materi working capital.pptx

Principles of Finance 5e, Ch. 15 Working Capital Management © 2012 Cengage Learning. All Rights Reserved.
May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Chapter 15
Working
Capital
Management
1

Chapter 15 – Learning Objectives
 Explain what working capital is and why proper
management of working capital is critical to the
survival of a firm.
 Describe general strategies a firm should follow
when managing its working capital accounts.
 Discuss how a firm should finance its working
capital needs.
May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. 2

Chapter 15 – Learning Objectives
 Describe the types of short-term credit firms use.
 Discuss why it is necessary to compute the cost
of credit and show how the cost of short-term
credit is determined?
 Discuss which assets generally are considered
good security for collateralized short-term loans
and the types of collateralized arrangements that
exist.

Working Capital Terminology
Working capital management
 The management of short-term assets
(investments) and liabilities (financing
sources)

Working capital
 A firm’s investment in short-term assets
 Cash
 Marketable securities
 Inventory
 Accounts receivable

Net working capital
 Current assets minus current liabilities
 The amount of current assets financed by
long-term liabilities and equity

Working capital policy
 Target levels for each current asset
account
 How current assets will be financed

Working capital only includes current
liabilities that are specifically used to
finance current assets

Working capital does not include current
liabilities that are due in the current
period as a result of long-term capital
decisions, even though these must be
considered when assessing the firm’s
ability to meet its current obligations

Not working capital:
 Current maturities of long-term debt
 Financing associated with a construction
program that will be funded with the
proceeds of a long-term security issue after
the project is completed
 Use of short-term debt to finance fixed
assets

The Requirement for External Working
Capital Financing
Seasonal variations
Business cycles
Expansion requires more working capital

The Cash Conversion Cycle
The length of time from the payment for
the purchase of raw materials to
manufacture a product until the
collection of accounts receivable
associated with the sale of the product

1. The inventory conversion period
 Length of time required to convert
materials into finished goods and then to
sell those goods
 The amount of time the product remains in
inventory in various stages of completion

2. The receivables collection period
 Average length of time required to convert
the firm’s receivables into cash
 Also called days sales outstanding (DSO)

3. The payables deferral period
 Average length of time between the
purchase of raw materials and labor and
the payment of cash for them

 The cash conversion cycle
 Net the three periods
 Average length of time a dollar is tied up
in current assets
Cash
conversion
cycle
=
Inventory
conversion
period
Receivables
collection
period
Payables
deferral
period
+ _

Argiles Textiles: Cash Conversion Cycle
Payables
Deferral
Period
(9.0 days)
Inventory Conversion
Period (81.0 days)
Cash Conversion Cycle
(81.0 days + 43.2 days – 9.0 days = 115.2 days)
Receivables Collection
Period (43.2 days)
Purchase Raw
Materials—Increase
Accounts Payable
Pay for Raw
Materials
(CASH OUT)
Sell Finished Goods—
Increase Accounts
Receivable
Collect Accounts
Receivable
(CASH IN)

Working Capital Investment and Financing
Policies
Two basic questions:
 1. What is the appropriate level for current
assets, both in total and by specific
accounts?
 2. How should current assets be financed?

Alternative Current Asset Investment
Policies
Relaxed current asset investment policy
 Relatively large amounts of cash and
marketable securities and inventories are
carried and sales are stimulated by a liberal
credit policy that results in a high level of
receivables

Policies
Restricted current asset investment
policy
 Holdings of cash and marketable securities
and inventories are minimized, and a
restrictive accounts receivable policy is
followed

Policies
Moderate current asset investment
policy
 A policy that is between the relaxed and
restricted policies

Policies
Current Assets
($)
Relaxed
Moderate
Restricted
0 50 100 150 200
40
30
20
10
Sales ($)
Current Assets to Support
Policy Sales of $100
Relaxed $30
Moderate 23
Restricted 16

Current Assets
Permanent current asset
 Current asset balances that do not change
due to seasonal or economic conditions
 These balances exist even at the trough of
a firm’s business cycle
Permanent current assets

Current Assets
Temporary current asset
 Current assets that fluctuate with seasonal
or economic variations in a firm’s business
Temporary current assets
Permanent current assets

Alternative Current Asset Financing
Policies
Maturity matching, or “self-liquidating”
approach
 A financing policy that matches asset and
liability maturities
 This would be considered a moderate
current asset financing policy

Policies
Conservative approach
 A policy where all of the fixed assets, all of
the permanent current assets, and some of
the temporary current assets of a firm are
financed with long-term capital

Policies
Aggressive approach
 A policy where all of the fixed assets of a
firm are financed with long-term capital, but
some of the firm’s permanent current
assets are financed with short-term
nonspontaneous sources of funds

Advantages and Disadvantages of Short-
Term Financing
 Speed
 A short-term loan can be obtained much more
quickly than long-term credit
 Flexibility
 For cyclical needs, avoid long-term debt
 Cost of issuing long-term debt is higher
 There might be penalties for payoff prior to maturity
 Long-term debt generally has restrictive covenants

Term Financing
Cost of long-term versus short-term debt
 Yield curve is generally upward sloping
 Short term interest rates are generally
lower than long-term rates

Term Financing
Risk of long-term versus short-term debt
 Short-term debt subjects the firm to more
risk than long-term debt
 Short-term interest expenses fluctuate
 Firm may not be able to repay short-term debt,
thus might be forced into bankruptcy

Short-Term Credit
Any liability originally scheduled for
repayment within one year

Sources of Short-Term Financing
 Accruals
 Continually recurring short-term liabilities
 Liabilities such as wages and taxes that increase
spontaneously with operations
 Accounts payable (trade credit)
 Credit created when one firm buys on credit from
another firm

Short-term bank loans
 Maturity typically 90 days
 Promissory note specifies terms and
conditions
 Amount, interest rate, repayment schedule,
collateral, and any other agreements

 Compensating balances of 10 to 20 percent
might be required to be maintained in a
checking account
 Line of credit can be arranged
 Specified maximum amount of funds
available

 Revolving credit agreement
 Line of credit where funds are committed,
or guaranteed by the lender
 Commitment fee
 Fee generally charged on the unused
balance of a revolving credit agreement

Commercial paper
 Unsecured short-term promissory notes
issued by large, financially sound firms to
raise funds

 Secured loans
 Loan backed by collateral
 For short-term loans, the collateral is often either
inventory or receivables
 Factoring is the sale of receivables
 Pledging is the use of receivables as collateral for
a loan
 The lender might seek recourse (payment) from
the borrowing firm for uncollectible receivables
used to secure a loan

Computing the Cost of Short-Term Credit
Dollar cost of borrowing
Amount of usable funds
rPER =
Effective
annual rate
Annual
percentage rate
= EAR = [1 + rPER]m - 1.0
= APR = rPER x m = rSIMPLE
Percentage cost per period = rPER
=
Dollar cost of borrowing
Amount of usable funds

Computing the Cost of Short-Term Credit
Discount interest loan
 A loan in which the interest, which is
calculated on the amount borrowed
(principal), is paid at the beginning of the
loan period
 Interest is paid in advance

Managing Cash and Marketable Securities
Cash management
 Goal of minimizing the amount of cash the
firm must hold for use in conducting its
normal business activities; must consider
the ability to:
 Pay suppliers
 Maintain its credit rating
 Meet unexpected cash needs

Firms Hold Cash For:
1. Transaction balance
 Cash balance necessary for day-to-day
operations
 The balance associated with routine payments
and collections
2. Compensating balance
 Deposit to meet bank loan requirements

Firms Hold Cash For:
3. Precautionary balance
 Cash balance held in reserve for unforeseen
fluctuations in cash flows
 Access to line of credit can reduce the need
for precautionary balances
4. Speculative balance
 Cash balance that is held to enable the firm to
take advantage of any bargain purchases that
might arise
 Easy access to borrowed funds can reduce the
need for speculative balances

Cash Management Techniques
Cash forecasts
Predict the timing of cash flows
Cash flow synchronization
Cash inflows coincide with cash
outflows, permitting a firm to hold low
transaction balances

Float
 The difference between the balance shown
in a checkbook and the balance on the
bank’s records

 Disbursement float
 The value of checks that have been written and
disbursed but have not fully cleared through
the banking system and thus have not been
deducted from the account on which they were
written
 Collection float
 The amount of checks that have been received
and deposited but have not yet been credited
to the account in which they were deposited,
because they have not cleared through the
banking system

Net float
The difference between disbursement
float and collection float
The difference between the balance
shown in the checkbook and the balance
shown on the bank’s books

Acceleration of receipts
 Lockbox arrangement
 Reduce float by having payments sent to
post office boxes located near customers
 Faster mail delivery
 Faster check clearing within the same
Federal Reserve district

Acceleration of receipts
 Preauthorized debit system
 Allows a customer’s bank to periodically
transfer funds from a customer’s account to a
selling firm’s bank account for the payment of
bills
 Concentration banking
 A technique used to move funds from many
bank accounts to a more central cash pool to
more effectively manage cash

Disbursement control
 Centralized disbursement system
 More control, but can delay payments
 Zero-balance account (ZBA)
 Special account used for disbursements that has a
balance of zero when there is no disbursement
activity
 Controlled disbursement accounts (CDA)
 Checking accounts in which funds are not
deposited until checks are presented for
payment, usually on a daily basis

Marketable securities
 Securities that can be sold on short notice
without loss of principal or original
investment
 Substitute for cash balances
 Temporary investment
 Finance seasonal or cyclical operations
 Amass funds to meet financial requirements in the
near future

Credit Management
Credit policy
 A set of decisions that include a firm’s
credit standards, credit terms, methods
used to collect credit accounts, and credit
monitoring procedures

Credit Management
Credit policy factors
 Credit standards
 Standards that indicate the minimum financial
strength a customer must have to be granted
credit
 Terms of credit
 Credit period
 The length of time for which credit is granted
 Length of credit period and any cash discounts
offered

Credit Management
Credit policy factors
 Collection policy
 The procedures followed by a firm to collect its
accounts receivables

Credit Management
Receivables monitoring
 The process of evaluating the credit policy
to determine if shifts in the customers’
payment patterns occur

Credit Management
 Receivables monitoring
 Days sales outstanding (DSO)
 The average length of time required to collect accounts
receivable
 Also called the average collection period
 Aging schedule
 Report showing how long accounts receivable have been
outstanding
 The report divides receivables into specified periods;
provides information about the proportion of receivables
that is current and the proportion that is past due for
given lengths of time

Argiles Textiles:
Receivables Aging Schedule, 2012
Age of Account
(days)
Net Amount
Outstanding
($ million)
Fraction of
Total
Receivables
Average
Days
0–30 $36.0 40% 18
31–60 45.0 50 55
61–90 5.4 6 77
Over 90 3.6 4 97
$90.0 100%
DSO = 0.40(18 days) + 0.50(55 days) + 0.06(77 days) + 0.04(97 days) = 43.2 days

Credit Management
Analyzing proposed changes in credit
policy
 Use NPV analysis the same as for capital
budgeting analysis
 Timings of the cash inflows and cash
outflows are important to the analysis

Inventory Management
 Raw materials
 Inventories purchased from suppliers that will
ultimately be transformed into finished goods
 Work in-process
 Inventory in various stages of completion
 Finished goods
 Inventories that have completed the production
process and are ready for sale

Optimal inventory level
Sustain operations at the lowest
possible cost

Stockout
 When a firm runs out of inventory and
customers arrive to purchase the product

Inventory costs
 Carrying costs
 Storage, insurance, use of funds, depreciation,
etc…
 Ordering costs
 Costs of placing an order
 The cost of each order is generally fixed
regardless of the average size of inventory

Total inventory costs (TIC)
= Total carrying costs + Total ordering costs
=
Carrying cost
per unit
æ
è
ç
ö
ø
÷ ´
Average units
in inventory
æ
è
ç
ö
ø
÷ +
Cost per
order
æ
è
ç
ö
ø
÷ ´
Number of
orders
æ
è
ç
ö
ø
÷
= C ´ PP
( ) ´
Q
2
æ
è
ç
ö
ø
÷ + O ´
T
Q
æ
è
ç
ö
ø
÷
C = carrying cost as a percent of PP
PP = purchase price of product
Q = quantity ordered
T = total demand for product
O = fixed cost per order

Economic order quantity (EOQ)
 The optimal quantity that should be ordered
 It is the quantity that will minimize the total
inventory costs

Economic Ordering Quantity Model
EOQ model
 Formula for determining the order quantity
that will minimize total inventory costs
EOQ =
2´O´T
C´ PP

EOQ model extensions
 Reorder point
 The level of inventory at which an order
should be placed
 Safety stocks
 Additional inventory carried to guard
against changes in sales rates or
production/shipping delays

EOQ model extensions
 Quantity discount
 A discount from the purchase price offered
for inventory ordered in large quantities
 Seasonal adjustments
 EOQ computed separately for each season
to account for sales variations

Inventory control systems
 Red-line method
 An inventory control procedure in which a red
line is drawn around the inside of an inventory-
stocked bin to indicate the reorder point
 Computerized inventory control system
 A system of inventory control in which a
computer is used to determine reorder points
and to adjust inventory balances

Inventory control systems
 Just-in-time system
 A system of inventory control in which a
manufacturer coordinates production with
suppliers so that raw materials or components
arrive just as they are needed in the
production process
 Out-sourcing
 The practice of purchasing components
rather than making them in-house

Multinational Working Capital Management
Cash management
 Speed up collections and slow down
disbursements
 Shift cash as rapidly as possible to those
areas where it is needed
 Put temporary cash balances to work
earning positive returns

Credit management
 Credit policy is more important
 Risk of default
 Political and legal collection constraints
 Exchange rate changes between sale and time
receivable is collected

Inventory management
 Concentrate inventory or distribute?
 Costs versus distribution schedules
 Exchange rates affect inventory
 Threat of expropriation
 Tax effects

Chapter Principles
Key Working Capital Management Concepts
 What is working capital and why is working capital management
critical to the survival of the firm?
 Working capital refers to the short-term assets of a firm. Poor
working capital management generally results in financial
distress
 What general strategies should a firm follow when managing its
working capital accounts?
 Collect funds that it is owed as quickly as possible and delay
payments that it owes for as long as possible.
 How should the firm finance its working capital needs?
 Most firms follow a maturity matching approach that specifies
firms should finance spontaneous, self-liquidating assets with
temporary debt and finance more permanent assets with
more permanent debt.

Chapter Principles
 What types of short-tem credit do firms use?
 Banks offer a variety of short-term loans
 A note that has a maturity of less than a year
 A line of credit
 Suppliers often permit firms to purchase materials on credit
(payables)
 Accruals—wages and taxes are the biggest
 How is the cost of short-term credit determined? Why
is it necessary to compute the cost of credit?
 The percentage cost of credit per period is equal to the dollar
cost of borrowing divided by the amount of funds that the
borrower can use
 Firms must know what they pay to use credit.

Chapter Principles
 Which assets are good security for
collateralized short-term loans? What are
some of the arrangements that exist with
secured short-term loans?
 Accounts receivable and inventory make good
collateral for short-term loans
 Receivables can be either factored (sold) or
pledged (used as collateral for a loan)
 Inventory arrangements can be in the forms of
blankets liens, trust receipts, or warehouse
receipts

End of Chapter 15
Working Capital
Management

materi working capital.pptx

Recommended

Recommended

More Related Content

Similar to materi working capital.pptx

Similar to materi working capital.pptx (20)

More from KomangMuliana1

More from KomangMuliana1 (6)

Recently uploaded

Recently uploaded (20)

materi working capital.pptx