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Foundations of Financial Management Page 1

Chapter 7

Chapter 7 - Outline
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Current Asset Management

What is Current Asset Management? Cash Management Ways to Improve Collections Marketable Securities 3 Primary Variables of Credit Policy Inventory Management Level vs. Seasonal Production Economic Ordering Quantity

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What is Current Asset Management?


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I. Cash Management
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Current

Asset Management is essentially an extension of working capital management It is concerned with the current assets of a firm (cash, A/R, marketable securities, and inventory)

Financial

manager wants to keep cash balances to a minimum There are 3 reasons for holding cash:
for everyday transactions (main reason) for compensating balances for precautionary needs (emergencies)

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2005 The McGraw-Hill Companies, Inc., All Rights Reserved.

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2005 The McGraw-Hill Companies, Inc., All Rights Reserved.

Foundations of Financial Management Page 2

FIGURE 7-2 Expanded cash flow cycle

II. Cash Management


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Goals

are to speed up the inflow of cash (or improve collections) and slow down the outflow of cash (or extend disbursements) Also will attempt to play the float

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2005 The McGraw-Hill Companies, Inc., All Rights Reserved.

McGraw-Hill/Irwin

2005 The McGraw-Hill Companies, Inc., All Rights Reserved.

TABLE 7-1 The use of float to provide funds

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TABLE 7-2 Playing the float

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2005 The McGraw-Hill Companies, Inc., All Rights Reserved.

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2005 The McGraw-Hill Companies, Inc., All Rights Reserved.

Foundations of Financial Management Page 3

II. Ways to Improve Collections


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FIGURE 7-3 Cash management network

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Collection Center
speeds up collection of A/R and reduces mailing time

Electronic Funds Transfer (or Wire Transfer of Funds)


funds-excess cash balances are transferred from collection points to a centralized location for use.

Lockbox System
when customers mail payment to a local post office box instead of to the firm

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2005 The McGraw-Hill Companies, Inc., All Rights Reserved.

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2005 The McGraw-Hill Companies, Inc., All Rights Reserved.

III. Marketable Securities


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FIGURE 7-6 An examination of yield and maturity characteristics

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Treasury

Bills (T-Bills) and Notes Certificates of Deposit (CDs) Bankers Acceptances Eurodollar Certificates of Deposit Passbook Savings Accounts Money Market Funds
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Foundations of Financial Management Page 4

IV. 3 Primary Variables of Credit Policy


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V. Inventory Management
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There are 3 things to consider in deciding whether to extend credit:


Credit Standards Terms of Trade Collection Policy Average Collection Period Ratio of Bad Debts to Credit Sales Aging of Accounts Receivable
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Inventory is divided into 3 categories:


Raw Materials Work in Progress (WIP) or Unfinished Goods Finished Goods

There are 2 basic costs associated with inventory:


Carrying Costs Ordering Costs
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2005 The McGraw-Hill Companies, Inc., All Rights Reserved.

V. Level vs. Seasonal Production


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V. Economic Ordering Quantity


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Level Production:
producing the same (equal) amount each month inventory costs are higher operating costs are lower

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)

Seasonal Production:
producing a different amount each month (based on the season) inventory costs are lower operating costs are higher
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Safety Stock:
extra inventory the firm keeps in stock in case of unforeseen problems

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Foundations of Financial Management Page 5

FIGURE 7-9 Determining the optimum inventory level

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2005 The McGraw-Hill Companies, Inc., All Rights Reserved.