This is the html version of the file http://www.csus.edu/indiv/s/schafferb/133CHAPTER072002.ppt.

Google automatically generates html versions of documents as we crawl the web.

Current Asset Management

(Chapter 7)
(Chapter 6 pages 143 145)
Working Capital Management
Current Asset Investment Policy
Temporary and Permanent
Current Assets
Zero Working Capital
Cash Management
Marketable Securities
Accounts Receivable Management
Inventory Management
 Working
Capital Management:
An Overview
Gross Working Capital -
(Current Assets)
New Working Capital -
(Current Assets - Current Liabilities)
Working Capital Management
o Involves investing
in current assets and financing
of current assets:

Current Asset Investment

Policy
Everything else remaining the same,
higher levels of current assets mean
lower risk and lower expected return
Lower Risk
 o Greater ability to meet short-run
obligations.
Lower Return
o Cash and marketable securities
typically yield low returns.
Furthermore,
whencurrent assets are increased,
additional financing costs will be
incurred thereby lowering returns.
Lower levels of current assets result in
opposite effects.

Alternative Current Asset

Investment Policies
Current Asset (millions of $)
Sales (millions of dollars)
Conservative - low risk
Aggressive - high risk
Moderate

Temporary vs. Permanent

Investment
in Current Assets
Temporary Investment - Commonly,
firms experience short-run fluctuations
in currentassets. For example, retail
department stores will have high levels
of inventory around Thanksgiving. In
January, the inventory should be low.
Permanent Investment - Firms always
have some minimum level of investment
incurrent assets (i.e., a permanent
investment). As a firm grows over time,
the level of
permanent current assets also grows
(e.g., a supermarket chain with 70
stores will have more permanent
inventory than a chain with 4 stores).
 Temporary and
Permanent Current Assets
Millions of dollars
Time Period
Temporary Fluctuations in
Current Assets
Permanent Current Assets

Cash Management: An
Overview
Beginning Cash Balance
+ Cash Inflows - - - Speed Up
- Cash Outflows - - - Slow Down
= Ending Cash Balance
- Desired Cash Balance
= Surplus or Shortage
 If Surplus: Pay off short-term debt or buy
marketable securities
If Shortage: Short-term borrowing or sell
marketable securities

Desired Cash Balance:

Precautionary Demand - Satisfy
possible, but as yet indefinite cash
needs.
Speculative Demand - Build
up current cash balances in anticipation
of future business costs being lower.
Risk Preferences
Compensating Balances
Transactions Demand - Cash needs
arising in the ordinary course of doing
business.

Float
 Much of cash management is oriented
towards managing the float.
Mail Float
o Time lapse from the moment a
customer mails a remittance check
until the firm begins to process it.
Processing Float
o Time required for the firm to process
remittance checks before they can
be deposited in the bank.

Float (Continued)
Transit Float
o Time necessary for a deposited
check to clear through the
commercial banking system and
become usable funds to the
company.
Disbursing Float
 o Funds available in the firms bank
account until its payment check has
cleared through the system.

Electronic Funds Transfer

Substantially reduces float
Some Examples:
o Automated teller machines
o Direct deposit of payroll checks
o Paying the supermarket and others
with bank cards.

Lock-Box System
Customers mail remittance
checks to P.O. Box.
Local bank processes and
deposits checks directly
 into the companys
account.
Reduces mail and
processing float.
Also reduces transit float if
lock-box is located near
Federal Reserve Bank or
branches.
Marketable Securities
The marketable securities portfolio is
typically used for temporary investments
of excess cash, or as a substitute for
cash (i.e., near cash). Therefore,
securities in the portfolio are generally
safe, short-term, and highly liquid.
Treasury Bills
 o Short-term obligations of the federal
government with maturities of 91
days to a year. They are traded on a
discount basis in bearer form. Not
taxable at state and local levels, but
taxable at the federal level.
Commercial Paper
o Unsecured promissory notes issued
by large corporations in amounts of
$25,000 or more (No active
secondary market).

Marketable Securities
Continued
Negotiable Certificates of Deposit (CDs)
o Offered by financial institutions (e.g.,
banks, S&Ls). Those big business is
interested in have $100,000
minimums.
 Bankers Acceptance: Generally arise
out of foreign trade.
o Importer (buyer) issues a promise to
pay a certain amount to the exporter
(seller).
o A bank accepts the promise, and
commits itself to pay the amount
when due.
o Exporter (seller) can now sell this
acceptance in the marketplace at a
discount (a price that is less than the
promised amount).

Accounts
Receivable Management
Major Decisions
o Credit Standards
o Credit Terms
o Collection Policy
 Credit Standards: Will they pay as
agreed?
o Credit Scoring
o Credit Reports
o Past Experience
o Financial Analysis
Debt Ratios, Liquidity Ratios,
Profit Ratios

Accounts
Receivable Management
(Continued)
Credit Terms
o Example: 2/10, net 30
Collection Policy
o Standard Operating Procedures
 o Be professional, firm, and do not
bluff.
o Vary procedures with slow payers.
o Evaluating Collection Efforts
Average Collection Period, Bad
Debt to Sales Ratio, Aging
Accounts Receivable,
Receivables to Assets Ratio,
Credit Sales to Receivables
Ratio.

Inventory Management
(Covered in Detail in
Production Management)
Basic Costs Associated With Inventory
o Carrying Costs
storage, insurance, cost of capital
used
o Ordering Costs
 placing orders, shipping and
handling
o Costs of Running Short
lost sales, reduced customer
goodwill
Objective
o Minimize total costs associated with
managing inventory.