Ch 14 Learning Goals

honeydewscreenManagement

Nov 9, 2013 (3 years and 11 months ago)

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Ch 14 Learning Goals

1.
Impact of working capital management on
liquidity, profitability and risk.

2.
Cash conversion cycle.

3.
Management of receipts and disbursements.

4.
Evaluate a change in credit policy.


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2003 Pearson Education, Inc.

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Working Capital management
(or short
-
term
financial management) is management of:


current assets


current liabilities

Working Capital Mgt

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2003 Pearson Education, Inc.

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Working Capital Management


The goal of working capital management is to
balance:


Liquidity


Profitability


Risk

in a way that contributes to firm value.

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2003 Pearson Education, Inc.

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Current

Assets






Fixed

Assets

Current

Liabilities




Long
-
Term

Debt




Equity

low
return

high
return

low
cost

high
cost

highest
cost

Working Capital Mgt

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2003 Pearson Education, Inc.

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Working Capital Mgt


A high level of current assets means:


More liquidity


Lower profitability


Less risk

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2003 Pearson Education, Inc.

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Working Capital Mgt


A high level of current liabilities means:


Less liquidity


Higher profitability


More risk




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2003 Pearson Education, Inc.

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Working Capital Mgt


Relative levels of current assets (CA) and
current liabilities (CL) are measured by:


Current ratio = CA / CL


Net working capital = CA
-

CL

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2003 Pearson Education, Inc.

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Working Capital Mgt


High current ratio and high net working capital
mean:


More liquidity


Lower profitability


Less risk

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2003 Pearson Education, Inc.

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Working Capital Mgt: the Cash
Conversion Cycle


Central to working capital management is
understanding the cash conversion cycle
(CCC).

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2003 Pearson Education, Inc.

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The Cash Conversion Cycle

The
Operating Cycle (OC)

is the time between
ordering materials and collecting from customers.

The
Cash Conversion Cycle (CCC)

is the time
between paying suppliers and collecting from
customers.

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2003 Pearson Education, Inc.

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Both the OC and CCC may be computed
as shown below.

The Cash Conversion Cycle

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MAX Company has an average age of inventory (AAI) of
60 days, an average collection period (ACP) of 40 days,
and an average payment period (APP) of 35 days.

Using these values, the operating cycle is 100 days and
the cash conversion cycle is 65 days (60 + 40
-

35). Both
are shown on time lines in Figure 13.1.

The Cash Conversion Cycle

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2003 Pearson Education, Inc.

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The Cash Conversion Cycle

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2003 Pearson Education, Inc.

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Reducing AAI or ACP, or lengthening APP reduces the
cash conversion cycle, thus reducing the amount of
financing required to support operations.

The Cash Conversion Cycle

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2003 Pearson Education, Inc.

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Accounts Receivable Management


A key component of the cash conversion cycle is the
average collection period,

which consists of two parts:


the time period from the sale until the customer
mails payment, (determined largely by our credit
terms) and



the time from the payment being mailed until the
firm collects funds in its bank account. This is
referred to as “float.”

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Float


Float occurs with both collections and
payments.


Float has 3 components:


Mail float


Processing float


Clearing float

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Lockbox system.



Concentration banking system.



Both systems reduce mail float and clearing float.

Speeding Collections

Management of Receipts & Disbursements

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2003 Pearson Education, Inc.

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Controlled Disbursing

involves the use of distant mailing
points and bank accounts to lengthen the mail float and
clearing float respectively.


This approach should be used carefully; it might strain
supplier relations.

Slowing Payments

Management of Receipts & Disbursements

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2003 Pearson Education, Inc.

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A firm’s credit policy includes:


Credit terms


Credit standards


Collection policy



Credit Policy

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Credit terms are composed of three parts:


the
cash discount


the cash
discount period


the
credit period


Example, if credit terms are 2/10 net 30, the discount is
2%, the discount period is 10 days, and the credit period
is 30 days.


Credit Terms

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Credit standards determine which customers qualify for
trade credit (and for how much credit they qualify).

Credit Standards

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Character


Capacity


Capital


Collateral


Conditions

Five C’s of Credit

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Credit scoring

is a procedure that awards points for
various borrower attributes.


The result is a score that measures the applicant’s
overall credit strength.


The purpose of credit scoring is to make consistent,
unbiased credit decisions quickly and inexpensively.

Credit Scoring

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2003 Pearson Education, Inc.

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Collection Policy


Collection policy

is a firm’s procedures for collecting
receivables when they are due.


The effectiveness of collection policy can be evaluated
partly by the level of bad debts, however bad debts also
depend on credit policy.


Firms should spend money to collect bad debts beyond
the point where the marginal cost exceeds the marginal
benefit.