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Working Capital includes a firms current assets, which consist of cash and marketable securities in addition to accounts receivable and inventories. It also consists of current liabilities, including accounts payable (trade credit), notes payable (bank loans), and accrued liabilities. Net Working Capital is defined as total current assets less total current liabilities.
Positive Net Working Capital (low return and low risk) Current Current low Assets Liabilities cost low Net Working return Capital > 0
Long-Term Debt
high return high cost
Fixed Assets
Equity
highest cost
Negative Net Working Capital (high return and high risk) Current Current low Assets Liabilities return low Net Working cost Capital < 0
high return
Long-Term Debt
Fixed Assets
Equity
Short-term financial managementmanaging current assets and current liabilitiesis one of the financial managers most important and time-consuming activities.
The goal of short-term financial management is to manage each of the firms current assets and liabilities to achieve a balance between profitability and risk that contributes positively to overall firm value.
Central to short-term financial management is an understanding of the firms cash conversion cycle.
CCC
Days 0
102
142
Days 0
15
142
a firms sales are constant, then its investment in operating assets should also be constant, and the firm will have only a permanent funding requirement. sales are cyclical, then investment in operating assets will vary over time, leading to the need for seasonal funding requirements in addition to the permanent funding requirements for its minimum investment in operating assets.
If
Assets (Dollars)
Fixed Assets
Time
Turn over inventory as quickly as possible without stock outs that result in lost sales.
Collect accounts receivable as quickly as possible without losing sales from highpressure collection techniques. Manage, mail, processing, and clearing time to reduce them when collecting from customers and to increase them when paying suppliers. Pay accounts payable as slowly as possible without damaging the firms credit rating.
2.
3.
4.
Classification of inventories:
Raw
Work-in-progress:
in production
Finished
goods: items that have been produced but not yet sold
The different departments within a firm (finance, production, marketing, etc.) often have differing views about what is an appropriate level of inventory.
Financial managers would like to keep inventory levels low to ensure that funds are wisely invested. Marketing managers would like to keep inventory levels high to ensure orders could be quickly filled.
Manufacturing managers would like to keep raw materials levels high to avoid production delays and to make larger, more economical production runs.
ABC system of inventory management divides inventory into three groups of descending order of importance based on the dollar amount invested in each. typical system would contain, group A would consist of 20% of the items worth 80% of the total dollar value; group B would consist of the next largest investment, and so on. of the A items would intensive because of the high dollar investment involved.
Control
EOQ = 2 x S x O C
Where:
S O C Q
= = = =
usage in units per period (year) order cost per order carrying costs per unit per period (year) order quantity in units
$1
The EOQ can be used to evaluate the total cost of inventory as shown on the following slides.
The Economic Order Quantity (EOQ) Model Ordering Costs = Cost/Order x # of Orders/Year
Ordering Costs = $25 x 2 = $50 Carrying Costs = Carrying Costs/Year x Order Size 2 Carrying Costs = ($1 x 100)/2 = $50
a company has calculated its EOQ, it must determine when it should place its orders. More specifically, the reorder point must consider the lead time needed to place and receive orders. If we assume that inventory is used at a constant rate throughout the year (no seasonality), the reorder point can be determined by using the following equation: Reorder point = lead time in days x daily usage Daily usage = Annual usage/360
Daily usage = 200/360 = 0.56 units/day Reorder point = 5 x 0.56 = 2.78 or 3 units
Thus, when RIBs inventory level reaches 3 units, it should place an order for 100 units. However, if RIB wishes to maintain safety stock to protect against stock outs, they would order before inventory reached 3 units.
JIT inventory management system minimizes the inventory investment by having material inputs arrive exactly at the time they are needed for production. a JIT system to work, extensive coordination must exist between the firm, its suppliers, and shipping companies to ensure that material inputs arrive on time. addition, the inputs must be of near perfect quality and consistency given the absence of safety stock.
For
In
systems are used to determine what to order, when to order, and what priorities to assign to ordering materials. MRP uses EOQ concepts to determine how much to order using computer software. It simulates each products bill of materials structure all of the products parts), inventory status, and manufacturing process.
the simple EOQ, the objective of MRP systems is to minimize a companys overall investment in inventory without impairing production.
Manufacturing
resource planning II (MRP II) is an extension of MRP that integrates data from numerous areas such as finance, accounting, marketing, engineering, and manufacturing suing a sophisticated computer system.
system generates production plans as well as numerous financial and management reports.
This
MRP and MRP II, which tend to focus on internal operations, enterprise resource planning (ERP) systems can expand the focus externally to include information about suppliers and customers. electronically integrates all of a firms departments so that, for example, production can call up sales information and immediately know how much must be produced to fill certain customer orders.
ERP
International inventory management is typically much more complicated for exporters and MNCs.
The production and manufacturing economies of scale that might be expected from selling globally may prove elusive if products must be tailored for local markets.
Transporting products over long distances often results in delays, confusion, damage, theft, and other difficulties.
The second component of the cash conversion cycle is the average collection period the average length of time from a sale on credit until the payment becomes usable funds to the firm.
The collection period consists of two parts:
the
time period from the sale until the customer mails payment, and the time from when the payment is mailed until the firm collects funds in its bank account.
Character: The applicants record of meeting past obligations. Capacity: The applicants ability to repay the requested credit. Capital: The applicants debt relative to equity. Collateral: The amount of assets the applicant has available for use in securing the credit. Conditions: Current general and industryspecific economic conditions.
Credit scoring is a procedure resulting in a score that measures an applicants overall credit strength, derived as a weighted-average of scores of various credit characteristics.
The procedure results in a score that measures the applicants overall credit strength, and the score is used to make the accept/reject decision for granting the applicant credit.
The firm sometimes will contemplate changing its credit standards to improve its returns and generate greater value for its owners.
A firms credit terms specify the repayment terms required of all of its credit customers.
Credit terms are composed of three parts:
The
For example, with credit terms of 2/10 net 30, the discount is 2%, the discount period is 10 days, and the credit period is 30 days.
Credit Monitoring
Credit monitoring is the ongoing review of a firms accounts receivable to determine whether customers are paying according to the stated credit terms. Slow payments are costly to a firm because they lengthen the average collection period and increase the firms investment in accounts receivable. Two frequently used techniques for credit monitoring are the average collection period and aging of accounts receivable.
The average collection period is the average number of days that credit sales are outstanding and has two parts:
The
time from sale until the customer places the payment in the mail, and time to receive, process, and collect payment.
The
Collection Policy
Collection float is the delay between the time when a payer deducts a payment from its checking account ledger and the time when the payee actually receives the funds in spendable form. Disbursement float is the delay between the time when a payer deducts a payment from its checking account ledger and the time when the funds are actually withdrawn from the account. Both the collection and disbursement float have three separate components.
Mail float is the delay between the time when a payer places payment in the mail and the time when it is received by the payee. Processing float is the delay between the receipt of a check by the payee and the deposit of it in the firms account. Clearing float is the delay between the deposit of a check by the payee and the actual availability of the funds which results from the time required for a check to clear the banking system.
Lockboxes
A
lockbox system is a collection procedure in which payers send their payments to a nearby post office box that is emptied by the firms bank several times a day. is different from and superior to concentration banking in that the firms bank actually services the lockbox which reduces the processing float. lockbox system reduces the collection float by shortening the processing float as well as the mail and clearing float.
It
Controlled Disbursing
Controlled
Disbursing involves the strategic use of mailing points and bank accounts to lengthen the mail float and clearing float respectively. approach should be used carefully, however, because longer payment periods may strain supplier relations.
This
transfers is a telecommunications bookkeeping device that removes funds from the payers bank and deposits them into the payees bankthereby reducing collections float. Automated clearinghouse (ACH) debits are pre-authorized electronic withdrawals from the payers account that are transferred to the payees account via a settlement among banks by the automated clearinghouse. ACHs clear in one day, thereby reducing mail, processing, and clearing float.
Zero-balance accounts (ZBAs) are disbursement accounts that always have an end-of-day balance of zero.
The purpose is to eliminate non-earning cash balances in corporate checking accounts. A ZBA works well as a disbursement account under a cash concentration system.