Chapter 13 Working Capital Management

1. Chapter 13Working Capital Management • Short-term Cash Flow Planning • Managing Accounts Receivable • Credit Terms, Float, and Cash Management • Inventory Management • Effect of Working Capital on Capital Budgeting

2. Short-term Cash Flow Planning • Cash is an inventory item • Need to know how much you will need to complete daily transactions • Anticipate daily cash inflow • Plan for any short fall between outflow and inflow • For a business it’s the cash conversion cycle (CCC) • CCC looks at the timing of cash flow or how long it takes the business to generate cash flow from a sale

3. Short-term Cash Flow Planning • CCC components • Production cycle – from when product is started until customer “buys” the product • Collection cycle – from time customer “buys” the product until customer makes payment • Payment cycle – from the time company receives materials for production until the company makes payment to supplier • CCC = Production + Collection - Payment

4. Short-term Cash Flow Planning • Estimating production cycle • Find average inventory • Determine inventory turnover using COGS • Calculate production cycle • Example page 351…7.6 Days • Estimate collection cycle • Find average accounts receivable • Determine A/R turnover using credit sales • Calculate collection cycle • Example page 352…13.8 days

5. Short-term Cash Flow Planning • Estimate payment cycle • Find average accounts payable • Determine accounts payable turnover • Calculate payment cycle • Example page 353…7.0 days • CCC = 7.6 + 13.8 – 7.0 = 14.4 days • Must carry operations 15 days

6. Managing Accounts Receivable • Objective in accounts receivable management: speed up receivables • Want payment from customers as soon as practical • Must be aware of standard business practices • First step is to estimate cash flow from sales • Cash sales at time of sale • Credit sales over extended period of time

7. Managing Accounts Receivable • Aging receivables • Identifies chronic late payers • Assigns late fees to proper accounts • Follow-up with late paying customers • Example 13.2 • Follow-up invoice with late fees • Late fees billed by individual invoices

8. Credit Terms, Float & Cash Management • Granting of credit to customers • Policy on qualifying customers for credit • Policy on payment plan • Policy on follow-up for late payments • Qualifying for credit • Credit screening • Increasing cost as more information required • Increasing cost usually match the increase in the size of the credit • Example 13.3 – Inflatable boats

9. Credit Terms, Float & Cash Management • Payment Policy • Methods to speed up receivables • Discount for speedy payment • Lock boxes for faster processing of payments • Wire transfers • Your Payment Policy (Accounts Payable) • Methods to slow down payables • Check payment • Playing the float with remote disbursements

10. Inventory Management • Keeping track of inventory • ABC Method • A goods are critical goods, or high priced goods • B goods are moderately priced or essential goods • C goods are low priced or non-essential goods • Most effort is spent on A goods • Little effort is spent on C goods • Economic Order Quantity – how much inventory to keep on hand

11. Inventory Management • Cost components of inventory • Carrying Costs • The storage and handling costs while inventory is in “store” or “manufacturing facililty” • Costs include space and utilities • Ordering Costs • The cost paid to ship inventory items from supplier to company • Does not include the cost of the item • EOQ finds optimal trade-off between carrying costs and ordering costs

12. Inventory Management • Carrying Costs (cc), per unit carrying costs times average inventory • Ordering Costs (oc) number of orders times cost per order • Total Inventory Costs = CC + OC • EOQ is optimal order quantity that minimizes total inventory costs with S being annual sales

13. Inventory Management • Additional Issues with EOQ • Reorder Point • Placement of order quantity before inventory hits zero due to shipping time • Does not alter the actual order quantity or average inventory on hand • Safety Stock • Placement of order quantity before inventory hits zero and with additional days in case order is delayed • Does not alter quantity but does increase average inventory on hand • JIT – Just in Time, system that sets safety stock to zero

14. Effect of Working Capital on Capital Budgeting • Working Capital usually a necessary component of a project • Build up current assets and current liabilities at start of a project • Necessary components for making products • Expensed as products are sold • Maintained inventory levels during the project but could build as production increases • Recover working capital at end of project • Draw down of inventory items supporting production • Because items are expensed in COGS must show recovery of current assets and current liabilities

15. Problems – First Set • Problem 1 – Business Operating Cycle • Problem 3 – Production Cycle • Problem 5 – Collection Cycle • Problem 7 – Payable Cycle • Problem 9 – Accounts Receivable • Problem 11– Aging Accounts Receivable

16. Problems – Second Set • Problem 13 – Credit Screening • Problem 15 – Credit Terms • Problem 17 – Economic Order Quantity