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Chapter 12 – Working Capital Management. Learning Objectives Illustrate how to manage accounts receivable Explain the components of credit policy Explains how to Speed up receivables Slow down payables Diagram the float Explain inventory management and EOQ

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Chapter 12 – Working Capital Management


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    1. Chapter 12 – Working Capital Management • Learning Objectives • Illustrate how to manage accounts receivable • Explain the components of credit policy • Explains how to • Speed up receivables • Slow down payables • Diagram the float • Explain inventory management and EOQ • Account for working capital in capital budgeting

    2. 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 • Collecting Accounts • How do customers pay (cash or credit) • When do customers pay (cash now…but credit?) • Credit sales over extended period of time

    3. Managing Accounts Receivable • Aging receivables • Identifies chronic late payers • Assigns late fees to proper accounts • Follow-up with late paying customers • Example 12.2, page 352 • Age customer account • Follow-up invoice with late fees • Late fees billed by individual invoices

    4. Credit • 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 • Self scoring – credit card or gasoline company card • Some verification of information and ability – car loan • Substantial verification of ability to repay – home loan • Increasing cost usually match the increase in the size of the credit • Example 12.3 – Inflatable boats – How much to spend on screening activities (NPV decision)

    5. Credit • Payment Policy • Methods to speed up receivables • Discount for speedy payment (implicit cost?) • Lock boxes for faster processing of payments • Wire transfers • Collecting Overdue Debt • Cost and Benefits of each stage • Collection agent, court, write of as bad debt • Methods to slow down payables • Check payment • Playing the float with remote disbursements

    6. 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 • Redundant Inventory Items • Economic Order Quantity – how much inventory to keep on hand

    7. Inventory Management • Cost components of inventory • Ordering Costs • The cost paid to ship inventory from supplier to company • Does not include the cost of the item • Carrying Costs • The storage and handling costs while inventory is in “store” or “manufacturing facility” • Costs include space and utilities • Smooth inventory consumption (big assumption of model) • EOQ finds optimal trade-off between carrying costs and ordering costs

    8. 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

    9. 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

    10. 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

    11. Homework • Problem 4 – Aging of Accounts Receivable • Problem 8 – Credit Terms • Problem 9 – EOQ • Problem 12 – Working Capital Impact