CHAPTER 22 Working Capital Management. Alternative working capital policies Cash, inventory, and A/R management Accounts payable management Short-term financing policies Bank debt and commercial paper. Basic Definitions. Gross working capital: Total current assets.
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Total current assets.
Current assets - Current liabilities.
Operating CA – Operating CL =
(Cash + Inv. + A/R) – (Accruals + A/P)
Includes both establishing working capital policy and then the day-to-day control of cash, inventories, receivables, accruals, and accounts payable.
Current 1.75x 2.25x
Quick 0.83x 1.20x
Debt/Assets 58.76% 50.00%
Turnover of cash 16.67x 22.22x
DSO (365-day basis) 45.63 32.00
Inv. turnover 4.82x 7.00x
F. A. turnover 11.35x 12.00x
T. A. turnover 2.08x 3.00x
Profit margin 2.07% 3.50%
ROE 10.45% 21.00%
Payables deferral 30.00 33.00
The cash conversion cycle focuses on the time between payments made for materials and labor and payments received from sales:
Cash Inventory Receivables Payables
conversion = conversion + collection - deferral .
cycle period period period
1. Sales forecast.
2. Information on collections delay.
3. Forecast of purchases and payment terms.
4. Forecast of cash expenses: wages, taxes, utilities, and so on.
5. Initial cash on hand.
6. Target cash balance.
Net Cash Inflows
Purchases 44,603.75 36,472.65
Wages 6,690.56 5,470.90
Rent 2,500.00 2,500.00
Total payments $53,794.31$44,443.55
Net CF $13,857.64 $18,311.85
Cash at start if no borrowing $ 3,000.00 $16,857.64
Net CF (slide 13) 13,857.64 18,311.85
Cumulative cash $16,857.64 $35,169.49
Less: target cash 1,500.00 1,500.00
Surplus $15,357.64 $33,669.49
SKI’s forecasted cash budgetindicates that the company’s cash holdings will exceed the targetedcash balance every month, except for October and November.
YES! A tighter credit policy may
discourage sales. Some customers
may choose to go elsewhere if they
are pressured to pay their bills
SKI buys $506,985 net, on terms of 1/10, net 30, and pays on Day 40. How much free and costly trade credit, and what’s the cost of costly trade credit?
Net daily purchases = $506,985/365
Annual gross purch. = $506,985/(1-0.01)
Payables = $1,389(10) = $13,890.
Payables level if don’t take discount:
Payables = $1,389(40) = $55,560.
Total trade credit = $55,560
Free trade credit = 13,890
Costly trade credit = $41,670
Pays 1.01% 12.167 times per year.
Periodic rate = 0.01/0.99 = 1.01%.
Periods/year = 365/(40 – 10) = 12.1667.
EAR = (1 + Periodic rate)n – 1.0
= (1.0101)12.1667 – 1.0 = 13.01%.
Lower dashed line, more aggressive.