Transcript Chapter 17
Chapter 14 McGraw-Hill/Irwin Working Capital Management and Policies Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved. 1 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 Short Term Financial Policy • Firms reduce net working capital needs – Manage need for current assets – Obtain current liabilities to fund current assets 14-7 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 Financing Terms Consider Asset Demand Peaks and Valleys 14-9 Alternative Financial Policies for Current Assets • Flexible financing policy • Restrictive financing policy • Compromise financing policy 14-10 Flexible Financing Long-Term Debt for Peak Asset Demand 14-11 Restrictive Financing: Long-Term Debt/Equity for Trough Asset Demand 14-12 Compromise Financing Seasonal Average Asset Demand Financed with Long-Term Debt/Equity 14-13 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 Unsecured Loans • Commercial loan from bank – Usually a line of credit – Fees can be explicit and implicit 14-15 Secured Loans • Asset-based loans – Lenders charge lower interest rates – Real estate, accounts receivable, inventory used as collateral 14-16 Other Financing Sources • Commercial paper • Banker’s acceptances 14-17 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 Reasons for Holding Cash • Transaction facilitation • Compensating balances • Investment opportunities 14-19 Baumol Model • Strength: Minimizes sum of opportunity costs and trading costs • Weakness: Unrealistic assumptions 14-20 The Miller-Orr Model • Assumes daily net cash flows normally distributed • Allows for cash inflows and outflows 14-21 Other Factors Influencing Target Cash Balance • Short-term borrowing for unexpected cash demands • Declining trading costs • Firm requirement to maintain compensating balances 14-22 Float Control: Collection and Disbursement of Cash Float – the period of time after check is written but not yet cleared and deposited 14-23 Float Control • Three types of collection float – Mail – In-house processing – Availability 14-24 Delaying Disbursements Legal ways to increase disbursement float – Zero-balance account – Drafts 14-25 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 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 Why Firms Have Excess Cash • Seasonal fluctuations • Preparation for a planned expenditure 14-28 What to Do with Surplus Cash • Appropriate investments – – – – – – Treasury bills Federal Funds Repurchase agreements Commercial paper Negotiable CDs Banker’s acceptances 14-29 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 Credit Policy: Terms of the Sale Credit terms include – Credit period – Cash discount – Description of the type of credit instrument 14-31 Credit Analysis • Determination of the borrower’s ability and willingness to pay • 5 C’s of credit: 1. 2. 3. 4. 5. Capacity Character Capital Collateral Conditions 14-32 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