© 2003 McGraw-Hill Ryerson Limited
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Current Asset ManagementCurrent Asset Management
McGraw-Hill Ryerson ©2003 McGraw-Hill Ryerson Limited
Prepared by:Terry FegartySeneca College
Revised by:P Chua
© 2003 McGraw-Hill Ryerson Limited
Chapter 7 - Outline
What is Current Asset Management?Cash Management (including Marketable Securities)
Optimum Level of CashUse of FloatWays to Improve CollectionsWays to Extend DisbursementsShort-term Investments
Accounts Receivable Management3 Primary Variables of Credit PolicyThe 4 C’s of Credit
Inventory ManagementEconomic Ordering QuantityJust-In-Time Inventory Systems
Summary and Conclusions
PPT 7-2
© 2003 McGraw-Hill Ryerson Limited
What is Current Asset Management? Current asset management involves managing the individual
CA accounts: Cash/Marketable Securities, Accounts Receivable and Inventory.
Its goal is to achieve a balance between liquidity and profitability that contributes positively to the firm’s value.
A financial manager needs to remember that the less liquid an asset is, the higher the required return, but it is also more risky, that is, the chances of not being able to pay short-term dues is greater.
PPT 7-3
© 2003 McGraw-Hill Ryerson Limited
Cash Management
Goal is to maintain optimum level of cashThis goal can be achieved by:
Manage float efficientlySpeed up collectionsSlow down disbursementsInvest in Marketable Securities
PPT 7-4
© 2003 McGraw-Hill Ryerson Limited
Optimum Level of Cash
Cash is non-earning CA item but necessary to maintain liquidity.
Maintain optimum cash level based on transaction and compensating requirements, cash flow projection, borrowing needs.
Invest excess cash in Marketable Securities for precautionary purposes. Savings accounts Money market funds Term deposits Treasury bills
© 2003 McGraw-Hill Ryerson Limited
Federal government securities:Treasury bills ъ 91days $1,000 Excellent Excellent 13.13%
1.91%Treasury bills 182 1,000 Excellent Excellent 13.25 1.97
Provincial government securitiesTreasury bills 91 25,000 Excellent Excellent 13.18 1.95
Nongovernment securities:Term deposits (large) 90 100,000 Good None† 12.75 1.45Term deposits (small) 90 5,000 Good None† 10.00 1.35Commercial paper 90 100,000 Good Fair 13.33 2.04Bankers’ acceptances 90 25,000 Good Good 13.27 2.05Eurodollar deposits (bid) 90 25,000 Good Excellent 12.81 2.11LIBOR (London Interbank Offered Rate) 90 100,000 Good Excellent 12.94 2.14Savings accounts Open None Excellent None† 8.75 .10-
1.00 Bank swap deposits 90 100,000 Excellent None13.23 1.98
Money market deposits (financial institutions) Open 500 Excellent None 10.15 1.00-
1.75 Overnight (call) money 1 day 100,000 ExcellentExcellent
— 2.24
* Many of these securities can be purchased with different maturities than those indicated. † Though not marketable, these investments are highly liquid and can often be withdrawn without penalty.‡ Quoted yields are often for wholesale amounts above $1 millionъ In the summer of 1981, 91-day Treasury Bills offered yields in excess of 20%
Table 7-3Types of short-term investments
Yield YieldMinimum Mar. 22, Jan. 3,
Maturity* Amount Safety Marketability 1990‡ 2002
PPT 7-12
© 2003 McGraw-Hill Ryerson Limited
Manage Float
Float refers to funds that have been sent by the payer but are not yet usable funds to the payee.
Types of Float Mail Float: time between placing payment in mail and when
it is received. Processing Float: time between receipt of payment and
deposit in firm’s account. Clearing Float: time between deposit of payment and when
spendable funds become available.
© 2003 McGraw-Hill Ryerson Limited
Table 7-1The use of float to provide funds
Bank Books (usable funds)Corporate Books (amounts actually cleared)
Initial amount $ 100,000 $ 100,000Deposits + 1,000,000 + 800,000Cheques – 900,000 – 400,000
Balance + $ 200,000 + $ 500,000
+ $300,000 float
PPT 7-6
© 2003 McGraw-Hill Ryerson Limited
Table 7-2Playing the float
PPT 7-7
Bank Books (usable funds)Corporate Books (amounts actually cleared)
Initial amount $ 100,000 $ 100,000Deposits + 1,000,000 + 800,000Cheques – 1,200,000 – 800,000
Balance – $ 100,000 + $ 100,000
+ $200,000 float
* Assumed to remain the same as in Table 7-1.
* *
© 2003 McGraw-Hill Ryerson Limited
Ways to Improve Collections
Can be achieved by timely processing and deposit of cheques received through:
Decentralization of collection by establishing Regional Collection Centres
speeds up collection of A/R and reduces mailing time Lockbox System
when customers mail payment to a local post office box instead of to the company headquarters
Electronic Funds Transfer / Electronic Data Interchange EFT is the exchange of payments and information between
companies’ computers Example is the Use of debit cards (Interac) and preauthorized
cheques a system where payments are automatically deducted from a
bank account
PPT 7-8
© 2003 McGraw-Hill Ryerson Limited
Figure 7-1Cash management network
LocalOffice
LocalOffice
LocalOffice
LocalOffice
Local Office
Local Office
LocalOffice
LocalOffice
Local Office
Local Office
Local bank branch
Local bank branch
Local bank branch
Local bank branch
Local bank branch
Central bank account
Corporate headquarters
Central bank account
Corporate headquarters
Reduce remittancetime – 1.5 days
Increase disbursementtime – 1 day
2.5 days freed-upcash balance
2.5 days freed-up cash balance$2 million – average cash movement per day$5 million available funds
Distantdisbursement centre
PPT 7-10
© 2003 McGraw-Hill Ryerson Limited
Ways to Extend Disbursements
Mail cheques from remote locations Pay bills beyond the net terms if this is acceptable
PPT 7-9
© 2003 McGraw-Hill Ryerson Limited
Accounts Receivable ManagementThe objective for managing accounts receivable is to collect
accounts receivable quickly without losing sales.
3 Primary Variables of Credit Policy Administration:
Credit Standards determine credit rating of customers 4 C’s of credit credit agencies, bureaus
Terms of Trade ex.; 2% / 10days / net 30 days
Collection Policy Average Collection Period Ratio of Bad Debts to Credit Sales Aging of Accounts Receivable
PPT 7-13
© 2003 McGraw-Hill Ryerson Limited
Customer Credit Profile - The 4 C’s
CHARACTER - willingness to pay Supplier, legal, union problems? Willing to provide information?
CAPACITY - ability to pay Past & future profits? Good management?
CAPITAL - net worth Growing assets? Low debt?
CONDITIONS - state of industry,economy Impact on customer How customer adapts
PPT 7-15
© 2003 McGraw-Hill Ryerson Limited
Table 7-4Dun & Bradstreet credit rating system
Key to RatingsComposite Credit Appraisal
Estimated Financial Strength High Good Fair Limited
5A . . . Over $50,000,000 1 2 3 44A . . . $10,000,000 to 50,000,000 1 2 3 43A . . . 1,000,000 to 10,000,000 1 2 3 42A . . . 750,000 to 1,000,000 1 2 3 41a . . . 500,000 to 750,000 1 2 3 4BA . . . 300,000 to 500,000 1 2 3 4BB . . . 200,000 to 300,000 1 2 3 4CB . . . 125,000 to 200,000 1 2 3 4CC . . 75,000 to 125,000 1 2 3 4DC . . 50,000 to 75,000 1 2 3 4DD . . 35,000 to 50,000 1 2 3 4EE . . 20,000 to 35,000 1 2 3 4FF . . 10,000 to 20,000 1 2 3 4GG . . 5,000 to 10,000 1 2 3 4HH . . Up to 5,000 1 2 3 4
PPT 7-16
© 2003 McGraw-Hill Ryerson Limited
Inventory Management
Optimum level of inventory will satisfy customer demand / production requirements while minimizing inventory costs
Inventory can be: Raw Materials Work in Progress (WIP)
or Unfinished Goods Finished Goods
There are 2 basic costs associated with inventory: Ordering Costs - may include purchasing, computer,
receiving cost, etc. Carrying Costs - may include storage, insurance,
obsolescence costs, etc.
PPT 7-17
© 2003 McGraw-Hill Ryerson Limited
Figure 7-4Determining the optimum inventory level
Cost of ordering and carrying inventory ($)
40
80
400
M
Carrying costs
Order size (units)
Ordering costs
Total costs
PPT 7-20
© 2003 McGraw-Hill Ryerson Limited
Economic Ordering Quantity
Economic Ordering Quantity (EOQ): the optimal (best) amount for the firm to order each
time occurs at the low point on the total cost curve the order size where total carrying costs equal total
ordering costs (assuming no safety stock)
PPT 7-22
© 2003 McGraw-Hill Ryerson Limited
EOQ Calculation
Economic Order Quantity is computed by:
whereS = usage in units per periodO = order cost per orderC = carrying cost per unit per periodQ = order quantity in units
Assumptions of the basic EOQ model: Inventory usage is at a constant rate. Order costs per order are constant. Delivery time of orders is consistent and order arrives as inventory reaches
zero.
C
OSEOQ
2
© 2003 McGraw-Hill Ryerson Limited
Total Inventory cost
Total Inventory cost is given by the following formula:
Where S = usage in units per period
O = order cost per orderC = carrying cost per unit per periodQ = order quantity in units
Average Inventory = EOQ/2
2
CQ
Q
SOTC
© 2003 McGraw-Hill Ryerson Limited
Safety StockDesigned to minimize stockouts“Extra” inventory the firm keeps in stock in case of unforeseen problems Management decision based on risk of stockout, desired level of serviceAv inventory (with safety stock) = EOQ/ 2 + safety stockCarrying costs = Ave Inventory (units) x carrying costs per unit
PPT 7-23
© 2003 McGraw-Hill Ryerson Limited
Just-In-Time Inventory Systems
Goal of JIT is manufacturing efficiency.Inventory management technique that minimizes inventory investment by having materials arrive at exactly the time they are needed for production.Extensive coordination between suppliers, shippers and production line is required.Computerized order and inventory systemsQuality control programs
© 2003 McGraw-Hill Ryerson Limited
Summary and Conclusions
Current assets include cash (the most liquid), short-term investments, accounts receivable, and inventory (the least liquid)
We manage cash by making timely collections and disbursements, and investing any temporary surpluses of cash in marketable securities
We manage accounts receivable by applying credit standards, credit terms and collection procedures
We manage inventory using such techniques as the economic ordering quantity and the just-in-time model
PPT7-25
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