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Assignment Review Lecture 7 Current Asset Mgmnt & Financing Analyzing Financial Performance (Gapenski Chapters 16 & 17) The “costs” of assets All assets have costs… Assets are financed by equity and liability: the fundamental accounting equation The concept of an opportunity cost

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assignment review lecture 7

Assignment ReviewLecture 7

Current Asset Mgmnt & Financing

Analyzing Financial Performance

(Gapenski Chapters 16 & 17)

the costs of assets
The “costs” of assets
  • All assets have costs…
    • Assets are financed by equity and liability: the fundamental accounting equation
    • The concept of an opportunity cost
  • Fixed assets…
    • Acquisition funded by loans or equity
    • But also incur a “carrying cost”… time value effect – also funded by loans or equity
current asset ca costs
Current asset (CA) costs
  • CA are also financed by equity/ liability:
    • Cash and marketable securities
    • Accounts receivable
    • Inventories
  • Difference between earning (marketable securities) and unearning (A/R, inventories) CA.
    • A/R can be factored
    • Inventories can be sold at discount…
optimizing ca
Optimizing CA
  • Rule is to keep CA to minimum possible without incurring > costs
  • A/R depends on trade credit offered – affected by customer demands and industry practice.
  • Inventory levels affected by:
    • Operating levels (e.g. process industries vs. hospitals) are “permanent” CA
    • “Safety stocks” and seasonal stock are “temporary” current assets
financing ca policies
Financing CA policies
  • Maturity matching – “moderate”
    • Permanent assets with equity and LT debt
    • Seasonal assets with ST debt
  • Conservative – equity and LT debt funds permanent assets and part of seasonal assets
  • Aggressive – ST borrowings fund seasonal and part of permanent assets

Why would you select each?

cash management
Cash management
  • Collect quickly/ disburse (pay) slowly
  • Collection: variety of methods get collections into cash, thence into earning assets: lockbox services, concentration banks, electronic funds transfer and automated clearinghouses
  • Disbursement: payables management, ZBAs at concentration banks, remote disbursement
receivables management
Receivables management
  • Cost of carrying A/R is a function of:
    • average collection period (ACP) aka Days Sales Outsanding (DSO)
    • average $sales/day
    • cost of financing
  • ACP depends on credit terms offered/ nature of the business
  • Reducing ACP generates a reduction in carrying cost and a one-time infusion of cash
  • “Aging schedules” can point to problems
  • HC providers face complexities other sectors do not
sources of short term financing
Sources of short term financing
  • Accrued expenses:
    • “free money”
    • Spontaneous
  • Accounts payable:
    • Free trade credit – pay w/in discount period
    • Costly trade credit – pay outside time

Ethical issues with: paying late and taking discount; or with “stretching”

  • Bank financing: short term loans, revolving credits, etc.
analyzing financial performance chapter 17
Analyzing financial performance(Chapter 17)

Statement of cash flows – How was cash generated?

  • Operating activities – core to business
  • Investing activities – generally, purchases/ sales of fixed assets
  • Financing – ST / LT securities as investments and as liabilities
ratio analysis
Ratio analysis
  • Common approaches, but values are industry-specific
  • Net income as numerator:
    • Total margin -- NI/ revenues
    • ROA -- NI/ total assets
    • ROE -- NI/ equity

Would you expect the ROA to be higher/ lower than the ROE? Why?

liquidity ratios
Liquidity ratios
  • Current ratio – CA/ CL
    • “Acid test” – remove inventories from CA
    • Some industries function with relatively high inventories
  • Days cash on hand: can a business meet its payments…an operational view
debt management ratios
Debt Management Ratios
  • Capitalization ratios – balance sheet data focusing on debt leverage
    • Debt/ equity
    • Debt/ assets
  • Coverage ratios – income statement data indicating whether net income can “cover” debt requirements
    • TIE ratio (times interest earned) = EBIT/ Interest exp

Complementary, but capitalization ratios are point in time…

dupont analysis
DuPont Analysis

ROE = Total margin x Total asset turnover x Equity multiplier

NI/ Equity = NI/ Rev x Rev/ assets x Assets/ equity

Total margin: expense control

Total asset turnover: asset utilizationEquity multiplier: debt utilization