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Transcript of 1 Chapter 14 Working Capital Management and Policies McGraw-Hill/Irwin Copyright © 2012 by The...
![Page 1: 1 Chapter 14 Working Capital Management and Policies McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.](https://reader036.fdocuments.in/reader036/viewer/2022062320/56649d215503460f949f71eb/html5/thumbnails/1.jpg)
1
Chapter 14Chapter 14 Working Capital Management and Policies
McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
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Revisiting the Balance Sheet Model of the Firm
• Current assets
– Most liquid
– Less profitable than fixed assets
– Represent net amount firm has to fund
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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
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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
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Operating Cycle
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Cash Cycle
• Portion of operating cycle firm must finance• Time between payment for inventory and sales
receipts
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Short Term Financial Policy
• Firms reduce net working capital needs
– Manage need for current assets
– Obtain current liabilities to fund current assets
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Size of Current Assets InvestmentTwo categories of carrying costs:
1) Opportunity costs with capital tied up in current assets
2) Explicit costs to maintain value of current assets
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Financing Terms Consider Asset Demand Peaks and Valleys
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Alternative Financial Policies for Current Assets
• Flexible financing policy
• Restrictive financing policy
• Compromise financing policy
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Flexible Financing Long-Term Debt for Peak Asset Demand
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Restrictive Financing: Long-Term Debt/Equity for Trough Asset Demand
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Compromise FinancingSeasonal Average Asset Demand Financed withLong-Term Debt/Equity
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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
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Unsecured Loans
• Commercial loan from bank
– Usually a line of credit
– Fees can be explicit and implicit
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Secured Loans
• Asset-based loans
– Lenders charge lower interest rates
– Real estate, accounts receivable, inventory used
as collateral
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Other Financing Sources
• Commercial paper
• Banker’s acceptances
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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
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Reasons for Holding Cash
• Transaction facilitation
• Compensating balances
• Investment opportunities
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Baumol Model• Strength: Minimizes sum of opportunity costs
and trading costs• Weakness: Unrealistic assumptions
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The Miller-Orr Model• Assumes daily net cash flows normally
distributed• Allows for cash inflows and outflows
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Other Factors Influencing Target Cash Balance
• Short-term borrowing for unexpected cash demands
• Declining trading costs• Firm requirement to maintain compensating
balances
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Float Control: Collection and Disbursement of Cash
Float – the period of time after check is written but not yet cleared and deposited
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Float Control• Three types of collection float
– In-house processing
– Availability
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Delaying Disbursements
Legal ways to increase disbursement float
– Zero-balance account
– Drafts
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Ethical and Legal QuestionsIllegal 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
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Investing Idle Cash• Most large firms invest in their own
marketable securities• Smaller firms invest in money-market fund or
bank sweep account
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Why Firms Have Excess Cash
• Seasonal fluctuations• Preparation for a planned expenditure
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What to Do with Surplus Cash• Appropriate investments– Treasury bills– Federal Funds– Repurchase agreements– Commercial paper– Negotiable CDs– Banker’s acceptances
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Credit ManagementTrade-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
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Credit Policy: Terms of the SaleCredit terms include
– Credit period
– Cash discount
– Description of the type of credit instrument
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Credit Analysis• Determination of the borrower’s ability and
willingness to pay• 5 C’s of credit:
1. Capacity2. Character3. Capital4. Collateral5. Conditions
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Collection Policy• Collecting past-due accounts from customers• Typical procedure– Send delinquency letters– Initiate telephone calls– Employ collection agency– Legal action against the customer
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