chapter 16
DESCRIPTION
Chapter 16. Management of Short-term Assets. Preliminary Definitions. Working capital: Current (short-term) assets Net working capital: Current assets minus current liabilities Working capital policy: Management of current assets and current liabilities. The Operating Cycle. - PowerPoint PPT PresentationTRANSCRIPT
Preliminary Definitions
• Working capital: Current (short-term) assets
• Net working capital: Current assets minus current liabilities
• Working capital policy: Management of current assets and current liabilities
The Operating Cycle
• Time it takes to produce output, sell it, and collect payment
• Timing of payments– Varies among industries
– Affects the need for short-term finance
Financing and Working Capital Policy
• Matching sources and uses of funds
• Basic principle: do not use short-term sources to finance long-term assets
• Cost structure of funds:– Long-term sources tend to be more
expensive than short-term source
Aggressive Working Capital Policy
• Use of more short-term sources– Increases profitability
– Increases risk
• But also increases the need to roll over or refinance short-term debt
Inventory Cycle
• Inventory is– acquired
– drawn down to some level
– replenished
– and the cycle is repeated
• The safety stock
The Economic Order Quantity (EOQ)
• Ordering costs versus carrying costs
• Fewer orders reduce ordering costs but increases carrying costs
The Economic Order Quantity (EOQ)
• The EOQ minimizes the sum of– Ordering costs (e.g., shipping and
processing costs) plus
– Carrying costs (e.g., warehouse expense, insurance, and interest expense)
The Economic Order Quantity (EOQ)
$ Costs
Order Size316
B
Total Ordering Costs
Total Carrying Costs
D
Total Costs
F
C
$3,180
E
A
The Inventory Cycle Combined with the EOQ
Days10
50
366
15
Safety Stock
Level of Inventory
Units of Inventory
0 5
The Inventory Cycle Combined with the EOQ
• Maximum inventory: EOQ plus the safety stock
• Minimum inventory: Safety stock
• Average inventory: EOQ/2 + safety stock
EOQ Model
• A very simple model
• Assumes– sales occur evenly– no quantity discounts– individual items are identifiable
• Highlights the trade off between ordering costs and carrying costs
Just-in-Time inventory management
• Designed to minimize the amount of inventory
• Requires– accurate forecasts– excellent timing– dependable shipping– flexible schedules– frequent communication
Management of Accounts Receivable
• Credit policy encompasses
– Who will receive credit
– Terms of credit
– Collections
Decision to Grant Credit
• Trade-off between additional sales versus additional costs
• Additional costs– Cost of goods sold
– Credit and collection costs
– Bad debt expense
– Carrying costs
Analyzing Accounts Receivable
• Receivables turnover: Credit sales/Accounts receivable
• Aging schedules: Determine payment patterns
Money Market Instruments and Yields the Instruments
• U.S. Treasury bills
• Commercial paper
• Negotiable certificates of deposit
• Banker's acceptances
• Eurodollar CDs
• Repurchase agreements (REPOs)
Yields: the Discount Yield
• Depends on– The principal amount
– The amount of the discount– The time to maturity
Yd = Par value - Price x ________360_______
Par value Number of days to maturity
Yields: the Discount Yield
• Yd = Par value - Price x ________360_______
Par value Number of days to maturity
• $10,000 - $9,791 x _360_ = $10,000 180
4.18%
• Yd = Par value - Price x _ 365______
Price Number of days to maturity
• $10,000 - $9,791 x _365_ = $9,791 180
Alternative Calculation: Simple Interest
4.33%