F307 Lecture Notes

8/10/2019 F307 Lecture Notes

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STF&WCM: Chapters 8/9

Work ing Capital Mgm t & Too ls

F307-B reeze Sess ion

Lectu re #5

Fall 2014

1Copyright 2014 - The Treasury Academy - All Rights Reserved


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Overview of Chapter 8 Topics Overview of Working Capital

Timelines and Float The Working Capital Cash

Conversion Cycle (CCC)

How Changes in Current Accounts

Impact External Financing Working Capital Investment and

Financing Strategies

Management of Credit and A/R

Management of Inventory Management of A/P

Global Management of WorkingCapital



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Cash Conversion Cycle

Build Inventory

Provide/SellServices &Products

CollectRevenues (A/R)

PurchaseSupplies,

Facilities, Etc.

Copyright 2014 - The Treasury Academy - All Rights Reserved 4

Borrow or

Liquidate

Investments

Invest or

Pay Down

Borrowings


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Operating Cash Flows


CashInf lows

Cash

Inf lows

Cash

Inf lows

ConcentrationAccount

Concentrat ion

Flows

Concentrat ion

Flows

Cash

Outf lows

Cash

Outf lows

Cash

Outf lows

Funding

Flows

Funding

Flows

Short-Term Investments

Short-Term Borrowing

Liquid i ty

Mgmt Flows

Liquid i ty

Mgmt Flows


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Purchase-to-Pay Cycle



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1) Which type of float do you thinkwould be most important for a large

B2B manufacturing company?1. Collection Float

2.Disbursement Float

3. Invoicing Float

4. Payment Float



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Focus of Treasury on Cash FlowTimeline

Treasury focus is on the payment portionof the cycle

Calculation: Float Neutral Calculation

TD = total days difference in payment timing r = Opportunity cost as an annual rate


1

Discount 1 r1 TD

365


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Float Neutral CalculationAssume r = 12% and TD = 3 days


1Discount 1 12%

1 3365

11 1 0.99901467

1.0009863

0.00098533

0.001 (Rounded) or 0.10%

If the buyer is allowed to take a disc oun t of 0.10 %, they

wo uld b e indi f ferent (in present value terms) between paying

by c heck or b y electron ic transfer (a speedup of 3 days in

loss of value)


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2) Assuming an opportunity cost of8% and a 60-day change in payment

timing, what discount rate wouldmake the payment float neutral?

1. 0.5%2. 1.0%

3. 1.3%

4. 1.6%


1Discount 1r

1 TD365


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Float Neutral CalculationAssume: r = 8% and TD = 60 days


1Discount 1

8%1 60

365

11 1 0.987021.01315

0.01298 = 1.3% (Rounded)

If the buyer is al lowed to take a disc oun t of 1.3 %, they would

be ind i f ferent (in p resent v alue terms) between paying

electronical ly today o r on day 60 by check (a speedup of 60

days in los s of value)


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Collection/Disbursement Float

Components Mail Float Mail Time

Processing Float Deposit Preparation Time

Availability Float Check Availability Time

Clearing Float

Check Clearing Time Measurement of Float

Dollar-Days



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3) Which of the following is NOTpart of the Cash Conversion Cycle?

1. Days Inventory

2. Days Cash

3. Days Receivables

4. Days Payables



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The Working Capital CashConversion Cycle (CCC)


Day 1 Day 30 Day 45 Day 80

PurchaseOf Materials

Payment ForMaterials

Sale ofProduct

Collect

Accounts

Receivable

Days Inventory

Days Receivables

Days Payables



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Problems in Managing CCC

Components Potential lost sales

Production stoppages

Stretched payables

Foregone cost-saving trade

discounts Higher prices assessed by

vendors on smaller orders orslow payments

Refusal to sell to weakcustomers

Excessive reliance on A/Prather than S/T bank credit



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4) What do you think is the mostimportant problem in managing the

CCC?1. Potential lost sales

2. Stretched payables

3. Production stoppages

4. Foregone trade

discounts



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Working Capital Investment andFinancing Strategies


Asset

Breakdown

Maturity

Matching

ConservativePolicy

Aggressive

Policy

Fixed AssetsPermanent

Current Assets

Fluctuating

Current Assets

Long-Term SourcesShort-Term

Sources

Long-Term SourcesS/T

Sources

Long-Term SourcesShort-Term

Sources

Selecting a Current Asset Investment Strategy Restrictive current asset investment

Relaxed current asset investment

Selecting a Current Asset Financing Strategy

5) C dit t d


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5) Credit management andaccounts receivable

management are essentiallythe same thing.

1. True

2. False



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Relationship Between Treasury andCredit Management

Separate func t ions

Credit manager administers policiesthat establish credit standards, defineterms of sale, approve credit sales, and

set individual and aggregate credit limits

A/R is created once a sale is made andtrade credit is extended

A/R management includes billingand processing payments,monitoring payment patterns, andcollecting delinquent accounts



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6) Short and long-term financialresources to supplement insufficient

cash flow for payments is known aswhat?

1. Character

2. Capacity

3. Capital

4. Collateral

5. Conditions



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The Five Cs of Credit


Character An intent or willingness to pay as evidencedby payment history

CapacityCurrent and future financial resources that

can be committed to pay obligations

CapitalShort- and long-term financial resources to

supplement insufficient cash flow for

payments

CollateralAssets or guarantees available to secure an

obligation if payment is not made

ConditionsGeneral economic environment and

economic conditions for the customer and

the seller


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Quantitative Credit Analysis Most often used measures:

Liquidity and WC ratios Debt management and

coverage ratios Profitability measures

Consumer Credit Scoring Process1. Differentiating risks2. FICO Score3. Set cutoff score4. Applying further analysis

where necessary



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7) Which of the following is NOT areason why B2B quantitative credit

analysis is less effective than forconsumer analysis?

1. B2B has smaller per

transaction exposure

2. Smaller B2B database

3. Impact of one large default4. Difficulty in obtaining private

company data



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Why Quantitative Credit Analysis isNot as Effective for B2B

The available databases aremuch smaller for B2B

The per-transaction exposure

is usually much larger Impact of one large default

Difficult to obtain financial info

for some customers, especiallyfor smaller, private companies



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Key Inventory Factors

Types of Inventory Raw Materials Work in Progress (WIP) Finished Goods Scraps or Obsolete Items Stores and Supplies

Levels of Inventory Impact of excess inventory Just-In-Time (JIT) inventory Supplier-managed replenishment programs Paid-on-production inventory process

Benefits and Costs of Inventory


I t Fi i


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Inventory Financing

If not financed as part of general working

capital requirements, alternatives may betied directly to the amount of inventory

Trade credit often finances a significantportion of inventory

Collateralized loans (asset-based lending)

Use of public or field warehouseto store inventory

Floor planning forhigh-value durablegoods



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Three-Way Match

PurchaseOrder

Receiving

AdviceInvoice

ApprovedVendorList ??



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Considerations for GlobalManagement of Working Capital

Global Working Capital ManagementTools and Techniques

Multicurrency Accounts

Netting Leading and Lagging Re-invoicing Center Internal Factoring Export Financing



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Before Netting


Source: ETM3 - AFP


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With Multilateral Netting


Source: ETM3 - AFP


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Re-invoicing Center Purpose

Buys goods from anexporting subsidiary

Resells the goods toan importingsubsidiary

Company OwnedSubsidiary


Source: ETM3 - AFP


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Before Re-invoicing


Source: ETM3 - AFP


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With Re-invoicing


Source: ETM3 - AFP

O i f Ch t 9 T i


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Overview of Chapter 9 Topics

Introduction

Cash DiscountCalculations Buyers Perspective

Sellers PerspectiveAccounts Receivable (A/R)

Monitoring and Control DSO & Aging Schedule

Balance Pattern

Cash Conversion Cycle(CCC)


Cost of a Buyer Not Taking a Cash


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Cost of a Buyer Not Taking a CashDiscount


D 365Discount Cost =

100 D N T

2 365=

100 2 30 10

2 365= = .0204 18.25 =.3723 or 37.23%

98 20Where

D = Discount percentage is 2%

N = Net period is 30 days

T = Discount period is 10 days

The cost o f not taking the discoun t can be compared w i th

the organizations opportunity cost to borrow short- term

fund s. If we assume a rate of 8% for th is examp le, then

borrow ing cos t wou ld be less than the cost of not taking the

d iscount so the organization should borrow the funds and

TAKE the discoun t.


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8) A company is offered termsof 1/10, Net 50. What is the

cost of not taking this discount?

1. 9.2%

2. 7.4%

3. 7.9%

4. 12.3%



100 D N T

Cost of a Buyer Not Taking a Cash


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Cost of a Buyer Not Taking a CashDiscount



100 D N T

1 365=

100 1 50 10

1 365= = .0101 9.125 = .09216 or 9.2%

99 40Where

D = Discount percentage is 1%

N = Net period is 50 days

T = Discount period is 10 days

The cost o f not taking the discoun t can be compared w i th

the organizations opportunity cost to borrow short- term

fund s. If we assume a rate of 8% for th is examp le, then

borrow ing cos t wou ld be less than the cost of not taking the

d iscount so the organization should borrow the funds and

TAKE the discoun t.

Benefit to Seller of Offering a Cash Discount


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Disc Pmt

Total Amount of Full Pmt 1 Disc RatePV

Annual Opp Cost1 Days in Disc Period

365

Disc Pmt

$100,000 1 .02 $98,000PV

1 .0041096.151 10

365

$98,000$97.598.91

1.0041096

Assume credit terms of 2/10, net 30 and opp . cost = 15

Present Value of Receiving Discoun ted Payment Am o

B fit t S ll f Off i C h Di t


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Assume credit terms of 2/10, net 30 and opp . cost = 15

Present Value of Receiving Ful l Payment Amount

Full Pmt

Total Amount of Full PmtPV

Annual Opp Cost1 Days in Net Period

365

Full Pmt

$100,000 $100,000PV1 .0123288.15

1 30365

$100,000$98,782.13

1.0123288

NPV = PVDay 10PVDay 30= $97,598.91$98,782.13 =$1,183.22


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Cash Conversion Cycle (CCC)

Days Inventory

Days Receivables

Days Payables

Cash Conversion Cycle (CCC) Cash Turnover Ratio

41

Days Inventory Days Receivables

Days Payables Cash Conversion Cycle

Working Capital Gap

Copyright 2014 - The Treasury Academy - All Rights Reserved

A i S h d l


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Aging ScheduleSeparates A/R into current and past-due

receivables in 30-day increments (on a customeror aggregate basis) and can determine the

percent past due

Age of A/R Amount of A/R % of Total A/R

Current $1,750,000 70%

1-30 Days Past Due 375,000 15%

31-60 Days Past Due 250,000 10%

Over 60 Days PastDue 125,000 5%

Total $2,500,000 100%



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A/R Balance Pattern for March



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Days Inventory

Days Receivables

Days Payables

Cash Conversion Cycle (CCC) Cash Turnover Ratio

44

Days Inventory Days Receivables

Days Payables Cash Conversion Cycle

Working Capital Gap

Copyright 2014 - The Treasury Academy - All Rights Reserved



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Elements in the cash

conversion cycle:

Days Inventory

Days

Receivables

Days Payables

Inventory

365Cost of Goods Sold

Accounts Receivable

365Sales

Accounts Payable 365Cost of Goods Sold


C h C i C l


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Elements in the cash

conversion cycle:

Days

Inventory

Days

Receivables

DaysPayables

Days103.153659,200

2,600365

COGS

Inv

Days41.3636515,000

1,700365

Sales

A/R

Days63.483659,2001,600365

COGSA/P



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Calculates the time required toconvert cash outflows

(necessary to produce

goods) into cash inflows

(through the collection ofaccounts receivable)

Days81.0363.48-41.36103.15

Pay.Days'-Rec.Days'Inv.Days'CCC


Cash Turnover Ratio


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Cash Turnover RatioIf a company has a cash

conversion cycle of

81.03 days, how manycash conversion cycles

does the company go

through in a year (cash

turnover)? 365 DaysCash Turnover =


365=81.03 Days

= 4.5 Times



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Chapter 8 & 9: Wrap-up

Dont forget to work on theChap 8-9 team case Repo rt

due and disc ussio n in class

on 10/13 and 10/15

Excel #2 (Ac coun t Analysis )due o n Friday, 10/17/14

Exam #2 cov ering Chapters 6,

7, 8, & 9 wil l be given in class

on 10/20 and 10/22

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