Copyright © 2014 Nelson Education Ltd. 6–1
PowerPoint Presentations for
Finance for Non-Financial Managers:
Seventh Edition
Prepared by
Pierre BergeronUniversity of Ottawa
Copyright © 2014 Nelson Education Ltd. 6–2
CHAPTER 6
Working Capital Management
Copyright © 2014 Nelson Education Ltd. 6–3
1. Explain the meaning of working capital and how it can be measured.
2. Discuss the flow of cash via the cash conversion cycle.
3. Describe several strategies for managing inventories.
4. Explore techniques for managing trade receivables.
5. Comment on managing cash and cash equivalents.
6. Explain how to manage current liability accounts to improve the cash flow cycle.
Learning Objectives
Copyright © 2014 Nelson Education Ltd. 6–4
• Working capital management involves:– management of individual current assets, current
liabilities, and interrelationships that link current assets with current liabilities and with other statement of financial position accounts
Meaning of Working Capital LO 1
Copyright © 2014 Nelson Education Ltd. 6–5
Net working capital is defined as current assets minus current liabilities.
Meaning of Working Capital
Inventories $ 70,000
Trade receivables 30,000
Notes receivable 5,000
Prepaid expenses 3,000
Marketable securities 10,000
Cash 10,000
Total current assets $128,000
Working Capital
Current assetsTrade and other payables $ 56,000
Notes payables 20,000
Accrued expenses 4,000
Taxes payable 8,000
Total current liabilities $ 88,000
Current liabilities
LO 1
Copyright © 2014 Nelson Education Ltd. 6–6
Cash Conversion Cycle
Purchase decision and
order
Credit decision
Purchase of raw materials
Delivery of raw materials
Inventory of raw materials
Manufacturing
Inventory of finished goods
Shipment
Payment to suppliers
Billing
Payment by customer
Processing payment
DepositCash
5 5
19
10
8
9 15
4
- 30
60
12
5 60
7
Existing 209 days
Target 160 days
Reduction 49 days
LO 2
Copyright © 2014 Nelson Education Ltd. 6–7
Cash Flow of Working Capital Accounts LO 2
Copyright © 2014 Nelson Education Ltd. 6–8
Using Futurama Ltd. (Slides 3-8 and 3-10)
Purpose: Measures the amount of days in working capital a business holds in order to meet its average daily sales requirements.
(Inventories + Trade receivables) - Trade payables
Revenue ÷ 365
($218,000 + $300,000) - $195,000
$2,500,000 ÷ 365
$323,000
$6,940
Days of Working Capital (DWC)
=
=
= 47.2 days
LO 2
Copyright © 2014 Nelson Education Ltd. 6–9
Using Futurama Ltd. (Slides 3-6 and 3-8)
Purpose Measures the efficiency with which a business converts revenue to cash flow from operations.
Cash flow from operations
Revenue
$126,000
$2,500,000
Cash Conversion Efficiency (CCE)
=
= 5.1%
LO 2
Copyright © 2014 Nelson Education Ltd. 6–10
• Goal– to replenish stocking points in such a
way as to minimize the total of all associated costs, and thereby enhance profitability of the business
Managing Inventories LO 3
Copyright © 2014 Nelson Education Ltd. 6–11
• Types of inventories1. Raw Materials
• lumber, steel, rubber, plastics, chemicals, paint and other finishing substances, supplies, and parts
2. Work-in-Progress • partially assembled or partially processed, not yet
completed
3. Finished Goods • goods completed and ready to be sold for resale by
wholesaling and retailing firms
Managing Inventories LO 3
Copyright © 2014 Nelson Education Ltd. 6–12
Inventory Levels LO 3
Copyright © 2014 Nelson Education Ltd. 6–13
Inventory Decisions LO 3
Order And Set-up Costs Holding Costs
Transportation costs Storage costs
Clerical costs of making orders Fire insurance
Cost of placing goods in storage Property taxes
Downtime on equipment Spoilage and deterioration
Quantity discounts Cost of borrowing
Rent of facilities
Obsolescence
Copyright © 2014 Nelson Education Ltd. 6–14
Calculating the Economic Order Quantity
Number Order Annual Average Average Annual Ordering cost of quantity order cost unit dollar holding +orders (units) $50.00 inventory investment costs Holding cost
per order (2) ÷ 2 (4) × $ 5.35 (5) × 15% (3) + (6) 1 2 3 4 5 6 7
1
2
5
6
8
10
5,000
2,500
1,000
833
625
500
50
100
250
300
400
500
2,500
1,250
500
416
312
250
13,375
6,687
2,675
2,226
1,669
1,337
2,006
1,003
401
334
250
200
2,056
1,103
651
634
650
700
LO 3
Copyright © 2014 Nelson Education Ltd. 6–15
Here’s the proof:
Annual order costs (6 × $50.00) = $300.00Annual carrying costs($5.35 × 790 = $4,226 ÷ 2 × 15%) = $317.00
Total inventory costs = $617.00
Economic Order QuantityF = Fixed costs per order
(clerical, processing, payment, receiving, verification, shelving) = $50.00
U = Units sold per year = 5,000
C = Carrying costs per unit/per year = $0.80(storage, insurance, rent, spoilage, interest charges)
EOQ =
EOQ = = 790 units
2 FU
C
2 × $50.00 × 5,000
$0.80
$5.35 ×15%
LO 3
Copyright © 2014 Nelson Education Ltd. 6–16
• Goal:– to set credit terms, grant credit to
customers, monitor payment patterns, and apply necessary collection procedures so as to increase profitability
Managing Trade Receivables LO 4
Copyright © 2014 Nelson Education Ltd. 6–17
Managing Trade Receivables
Credit policy consists of choosing the appropriate credit terms to offer to customers (present and future). Terms differ from product to product and industry to industry.
Example: Selling price $120.00
Cost of product $ 90.00
Cost of capital 10%
Should the company grant 2/10, net 30 days?
$90.00 × 10% × = $1.4860-day delay
365 days
Effective priceCost of productCredit costsFinance costsProfit
-$ _________ _________ _________
+ _________$ _________
-$ _________ _________ _________
+ _________$ _________
10-day payment 60-day payment
117.60 120.00 90.00 90.00
28.96 28.52 1.61 ---
.25 1.48
LO 4
Copyright © 2014 Nelson Education Ltd. 6–18
Grant Credit to Customers (Credit Report)LO 4
Copyright © 2014 Nelson Education Ltd. 6–19
Return on investment = = = 14.6%
Changing Credit Terms
Incremental profit $27,000
Incremental investment $185,400
Expected volume (units)
Expected revenue ($10.00 per unit)
Expected profit before bad debts (10% of revenue)
Expected bad debt expense (% of revenue)
Expected profit (after bad debts)
Incremental profit
Expected collection period (days)
Average trade receivables
Incremental investment
Return on investment calculation for changing the firm’s credit terms
Existing terms
400,000
4,000,000
400,000
20,000 (.5%)
380,000
---
29
315,800
-----
Existing terms
440,000
4,400,000
440,000
33,000 (.75%)
407,000
27,000
42
501,200
185,400
LO 4
Copyright © 2014 Nelson Education Ltd. 6–20
• Goal: – To reduce the amount of cash that is
being used within the firm to increase profitability, but without reducing business activities or exposing the firm to undue risk in its financial obligations
Managing Cash and Cash Equivalents LO 5
Copyright © 2014 Nelson Education Ltd. 6–21
Cash flows in connection with credit serve to introduce the
concept of _________, which is the time lag or delay
between the moment of disbursement of funds on the part
of the customer and the moment of receipt of funds on the
part of the seller (i.e., mail time, processing time, and
clearing time with the banking system).
Managing Cash and Cash Equivalents
$20,000 × 12% × = $131.5120 days late for payment
365 days
FLOAT
LO 5
Copyright © 2014 Nelson Education Ltd. 6–22
Ways to Improve Collection of Cash
1. Change customer paying habits• Letters, telephone calls, or personal
visits• Economic incentive for paying bills
faster–offer discounts (i.e., 2/10, N/30)
continued…
LO 5
Copyright © 2014 Nelson Education Ltd. 6–23
Ways to Improve Collection of Cash
2. Improve the delivery system (reduce the negative float)• Regional banking
– customers pay bills to banks since they can transfer funds more quickly than mail order delivery.
• Lockbox collection system – firm rents post office box and bank monitors the
lockbox periodically• Electronic communications
– Example: data-phone wire systems
continued…
LO 5
Copyright © 2014 Nelson Education Ltd. 6–24
Ways to Improve Collection of Cash
3. Bypass the problem • Factoring of trade receivables
LO 5
Copyright © 2014 Nelson Education Ltd. 6–25
Managing Current Liability Accounts
• Trade and other payables
• Working capital loans
• Short-term loans made to finance
working capital accounts
• Examples: inventories, trade
receivables
LO 6
Top Related