Download - FIN. MGT2
Working Capital Management
By: GMAF, CPA
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Topics in Chapter
•Alternative current operating assets investment and financing policies
•Cash, inventory, and A/R management•Accounts payable management•Short-term financing•Bank loans, their costs, and commercial
paper
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Basic Definitions
•Working capital: Total current assets used in
operations.•Net working capital:
Current assets – Current liabilities.•Net operating working capital (NOWC):
Operating CA – Operating CL =(Cash + Inv. + A/R) – (Accruals +
A/P)
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Definitions (Continued)
•Working capital management: Includes both establishing working capital policy and then the day-to-day control of cash, inventories, receivables, accruals, and accounts payable.
•Working capital policy:▫The level of each current asset.▫How current assets are financed.
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Cash Conversion Cycle
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The cash conversion cycle focuses on the time between payments made for materials and labor and payments received from sales: Cash Conversion = Cycle
InventoryConversion + Period
Average Collection − Period
Payables Deferral Period
Cash Conversion Cycle (Cont.)
•Data:▫Annual sales = $660,000▫COGS/Sales = 90%▫Inventory turnover = Sales/Inventory = 6.
•Inventory = $660,000/6 = $110,000.•COGS = (0.9)($660,000) = $594,000.•Inv. Conv. = $110,000/($594,000/365)• = 67.6 days.
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Cash Conversion Cycle (Cont.)
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CCC = + –
CCC = 67.6 + 45.6 – 30
CCC = 83.2 days.
Inventory conversion
period
Payables deferral period
Days salesoutstanding
Cash Management: Cash doesn’t earn interest, so why hold it?•Transactions (Routine): Must have some
cash to pay current bills.•Transactions (Precaution): “Safety stock.”
But lessened by credit line and marketable securities.
•Compensating balances: For loans and/or services provided.
•Essential that the firm have sufficient cash to take trade discounts.
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What’s the goal of cash management?Minimize the cash amount the firm must
hold for conducting its normal business activities, yet, at the same time, have a sufficient cash reserve to:•take trade discounts.•pay promptly and maintain its credit rating.•meet any unexpected cash needs.
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Ways to Minimize Cash Holdings•Use lockboxes.•Insist on wire transfers or automatic debit
from customers.•Synchronize inflows and outflows.•Use float.
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Minimizing Cash (Continued)
•Increase forecast accuracy to reduce the need for a cash “safety stock.”
•Hold marketable securities instead of a cash “safety stock.”
•Negotiate a line of credit (also reduces need for a “safety stock”).
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Cash Budget: The Primary Cash Management Tool•Purpose: Uses forecasts of cash inflows,
outflows, and ending cash balances to predict loan needs and funds available for temporary investment.
•Timing: Daily, weekly, or monthly, depending upon budget’s purpose. Monthly for annual planning, daily for actual cash management.
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Data Required for Cash Budget•Sales forecast.•Information on collections delay.•Forecast of purchases and payment
terms.•Forecast of cash expenses: wages, taxes,
utilities, and so on.•Initial cash on hand.•Target cash balance.
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Should depreciation be explicitly included in the cash budget?•No. Depreciation is a noncash charge.
Only cash payments and receipts appear on cash budget.
•However, depreciation does affect taxes, which do appear in the cash budget.
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What are some other potential cash inflows besides collections?•Proceeds from fixed asset sales.•Proceeds from stock and bond sales.•Interest earned.•Court settlements.
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