transfer <ul><li>Substantially reduces float </li></ul><ul><li>Some Examples: </li></ul><ul><ul><li>Automated teller machines </li></ul></ul><ul><ul><li>Direct deposit of payroll checks </li></ul></ul><ul><ul><li>Paying the supermarket and others with bank cards. </li></ul></ul>
  12. 12. Lock-Box System <ul><li>Customers mail remittance checks to P.O. Box. </li></ul><ul><li>Local bank processes and deposits checks directly into the company’s account. </li></ul><ul><li>Reduces mail and processing float. </li></ul><ul><li>Also reduces transit float if lock-box is located near Federal Reserve Bank or branches. </li></ul>
  13. 13. Marketable Securities <ul><li>The marketable securities portfolio is typically used for temporary investments of excess cash, or as a substitute for cash (i.e., near cash). Therefore, securities in the portfolio are generally safe, short-term, and highly liquid. </li></ul><ul><li>Treasury Bills </li></ul><ul><ul><li>Short-term obligations of the federal government with maturities of 91 days to a year. They are traded on a discount basis in bearer form. Not taxable at state and local levels, but taxable at the federal level. </li></ul></ul><ul><li>Commercial Paper </li></ul><ul><ul><li>Unsecured promissory notes issued by large corporations in amounts of $25,000 or more (No active secondary market). </li></ul></ul>
  14. 14. Marketable Securities Continued <ul><li>Negotiable Certificates of Deposit (CDs) </li></ul><ul><ul><li>Offered by financial institutions (e.g., banks, S&Ls). Those big business is interested in have $100,000 minimums. </li></ul></ul><ul><li>Banker’s Acceptance : Generally arise out of foreign trade. </li></ul><ul><ul><li>Importer (buyer) issues a promise to pay a certain amount to the exporter (seller). </li></ul></ul><ul><ul><li>A bank accepts the promise, and commits itself to pay the amount when due. </li></ul></ul><ul><ul><li>Exporter (seller) can now sell this acceptance in the marketplace at a discount (a price that is less than the promised amount). </li></ul></ul>
  15. 15. Accounts Receivable Management <ul><li>Major Decisions </li></ul><ul><ul><li>Credit Standards </li></ul></ul><ul><ul><li>Credit Terms </li></ul></ul><ul><ul><li>Collection Policy </li></ul></ul><ul><li>Credit Standards : Will they pay as agreed? </li></ul><ul><ul><li>Credit Scoring </li></ul></ul><ul><ul><li>Credit Reports </li></ul></ul><ul><ul><li>Past Experience </li></ul></ul><ul><ul><li>Financial Analysis </li></ul></ul><ul><ul><ul><li>Debt Ratios, Liquidity Ratios, Profit Ratios </li></ul></ul></ul>
  16. 16. Accounts Receivable Management (Continued) <ul><li>Credit Terms </li></ul><ul><ul><li>Example: 2/10, net 30 </li></ul></ul><ul><li>Collection Policy </li></ul><ul><ul><li>Standard Operating Procedures </li></ul></ul><ul><ul><li>Be professional, firm, and do not bluff. </li></ul></ul><ul><ul><li>Vary procedures with slow payers. </li></ul></ul><ul><ul><li>Evaluating Collection Efforts </li></ul></ul><ul><ul><ul><li>Average Collection Period, Bad Debt to Sales Ratio, Aging Accounts Receivable, Receivables to Assets Ratio, Credit Sales to Receivables Ratio. </li></ul></ul></ul>
  17. 17. Inventory Management (Covered in Detail in Production Management) <ul><li>Basic Costs Associated With Inventory </li></ul><ul><ul><li>Carrying Costs </li></ul></ul><ul><ul><ul><li>storage, insurance, cost of capital used </li></ul></ul></ul><ul><ul><li>Ordering Costs </li></ul></ul><ul><ul><ul><li>placing orders, shipping and handling </li></ul></ul></ul><ul><ul><li>Costs of Running Short </li></ul></ul><ul><ul><ul><li>lost sales, reduced customer goodwill </li></ul></ul></ul><ul><li>Objective </li></ul><ul><ul><li>Minimize total costs associated with managing inventory. </li></ul></ul>

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