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Chapter 10 Working Capital Management Management of Cash and Marketable Securities Reasons for holding cash Transactions motive Precautionary motive Speculative motive Compensating balance requirements Compensating balance requirement raises effective cost of loan

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Chapter 10 l.jpg

Chapter 10

Working Capital Management


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Management of Cash and Marketable Securities

  • Reasons for holding cash

    • Transactions motive

    • Precautionary motive

    • Speculative motive

    • Compensating balance requirements

  • Compensating balance requirement raises effective cost of loan

  • Meet some of cash needs with marketable securities


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Management of Cash and Marketable Securities

  • To improve cash flow:

    • Synchronize cash inflows with cash outflows

    • Expedite check clearing

    • Slow disbursements

    • Maximize use of float

  • New development in financial services industry are impacting cash management

    • Electronic funds transfer system

    • Money market mutual funds

    • Commercial bank cash management services


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Accounts Receivable Management

  • Balance cost of extending credit with benefit derived from credit sales

  • Whether or not to offer credit is generally dictated by industry practice

  • Five C’s of credit analysis

    • Character, Capacity, Capital, Collateral, Conditions


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Accounts Receivable Management

  • Commercial credit service:

    • Dun and Bradstreet

    • Credit Interchange

  • Cost of credit

    • Cost of financing accounts receivable

    • Cost of offering discounts

    • Cost of bad debt losses


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Accounts Receivable Management

  • Exhibits 10.1 and 10.2 illustrate impact of two alternative credit policies

  • Credit manager is also responsible for supervising collection of accounts receivable; balance the need to collect with the need to maintain customer goodwill


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Inventory Management

  • Economic order quantity model balances carrying costs and ordering costs

  • Carrying costs increase with increases in average inventory level

  • Ordering costs decrease with increases in average inventory level

  • EOQ model determines optimal average inventory level such that sum of ordering costs and carrying costs is minimized


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Inventory Management

  • Exhibit 10.3 graphs cost behavior

  • Modify basic model for delivery lags and uncertainty in estimates

  • Appendix 10.1 gives mathematical derivation for EOQ


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Sources of Short-term Financing

  • Trade credit is a source of spontaneous financing

  • Short-term commercial bank loans can be secured or unsecured

  • Commercial paper is used by only the largest firms with AAA credit ratings


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Financing Accounts Receivable

  • Accounts receivable can be pledged as general collateral

  • Assigned: borrowing firm signs over right to collect receivables to lender

  • Factored: accounts receivable are sold at a discount to a commercial factor, commercial bank, or other lenders; the factor provides financing, acts as borrower’s credit department, and assumes risk of default; this is an expensive method


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Inventory Financing

  • A blanket lien comparable to pledging accounts receivable is most common

  • Trust receipt creates a specific lien against specific asset; it is used in financing big-ticket inventory items, such as cars

  • Field warehouse: inventory pledged as collateral under physical control of leader


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