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Chapter 14 Working Capital
Management and Policies
McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
Revisiting the Balance Sheet Model of
the Firm
• Current assets
– Most liquid
– Less profitable than fixed assets
– Represent net amount firm has to fund
14-2
Revisiting the
Balance Sheet Model
• Net working capital =
Current Assets – Current Liabilities
– Firm’s objective is to fund the least amount of net
working capital possible
14-3
Tracing Cash and
Net Working Capital
• Operating Cycle is the time needed to
– Acquire raw materials and turn into finished goods
– Sell and receive payment for them
14-4
Operating Cycle
14-5
Cash Cycle
• Portion of operating cycle firm must finance
• Time between payment for inventory and sales
receipts
14-6
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Capital.ppt

  • 1. 1 Chapter 14 Working Capital Management and Policies McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
  • 2. Revisiting the Balance Sheet Model of the Firm • Current assets – Most liquid – Less profitable than fixed assets – Represent net amount firm has to fund 14-2
  • 3. Revisiting the Balance Sheet Model • Net working capital = Current Assets – Current Liabilities – Firm’s objective is to fund the least amount of net working capital possible 14-3
  • 4. Tracing Cash and Net Working Capital • Operating Cycle is the time needed to – Acquire raw materials and turn into finished goods – Sell and receive payment for them 14-4
  • 6. Cash Cycle • Portion of operating cycle firm must finance • Time between payment for inventory and sales receipts 14-6
  • 7. Short Term Financial Policy • Firms reduce net working capital needs – Manage need for current assets – Obtain current liabilities to fund current assets 14-7
  • 8. Size of Current Assets Investment Two categories of carrying costs: 1) Opportunity costs with capital tied up in current assets 2) Explicit costs to maintain value of current assets 14-8
  • 9. Financing Terms Consider Asset Demand Peaks and Valleys 14-9
  • 10. Alternative Financial Policies for Current Assets • Flexible financing policy • Restrictive financing policy • Compromise financing policy 14-10
  • 11. Flexible Financing Long-Term Debt for Peak Asset Demand 14-11
  • 12. Restrictive Financing: Long-Term Debt/Equity for Trough Asset Demand 14-12
  • 13. Compromise Financing Seasonal Average Asset Demand Financed with Long-Term Debt/Equity 14-13
  • 14. Short-Term Financial Plans • Firms not using flexible financing will need to seek short-term solutions – Unsecured loans – Secured loans – Other short-term financing alternatives 14-14
  • 15. Unsecured Loans • Commercial loan from bank – Usually a line of credit – Fees can be explicit and implicit 14-15
  • 16. Secured Loans • Asset-based loans – Lenders charge lower interest rates – Real estate, accounts receivable, inventory used as collateral 14-16
  • 17. Other Financing Sources • Commercial paper • Banker’s acceptances 14-17
  • 18. Cash Management • Clarification on terminology cash flow vs. cash account – Cash flows are good – Cash account is a current asset with high liquidity and low profitability 14-18
  • 19. Reasons for Holding Cash • Transaction facilitation • Compensating balances • Investment opportunities 14-19
  • 20. Baumol Model • Strength: Minimizes sum of opportunity costs and trading costs • Weakness: Unrealistic assumptions 14-20
  • 21. The Miller-Orr Model • Assumes daily net cash flows normally distributed • Allows for cash inflows and outflows 14-21
  • 22. Other Factors Influencing Target Cash Balance • Short-term borrowing for unexpected cash demands • Declining trading costs • Firm requirement to maintain compensating balances 14-22
  • 23. Float Control: Collection and Disbursement of Cash Float – the period of time after check is written but not yet cleared and deposited 14-23
  • 24. Float Control • Three types of collection float – Mail – In-house processing – Availability 14-24
  • 25. Delaying Disbursements Legal ways to increase disbursement float – Zero-balance account – Drafts 14-25
  • 26. Ethical and Legal Questions Illegal practices – Using collected cash before receiving it – Continuing to use disbursed cash after check sent – Check kiting is drawing money against account with insufficient funds 14-26
  • 27. Investing Idle Cash • Most large firms invest in their own marketable securities • Smaller firms invest in money-market fund or bank sweep account 14-27
  • 28. Why Firms Have Excess Cash • Seasonal fluctuations • Preparation for a planned expenditure 14-28
  • 29. What to Do with Surplus Cash • Appropriate investments – Treasury bills – Federal Funds – Repurchase agreements – Commercial paper – Negotiable CDs – Banker’s acceptances 14-29
  • 30. Credit Management Trade-off between the opportunity cost of lost sales, and the carrying costs of funding Accounts Receivable (AR) plus the expected costs of default on AR 14-30
  • 31. Credit Policy: Terms of the Sale Credit terms include – Credit period – Cash discount – Description of the type of credit instrument 14-31
  • 32. Credit Analysis • Determination of the borrower’s ability and willingness to pay • 5 C’s of credit: 1. Capacity 2. Character 3. Capital 4. Collateral 5. Conditions 14-32
  • 33. Collection Policy • Collecting past-due accounts from customers • Typical procedure – Send delinquency letters – Initiate telephone calls – Employ collection agency – Legal action against the customer 14-33