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Finance 3rd Edition

Cornett, Adair, and Nofsinger

14

Copyright 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.

Working Capital

Management and

Policies


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14-2

Revisiting the Balance Sheet Model

Current assets Most liquid

Less profitable than fixed assets

Represent net amount firm has to fund


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14-3

Revisiting the Balance Sheet Model

Net working capital =Current AssetsCurrent Liabilities

Firms objective is to fund the least amount ofnet working capital possible


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14-4

Tracing Cash and Net Working Capital

Operating Cycle is the time needed toAcquire raw materials and turn into finished

goods

Sell and receive payment for them


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14-5

Operating Cycle


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14-6

Cash Cycle

Portion of operating cycle firm must finance Time between payment for inventory and

sales receipts


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Short-Term Financial Policy

Firms reduce net working capital needs Manage need for current assets

Obtain current liabilities to fund current assets


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Size of Current Assets Investment

Two categories of carrying costs1) Opportunity costs with capital tied up in currentassets

2) Explicit costs to maintain value of current assets


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14-9

Financing Terms -- Asset Demand Peaks and Valleys


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14-10

Alternative Financial Policies for Current Assets

Flexible financing policy Restrictive financing policy

Compromise financing policy


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14-11

Flexible Financing

Long-Term Debt for Peak Asset Demand


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14-12

Restrictive Financing

Long-Term Debt/Equity for Trough AssetDemand


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14-13

Compromise Financing

Seasonal Average Asset Demand Financedwith Long-Term Debt/Equity


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14-14

Short-Term Financial Plans

Firms not using flexible financing will needto seek short-term solutions

Unsecured loans

Secured loans

Other short-term financing alternatives


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14-15

Unsecured Loans

Commercial loan from bank Usually a line of credit

Fees can be explicit and implicit


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Secured Loans

Asset-based loans Lenders charge lower interest rates

Real estate, accounts receivable, inventory

used as collateral


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14-17

Other Financing Sources

Commercial paper Bankers acceptances


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Cash Management

Clarification on terminology cash flow vs.cash account

Cash flows are good

Cash account is a current asset with highliquidity and low profitability


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14-19

Reasons for Holding Cash

Transaction facilitation Compensating balances

Investment opportunities


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14-20

Baumol Model

Strength: Minimizes sum of opportunitycosts and trading costs

Weakness: Unrealistic assumptions


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14-21

The Miller-Orr Model

Assumes daily net cash flows normallydistributed

Allows for cash inflows and outflows


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14-22

Influences on Target Cash Balance

Short-term borrowing for unexpected cashdemands

Declining trading costs

Firm requirement to maintain compensatingbalances


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14-23

Float Control: Cash Collection and Disbursement

Floatthe period of time after check iswritten but not yet cleared and deposited


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Float Control

Three types of collection float Mail

In-house processing

Availability


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14-25

Delaying Disbursements

Legal ways to increase disbursement float Zero-balance account

Drafts


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14-26

Ethical and Legal Questions

Illegal practices Using collected cash before receiving it

Continuing to use disbursed cash after check

sent Check kiting is drawing money against account

with insufficient funds


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14-27

Investing Idle Cash

Most large firms invest in their ownmarketable securities

Smaller firms invest in money-market fund

or bank sweep account


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14-28

Why Firms Have Excess Cash

Seasonal fluctuations Cyclical sales or purchases

Preparation for a planned expenditure


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14-29

What to Do with Surplus Cash

Appropriate investments Treasury bills

Federal Funds

Repurchase agreements Commercial paper

Negotiable CDs

Bankers acceptances


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Credit Management

Trade-off between the opportunity cost oflost sales, and the carrying costs of funding

Accounts Receivable (AR) plus the

expected costs of default on AR


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Credit Policy -- Terms of the Sale

Credit terms include Credit period

Cash discount

Description of the type of credit instrument


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Credit Analysis

Determination of the borrowers ability andwillingness to pay

5 Cs of credit:

1. Capacity

2. Character

3. Capital

4. Collateral

5. Conditions


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Collection Policy

Collecting past-due accounts fromcustomers

Typical procedure

Send delinquency letters

Initiate telephone calls

Employ collection agency

Legal action against the customer

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