working capital and current assets

7/29/2019 Working Capital and Current Assets

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3/18/2013 Working Capital and Current Assets 1

Working Capital and CurrentAssets


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Working Capital

1. Net Working Capital = CA - CL

2. NWC 0 implies

a) current ratio 1

b) some long-term financing of short-term assets

3. Size of NWC depends on cash conversion cycleand terms of trade

a) inventory holding period

b) A/R collection period

c) A/P payment period


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Operating and Cash CyclesIllustrated

Inventory period Accounts receivable period

Accounts payable

period

Cash paid for inventory

Operating cycle

Cash cycle

The operating cycle is the time period from inventory purchase until the receipt of cash. (Sometimes

the operating cycle does not include the time from placement of the order until arrival of the stock.)

The cash cycle is the time period from when cash is paid out to when cash is received.

Inventory

purchased

Inventory

sold

Cash

received


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Imintrouble Wholesale2003 Income Statement($ in thousands)

Net Sales (all on credit) $710.00

Cost of goods sold 480.00

Depreciation 30.00

Earnings before interest andtaxes $200.00

Interest 20.00

Taxable income 180.00

Taxes 53.45

Net income $126.55

Retained earnings $100

Dividends 26.55


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Imintrouble WholesaleBalance Sheet as of December 31($ in thousands)

Assets 2003

Cash $50

Accounts receivable 310

Inventory 385

Net plant and equipment 1,100

Total assets $1,845

Liabilities and Equity

Accounts payable $260

Notes payable 175

Long-term debt:

Common stock 290

Retained earnings 895

Total liabilities and equity $1,845


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Imintrouble, Inc. Operating Cycle

dayperCOGS

Inventory

365/480

385

days292

daypersalesCredit

A/R

365/710

310

days159

*dayperPurchases

A/P

365/480

260

days197

* For wholesaler, COGS

approximately equals Purchases

(assuming no buildup in inventory)

a) Inventory Period

b) Accounts

Receivable Period

c) Payment Period


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Short-Term Financial Management

Cash

Bank Balances

Marketable Securities

Credit Line

Commercial Paper

IN OUT

Liquidity Reserve

Backup Liquidity


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Short-Term Financial Management

Seller

Buyer

Receive

Order

Place

Order

Ship

Goods

Send

Invoice

Receive

Goods

Receive

Invoice

Draw

Check

Mail

Check

Receive

Check

Deposit

Check

Available

Funds

Check

Clears

Balance SheetCash

Marketable Securities

Accounts Receivable

Inventory

Accounts Payable

PositionsCash Manager Credit Manager

Marketing Production/Inventory

Purchasing Payables Manager

Controller Treasury Manager


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Check Clearing Illustrated

1 Payroll writes check 2 Payee receives check

Check Deposited

Check forwarded

Payment through debit

Check presented

Canceled check

Payees bank

Federal Reserve Bank

or

Correspondent bank

or

Local clearinghouse

Payment through credit

45

6

3


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MICR Line (Magnetic Ink Character Recognition)

12 Federal Reserve District Bank, 12 = San Francisco District

21 Branch or City and clearing arrangements, 21=Phoenix Branch of FED

170 Bank ABA Number

6 Check digit (computer reading check)

1496 Sequence number

273 921720 Payer account number

Last 10 Encoded check amount in cents


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FedWire Transfer

Cost: $15 to $30 for both sending and receiving institutions

Payer

(Company A)

Payee

(Company B)

Bank A Bank BFed Reserve

System

1. Instructions

3. Debit As reserve account

Credit Bs reserve account

2. Instructions

6. Confirmation 5. Notification

4. Notification


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Cash Concentration

1

2000

2 Bank 2

Bank 1

Bank 2000W

hollyOwned

Franchised

1

10,000

2

LB 1

LB 5

Concentration Bank

Fed Reserve City

Short-term Borrowing and Investing

Maintenance of Cash Reserves and

Compensating Balances

Disbursement

Bank 1

Non-Fed City

Disbursement

Bank 2

Non-Fed City


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Bank Float

DayChecksWritten

ChecksDeposited My Book

BankLedger

BankAvailable

Monday 50 50 100 100

Tuesday 100 150 200 100

Wednesday

150 200 200

Thursday 150 200 200Friday 150 150 150

Beginning balance = $100

Disbursement time = 4 days

Deposit time = 1 day

Disbursement Float (Mail, Processing, Presentation)

Deposit Float (Processing, Availability)

Net Bank Float


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Net Bank Float

Day

Deposit

s Made

Checks

Written

Company

BookBalanc

e

BankAvailabl

eBalanc

eMon 2 2 0 0

Tue 2 2 0 2

Wed 2 2 0 4

Thurs 2 2 0 6

Fri 2 2 0 8Sat 0 0 0 8

Sun 0 0 0 8

Day

Deposit

s Made

Checks

Written

Company

BookBalanc

e

BankAvailabl

eBalanc

eMon 2 2 0 8

Tue 2 2 0 8

Wed 2 2 0 8

Thurs 2 2 0 8

Fri 2 2 0 8Sat 0 0 0 8

Sun 0 0 0 8

Mail, payee processing, bank clearing 5 days

Availability 1 day

Week 1Week 2

Net bank Float = ($2 million * 5 days)($2 million * 1 day)

= $ 8 million


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Red Book BalancesNet Bank Float $ 8 million

Red Book Balance - 6 million

Available Balance $ 2 millionWindow Dressing

A. Actual

Cash -6 Trade payables 10

Marketable securities 8 Short-term debt 20

B. Combine

Cash & Marketablesecurities

2 Trade payables 10

Short-term debt 20

C. Borrow

Cash 2 Trade payables 10


D. Net Drafts

Cash 2 Trade payables 10


Net drafts 8


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Disbursement System

Bedfort Meats

S.L.C.

McDonalds

S.L.C. Region

McDonaldsAccounts Payable

Chicago HQ

Concentration Bank

Chicago

Disbursement Bank

Oregon

Zions Bank

S.L.C.

Clearing System

1. Meat, invoice

2. Authorization Invoice

10. Transfer cash to cover check

8. Notify headquarters

7. Present check

6. Send check through clearing house

5. Deposit check Schedule payment Enter into forecast

Decide drawee bank

3.

4. Release Payments


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A. Three Regular Disbursement Accounts

B. Zero Balance Accounts

Payroll Vendor Refunds

Buffer Needed in Accounts

Payroll Vendor Refunds

Master


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Annual Savings fromBetter Collection Tactics

Collections per day $60,000

Collection days:Old method 5 days

New method 3 days

Cost of borrowing 11%

$60,000/day x .11 x 2 days = $13,200


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Why Hold Cash and MarketableSecurities?

1. Transactions

2. Precautionary Reserves

3. Investment Reserve

4. Required Reserves and Compensating

Balances


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Why Market Securities?

1. Substitute for Cash

2. Temporary Investment

seasonal operations

known financial requirement (i.e.,

dividends, acquisition)

after sale of long-term securities


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Desirable Characteristics ofMarketable Securities

1. Low financial risk (default)

2. Low interest rate risk

3. High liquidity

4. High after-tax return


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Investment Alternatives

1. U.S. Treasury Bills and Notes

2. Certificates of Deposit

3. Commercial Paper4. Repurchase Agreements

5. Eurodollar (CDs) and LIBOR

6. Money-market Mutual Fund

7. Savings Accounts


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Why Credit Sales?

Uncouple actual trade from payment

Encourage purchases that may not be

made from you without credit


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Credit DecisionQ: Could the company extend credit to Class C customers?

Facts

Class C customers

Additional sales/year Percent of sales uncollectible

Average payment period

Incremental collection costs/year

$1,700,0005 %

45 days

$34,000

Selling corporation: Production and selling costs

Tax rate

75 %

40 %


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Credit Decision

Additional Sales $1,700,000

Accounts uncollectible (5% of sales) 85,000

Annual incremental revenue 1,615,000

Collection costs 34,000

Variable production and selling costs (75% of sales) 1,275,000

Annual income before taxes 306,000

Taxes (40%) 122,400

Annual incremental income after tax $183,600

A:

Investment in Accounts Receivable: $209,589days45days365

000,700,1$x

Profit margin on new sales = %8.10000,700,1

600,183

Return on investment in A/R* = %6.87589,209

600,183

* In fact, there may be an investment needed in inventory and perhaps plant and equipment depending on capacity and availability .


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Loosening Credit Policy 20-30Days

Costs and Benefits

Bad Debt Cash Discount

Opportunity Cost: Contribution

a) Accounts Receivable

b) Net Working Capital (i.e.Inventory)

Collection costs


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Sales

Old sales sales

Contribution margin

Tax rate

% return (discount rate)

Avg. collection period

Old policy

New policy

Bad debt on new sales

Other net working capital is 10% of sales

collection exp. + $100

$100,000$10,00

30%

50%

20%

20 days

30 days

3%


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Opportunity Cost of Increased

InvestmentNew A/R:

New W/C:

Old A/R:

Total investment RequiredDiscount Rate

Opportunity Cost of Increased Investment

days30X360

000,10$

10%X000,10$

days10X360

000,100$

= $833

= $1,000

= $2,777

$4,61020%

922


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Cost-Benefit Analysis

Costs Benefits

A/T bad debt $150 Sales 10,000

A/T collection 50 B/T contribution 3,000Opportunity costof investment 922 A/T benefits 1,500

Total costs $1,122

After tax bad debt = ($10,000)(3%) (1 - .5)

After tax collection costs = ($100) (1 - .5)

a

a

b

b


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The Five Cs of Credit

Character

Willingness to pay

Capacity

Ability to payCapital

Financial reserves

Collateral

Pledged assetsConditions

Relevant economic conditions


32/32


Why Carry Inventory?

Raw materials

Uncertain delivery

vs.

Smooth production

Work in processLength of production

process

Finished goodsUncertain productivityand delivery

vs.

Uncertain sales

working capital and current assets

Documents