SEVEN

CHAPTER

Current Asset
Management

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Table 7-1
The use of float to provide funds
Foundations of Financial
Management
PPT 7-1

Bank Books (usable funds)

Corporate Books (amounts actually cleared)

Initial amount $ 100,000 $ 100,000

Deposits + 1,000,000 + 800,000
Cheques – 900,000 – 400,000
Balance + $ 200,000 + $ 500,000
+ $300,000 float

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Table 7-2
Playing the float
Foundations of Financial
Management
PPT 7-1

Bank Books (usable funds)

Corporate Books (amounts actually cleared)

Initial amount $ 100,000 $ 100,000

Deposits + 1,000,000 * + 800,000 *
Cheques – 1,200,000 – 800,000
Balance – $ 100,000 + $ 100,000
+ $200,000 float

* Assumed to remain the same as in Table 7-1.

Block
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Short
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Figure 7-1
Cash management network
Foundations of Financial
Management
PPT 7-2

Local Local
Local Local
Local Local
Local Local
Local
Local
Office
Office Office
Office Office
Office Office
Office Office
Office
Local Local Local Local Local
bank bank bank bank bank
branch branch branch branch branch

Centralbank
bankaccount
account Reduce remittance
Central time – 1.5 days
Corporateheadquarters
Corporate headquarters
Increase disbursement
time – 1 day
2.5 days freed-up
cash balance
2.5 days freed-up cash balance
$2 million – average cash
movement per day Distant
Block $5 million available funds disbursement
Hirt centre
Short
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Table 7-3
Types of short-term investments
Foundations of Financial
Management

Yield
PPT 7-3

Yield
Minimum Mar. 22, Mar. 22,
Maturity* Amount Safety Marketability 1990‡ 1999

Federal government securities:

Treasury bills 91days $1,000 Excellent Excellent 13.13% 4.86%
Treasury bills 182 1,000 Excellent Excellent 13.25 4.95
Provincial government securities
Treasury bills 91 25,000 Excellent Excellent 13.18 4.92
Nongovernment securities:
Term deposits (large) 90 100,000 Good None† 12.75 4.60
Term deposits (small) 90 5,000 Good None† 10.00 4.00
Commercial paper 90 100,000 Good Fair 13.33 5.16
Bankers’ acceptances 90 None Good Good 13.27 5.10
Eurodollar deposits (bid) 90 25,000 Good Excellent 12.81 5.12
LIBOR (London Interbank
Offered Rate) 90 100,000 Good Excellent 12.94 5.30
Savings accounts Open None Excellent None† 8.75 .25-1.00
Bank swap deposits 90 100,000 Excellent None 13.23 5.03
Money market deposits
(financial institutions) Open 500 Excellent None 10.15 3.20-4.40
Overnight (call) money 1 day 100,000 Excellent Excellent — 5.00

* Many of these securities can be purchased with different maturities than those indicated.
Block † Though not marketable, these investments are highly liquid and can often be withdrawn without penalty.
Hirt ‡Quoted yields are often for wholesale amounts above $1 million
Short
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Figure 7-3
Financing growth in accounts receivable
Foundations of Financial
Management
PPT 7-4

Accounts
receivable

Buildup
Inventory 12%
return
Marketable
Forgo Accounts
securities 10%
payable
return Bank loan
Forgo
8% 7.5%
return cost 7%
cost

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Table 7-4
Dun & Bradstreet credit rating system
Foundations of Financial
Management
PPT 7-5

Key to Ratings
Composite Credit Appraisal
Estimated Financial Strength High Good Fair Limited
5A . . . Over $50,000,000 1 2 3 4
4A . . . $10,000,000 to 50,000,000 1 2 3 4
3A . . . 1,000,000 to 10,000,000 1 2 3 4
2A . . . 750,000 to 1,000,000 1 2 3 4
1a . . . 500,000 to 750,000 1 2 3 4
BA . . . 300,000 to 500,000 1 2 3 4
BB . . . 200,000 to 300,000 1 2 3 4
CB . . . 125,000 to 200,000 1 2 3 4
CC . . 75,000 to 125,000 1 2 3 4
DC . . 50,000 to 75,000 1 2 3 4
DD . . 35,000 to 50,000 1 2 3 4
EE . . 20,000 to 35,000 1 2 3 4
Block FF . . 10,000 to 20,000 1 2 3 4
Hirt GG . . 5,000 to 10,000 1 2 3 4
Short HH . . Up to 5,000 1 2 3 4
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Figure 7-4
Determining the optimum inventory level
Foundations of Financial
Management
PPT 7-6

Cost of ordering and carrying inventory ($)

Total costs
Carrying costs

M
80

40

Ordering costs
Block
Hirt 400
Short Order size (units)
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Chapter 7 - Outline
Foundations of Financial
Management

LT 7-1
• What is Current Asset Management?
• Cash Management
• Optimum Level of Cash
• Ways to Improve Collections
• Ways to Extend Disbursements
• Marketable Securities
– Types of Securities
– Yield Calculation
• 3 Primary Variables of Credit Policy
– Credit Policy Decision
• Inventory Management
• Economic Ordering Quantity
Block
Hirt • Just-In-Time Inventory Systems
Short • Level vs. Seasonal Production
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What is Current Asset Management?

Foundations of Financial
Management

LT 7-2

• 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)

• A financial manager needs to remember that the less liquid

an asset is, the higher the required return

Block
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Short
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Cash Management
Foundations of Financial
Management
LT 7-3

• Use cash budgets

• Speed up collections
• Extend disbursements
• Maintain optimum level of cash
• Invest excess cash

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Optimum Level of Cash

Foundations of Financial
Management
LT 7-4

How much to keep in Low-risk, liquid

cash? investments
– transaction needs? • Savings accounts
– cash flows predictable? • Money market funds
– borrowing • Term deposits
arrangements? • Treasury bills
– interest rates? • US $ deposits

Keep safety level in cash, Earn small return on

invest excess excess funds
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Ways to Improve Collections

Foundations of Financial
Management

LT 7-5

• Timely processing and deposit of cheques received

• 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
– exchange of payments and information between
companies’ computers
• Use of debit cards (Interac) and preauthorized cheques
Block – a system where payments are automatically deducted
Hirt
Short from a bank account
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Ways to Extend Disbursements

Foundations of Financial
Management
LT 7-6

• Mail cheques from remote locations

• “Play the Float”
• Electronic Funds Transfer

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Foundations of Financial

3 Primary Variables of Credit Policy

Management

LT 7-7

3 things to consider in deciding whether to extend credit:

– 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
Block
Hirt • Aging of Accounts Receivable
Short
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Inventory Management
Foundations of Financial
Management

LT 7-8

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:

– Ordering Costs
– Carrying Costs

Optimum level of inventory will satisfy customer demand /

Block
Hirt
production requirements while minimizing ordering and
Short carrying costs
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Economic Ordering Quantity

Foundations of Financial
Management

LT 7-9

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)

Safety Stock:
– “extra” inventory the firm keeps in stock in case of
Block unforeseen problems
Hirt
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Just-In- Time Inventory Systems

Foundations of Financial
Management

LT 7-10

Features Benefits
•Minimum levels of inventory •Lower carrying costs
•Orders in small lot sizes •Automatic ordering
•Computerized order and •Fewer accounting errors
inventory systems •Lower quality control costs
•Electronic data interchange •Elimination of waste
•Short delivery times
•Small number of suppliers
•Quality control programs
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Level vs. Seasonal Production

Foundations of Financial
Management

LT 7-11

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

Seasonal Production:
– producing a different amount each month (based on the
season)
– inventory costs are lower
– operating costs are higher
Block
Hirt
Short
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