Tài chính doanh nghiệp - Chapter 13: Working capital and current asset management

Chapter 13Working Capital and Current Asset ManagementLearning GoalsUnderstand short-term financial management, net working capital, and the related trade-off between profitability and risk.Describe the cash conversion cycle, its funding requirements, and the key strategies for managing it.Discuss inventory management: differing views, common techniques, and international concerns.2Copyright © 2006 Pearson Addison-Wesley. All rights reserved.Learning Goals (cont.)Explain the credit selection process and the quantitative procedure for evaluating changes in credit standards.Review the procedures for quantitatively considering cash discount changes, other aspects of credit terms, and credit monitoring.Understand the management of receipts and disbursements, including float, speeding up collections, slowing down payments, cash concentration, zero balance accounts, and investing in marketable securities.3Copyright © 2006 Pearson Addison-Wesley. All rights reserved.Long & Short Term Assets & Liabilities4Copyright © 2006 Pearson Addison-Wesley. All rights reserved.Net Working CapitalWorking Capital includes a firm’s current assets, which consist of cash and marketable securities in addition to accounts receivable and inventories.It also consists of current liabilities, including accounts payable (trade credit), notes payable (bank loans), and accrued liabilities.Net Working Capital is defined as total current assets less total current liabilities.5Copyright © 2006 Pearson Addison-Wesley. All rights reserved.CurrentAssetsNet WorkingCapital > 0Fixed AssetsCurrent LiabilitiesLong-TermDebtEquitylow returnhigh returnlow costhigh costhighest costThe Tradeoff Between Profitability & RiskPositive Net Working Capital (low return and low risk)6Copyright © 2006 Pearson Addison-Wesley. All rights reserved.The Tradeoff Between Profitability & Risk (cont.)Negative Net Working Capital (high return and high risk)CurrentAssetsFixed AssetsCurrent LiabilitiesNet WorkingCapital < 0Long-TermDebtEquitylow returnhigh returnlow costhigh costhighest cost7Copyright © 2006 Pearson Addison-Wesley. All rights reserved.The Tradeoff Between Profitability & Risk (cont.)8Copyright © 2006 Pearson Addison-Wesley. All rights reserved.The Cash Conversion CycleShort-term financial management—managing current assets and current liabilities—is on of the financial manager’s most important and time-consuming activities.The goal of short-term financial management is to manage each of the firms’ current assets and liabilities to achieve a balance between profitability and risk that contributes positively to overall firm value.Central to short-term financial management is an understanding of the firm’s cash conversion cycle.9Copyright © 2006 Pearson Addison-Wesley. All rights reserved.The Operating Cycle (OC) is the time between ordering materials and collecting cash from receivables.The Cash Conversion Cycle (CCC) is the time between when a firm pays it’s suppliers (payables) for inventory and collecting cash from the sale of the finished product.Calculating the Cash Conversion Cycle10Copyright © 2006 Pearson Addison-Wesley. All rights reserved.Calculating the Cash Conversion Cycle (cont.)Both the OC and CCC may be computed as shown below.11Copyright © 2006 Pearson Addison-Wesley. All rights reserved.MAX Company, a producer of paper dinnerware, has annual sales of $10 million, cost of goods sold of 75% of sales, and purchases that are 65% of cost of goods sold. MAX has an average age of inventory (AAI) of 60 days, an average collection period (ACP) of 40 days, and an average payment period (APP) of 35 days.Using the values for these variables, the cash conversion cycle for MAX is 65 days (60 + 40 - 35) and is shown on a time line in Figure 14.1.Calculating the Cash Conversion Cycle (cont.)12Copyright © 2006 Pearson Addison-Wesley. All rights reserved.Calculating the Cash Conversion Cycle (cont.)13Copyright © 2006 Pearson Addison-Wesley. All rights reserved.The resources MAX has invested in the cash conversion cycle assuming a 365-day year are:Obviously, reducing AAI or ACP or lengthening APP will reduce the cash conversion cycle, thus reducing the amount of resources the firm must commit to support operations.Calculating the Cash Conversion Cycle (cont.)14Copyright © 2006 Pearson Addison-Wesley. All rights reserved.Funding Requirements of the CCCPermanent vs. Seasonal Funding NeedsIf a firm’s sales are constant, then its investment in operating assets should also be constant, and the firm will have only a permanent funding requirement.If sales are cyclical, then investment in operating assets will vary over time, leading to the need for seasonal funding requirements in addition to the permanent funding requirements for its minimum investment in operating assets.15Copyright © 2006 Pearson Addison-Wesley. All rights reserved.Nicholson Company holds, on average, $50,000 in cash and marketable securities, $1,250,000 in inventory, and $750,000 in accounts receivable. Nicholson’s business is very stable over time, so its operating assets can be viewed as permanent. In addition, Nicholson’s accounts payable of $425,000 are stable over time. Nicholson has a permanent investment in operating assets of $1,625,000 ($50,000 + $1,250,000 + $750,000 - $425,000). This amount would also equal the company’s permanent funding requirement.Funding Requirements of the CCC (cont.)Permanent vs. Seasonal Funding Needs16Copyright © 2006 Pearson Addison-Wesley. All rights reserved.Funding Requirements of the CCC (cont.)Permanent vs. Seasonal Funding NeedsIn contrast, Semper Pump Company, which produces bicycle pumps, has seasonal funding needs. Semper has seasonal sales, with its peak sales driven by purchases of bicycle pumps. Semper holds, at minimum, $25,000 in cash and marketable securities, $100,000 in inventory, and $60,000 in accounts receivable. At peak times, Semper’s inventory increases to $750,000 and its accounts receivable increase to $400,000. To capture production efficiencies, Semper produces pumps at a constant rate throughout the year. Thus, accounts payable remain at17Copyright © 2006 Pearson Addison-Wesley. All rights reserved.Funding Requirements of the CCC (cont.)Permanent vs. Seasonal Funding Needs$50,000 throughout the year. Accordingly, Semper has a permanent funding requirement for its minimum level of operating assets of $135,000 ($25,000 + $100,000 + $60,000 - $50,000) and peak seasonal funding requirements of $900,000 [($125,000 + $750,000 + $400,000 - $50,000) - $135,000]. Semper’s total funding requirements for operating assets vary from a minimum of $135,000 (permanent) to a a seasonal peak of $1,125,000 ($135,000 + $900,000) as shown in Figure 14.2.18Copyright © 2006 Pearson Addison-Wesley. All rights reserved.Funding Requirements of the CCC (cont.)Permanent vs. Seasonal Funding Needs19Copyright © 2006 Pearson Addison-Wesley. All rights reserved.Semper Pump has a permanent funding requirement of $135,000 and seasonal requirements that vary between $0 and $990,000 and average $101,250. If Semper can borrow short-term funds at 6.25% and long term funds at 8%, and can earn 5% on any invested surplus, then the annual cost of the aggressive strategy would be:Funding Requirements of the CCC (cont.)Aggressive vs. Conservative Funding Strategies20Copyright © 2006 Pearson Addison-Wesley. All rights reserved.Funding Requirements of the CCC (cont.)Aggressive vs. Conservative Funding StrategiesAlternatively, Semper can choose a conservative strategy under which surplus cash balances are fully invested. In Figure 13.2, this surplus would be the difference between the peak need of $1,125,000 and the total need, which varies between $135,000 and $1,125,000 during the year.21Copyright © 2006 Pearson Addison-Wesley. All rights reserved.Funding Requirements of the CCC (cont.)Aggressive vs. Conservative Funding StrategiesClearly, the aggressive strategy’s heavy reliance on short-term financing makes it riskier than the conservative strategy because of interest rate swings and possible difficulties in obtaining needed funds quickly when the seasonal peaks occur.The conservative strategy avoids these risks through the locked-in interest rate and long-term financing, but is more costly. Thus the final decision is left to management.22Copyright © 2006 Pearson Addison-Wesley. All rights reserved.Strategies for Managing the CCCTurn over inventory as quickly as possible without stock outs that result in lost sales.Collect accounts receivable as quickly as possible without losing sales from high-pressure collection techniques.Manage, mail, processing, and clearing time to reduce them when collecting from customers and to increase them when paying suppliers.Pay accounts payable as slowly as possible without damaging the firm’s credit rating.23Copyright © 2006 Pearson Addison-Wesley. All rights reserved.Inventory Management: Inventory FundamentalsClassification of inventories:Raw materials: items purchased for use in the manufacture of a finished productWork-in-progress: all items that are currently in productionFinished goods: items that have been produced but not yet sold24Copyright © 2006 Pearson Addison-Wesley. All rights reserved.Inventory Management: Differing Views About InventoryThe different departments within a firm (finance, production, marketing, etc.) often have differing views about what is an “appropriate” level of inventory.Financial managers would like to keep inventory levels low to ensure that funds are wisely invested.Marketing managers would like to keep inventory levels high to ensure orders could be quickly filled.Manufacturing managers would like to keep raw materials levels high to avoid production delays and to make larger, more economical production runs.25Copyright © 2006 Pearson Addison-Wesley. All rights reserved.Techniques for Managing InventoryThe ABC SystemThe ABC system of inventory management divides inventory into three groups of descending order of importance based on the dollar amount invested in each.A typical system would contain, group A would consist of 20% of the items worth 80% of the total dollar value; group B would consist of the next largest investment, and so on.Control of the A items would intensive because of the high dollar investment involved.26Copyright © 2006 Pearson Addison-Wesley. All rights reserved.EOQ = 2 x S x O CTechniques for Managing Inventory (cont.)The Economic Order Quantity (EOQ) ModelWhere:S = usage in units per period (year)O = order cost per orderC = carrying costs per unit per period (year)Q = order quantity in units27Copyright © 2006 Pearson Addison-Wesley. All rights reserved.Techniques for Managing Inventory (cont.)The Economic Order Quantity (EOQ) ModelAssume that RLB, Inc., a manufacturer of electronic test equipment, uses 1,600 units of an item annually. Its order cost is $50 per order, and the carrying cost is $1 per unit per year. Substituting into the above equation we get:EOQ = 2(1,600)($50) = 400 $1The EOQ can be used to evaluate the total cost of inventory as shown on the following slides.28Copyright © 2006 Pearson Addison-Wesley. All rights reserved.Techniques for Managing Inventory (cont.)The Economic Order Quantity (EOQ) ModelOrdering Costs = Cost/Order x # of Orders/YearCarrying Costs = Carrying Costs/Year x Order Size 2Total Costs = Ordering Costs + Carrying CostsOrdering Costs = $50 x 4 = $200Carrying Costs = ($1 x 400)/2 = $200Total Costs = $200 + $200 = $40029Copyright © 2006 Pearson Addison-Wesley. All rights reserved.Reorder point = lead time in days x daily usageDaily usage = Annual usage/360The Reorder PointOnce a company has calculated its EOQ, it must determine when it should place its orders.More specifically, the reorder point must consider the lead time needed to place and receive orders.If we assume that inventory is used at a constant rate throughout the year (no seasonality), the reorder point can be determined by using the following equation:Techniques for Managing Inventory (cont.)30Copyright © 2006 Pearson Addison-Wesley. All rights reserved.Reorder point = 10 x 4.44 = 44.44 or 45 unitsDaily usage = 1,600/360 = 4.44 units/dayUsing the RIB example above, if they know that it requires 10 days to place and receive an order, and the annual usage is 1,600 units per year, the reorder point can be determined as follows:Thus, when RIB’s inventory level reaches 45 units, it should place an order for 400 units. However, if RIB wishes to maintain safety stock to protect against stock outs, they would order before inventory reached 45 units.Techniques for Managing Inventory (cont.)The Reorder Point31Copyright © 2006 Pearson Addison-Wesley. All rights reserved.Just-In-Time (JIT) SystemThe JIT inventory management system minimizes the inventory investment by having material inputs arrive exactly at the time they are needed for production.For a JIT system to work, extensive coordination must exist between the firm, its suppliers, and shipping companies to ensure that material inputs arrive on time.In addition, the inputs must be of near perfect quality and consistency given the absence of safety stock.Techniques for Managing Inventory (cont.)32Copyright © 2006 Pearson Addison-Wesley. All rights reserved.Computerized Systems for Resource ControlMRP systems are used to determine what to order, when to order, and what priorities to assign to ordering materials.MRP uses EOQ concepts to determine how much to order using computer software.It simulates each product’s bill of materials structure all of the product’s parts), inventory status, and manufacturing process.Techniques for Managing Inventory (cont.)33Copyright © 2006 Pearson Addison-Wesley. All rights reserved.Computerized Systems for Resource ControlLike the simple EOQ, the objective of MRP systems is to minimize a company’s overall investment in inventory without impairing production.Manufacturing resource planning II (MRP II) is an extension of MRP that integrates data from numerous areas such as finance, accounting, marketing, engineering, and manufacturing suing a sophisticated computer system.This system generates production plans as well as numerous financial and management reports.Techniques for Managing Inventory (cont.)34Copyright © 2006 Pearson Addison-Wesley. All rights reserved.Techniques for Managing Inventory (cont.)Computerized Systems for Resource ControlUnlike MRP and MRP II, which tend to focus on internal operations, enterprise resource planning (ERP) systems can expand the focus externally to include information about suppliers and customers.ERP electronically integrates all of a firm’s departments so that, for example, production can call up sales information and immediately know how much must be produced to fill certain customer orders.35Copyright © 2006 Pearson Addison-Wesley. All rights reserved.Inventory Management: International Inventory ManagementInternational inventory management is typically much more complicated for exporters and MNCs.The production and manufacturing economies of scale that might be expected from selling globally may prove elusive if products must be tailored for local markets.Transporting products over long distances often results in delays, confusion, damage, theft, and other difficulties.36Copyright © 2006 Pearson Addison-Wesley. All rights reserved.Accounts Receivable ManagementThe second component of the cash conversion cycle is the average collection period – the average length of time from a sale on credit until the payment becomes usable funds to the firm.The collection period consists of two parts:the time period from the sale until the customer mails payment, andthe time from when the payment is mailed until the firm collects funds in its bank account.37Copyright © 2006 Pearson Addison-Wesley. All rights reserved.Accounts Receivable Management:The Five Cs of CreditCharacter: The applicant’s record of meeting past obligations.Capacity: The applicant’s ability to repay the requested credit.Capital: The applicant’s debt relative to equity.Collateral: The amount of assets the applicant has available for use in securing the credit.Conditions: Current general and industry-specific economic conditions.38Copyright © 2006 Pearson Addison-Wesley. All rights reserved.Accounts Receivable Management:Credit ScoringCredit scoring is a procedure resulting in a score that measures an applicant’s overall credit strength, derived as a weighted-average of scores of various credit characteristics.The procedure results in a score that measures the applicant’s overall credit strength, and the score is used to make the accept/reject decision for granting the applicant credit.39Copyright © 2006 Pearson Addison-Wesley. All rights reserved.Accounts Receivable Management:Credit Scoring (cont.)The purpose of credit scoring is to make a relatively informed credit decision quickly and inexpensively.For a demonstration of credit scoring, including the use of a spreadsheet for that purpose, see the book’s Web site at www.aw.com/gitman.40Copyright © 2006 Pearson Addison-Wesley. All rights reserved.Accounts Receivable Management:Changing Credit StandardsThe firm sometimes will contemplate changing its credit standards to improve its returns and generate greater value for its owners.41Copyright © 2006 Pearson Addison-Wesley. All rights reserved.Dodd Tool, a manufacturer of lathe tools, is currently selling a product for $10/unit. Sales (all on credit) for last year were 60,000 units. The variable cost per unit is $6. The firm’s total fixed costs are $120,000. Dodd is currently contemplating a relaxation of credit standards that is anticipated to increase sales 5% to 63,000 units. It is also anticipated that the ACP will increase from 30 to 45 days, and that bad debt expenses will increase from 1% of sales to 2% of sales. The opportunity cost of tying funds up in receivables is 15%.Given this information, should Dodd relax its credit standards?Changing Credit Standards Example42Copyright © 2006 Pearson Addison-Wesley. All rights reserved.Changing Credit Standards Example (cont.)43Copyright © 2006 Pearson Addison-Wesley. All rights reserved.Changing Credit Standards Example (cont.)Additional Profit Contribution from Sales44Copyright © 2006 Pearson Addison-Wesley. All rights reserved.Changing Credit Standards Example (cont.)45Copyright © 2006 Pearson Addison-Wesley. All rights reserved.Changing Credit Standards Example (cont.)46Copyright © 2006 Pearson Addison-Wesley. All rights reserved.Changing Credit Standards Example (cont.)47Copyright © 2006 Pearson Addison-Wesley. All rights reserved.Changing Credit TermsA firm’s credit terms specify the repayment terms required of all of its credit customers.Credit terms are composed of three parts:The cash discountThe cash discount periodThe credit periodFor example, with credit terms of 2/10 net 30, the discount is 2%, the discount period is 10 days, and the credit period is 30 days.48Copyright © 2006 Pearson Addison-Wesley. All rights reserved.MAX Company has an average collection period of 40 days (turnover = 365/40 = 9.1). In accordance with the firm’s credit terms of net 30, this period is divided into 32 days until the customers place their payments in the mail (not everyone pays within 30 days) and 8 days to receive, process, and collect payments once they are mailed. MAX is considering initiating a cash discount by changing its credit terms from net 30 to 2/10 net 30. The firm expects this change to reduce the amount of time until the payments are placed in the mail, resulting in an average collection period of 25 days (turnover = 365/25 = 14.6).Changing Credit Terms Example49Copyright © 2006 Pearson Addison-Wesley. All rights reserved.Insert Table 14.3 hereChanging Credit Terms Example (cont.)50Copyright © 2006 Pearson Addison-Wesley. All rights reserved.Credit MonitoringCredit monitoring is the ongoing review of a firm’s accounts receivable to determine whether customers are paying according to the stated credit terms.Slow payments are costly to a firm because they lengthen the average collection period and increase the firm’s investment in accounts receivable.Two frequently used techniques for credit monitoring are the average collection period and aging of accounts receivable.51Copyright © 2006 Pearson Addison-Wesley. All rights reserved.Credit Monitoring: Average Collection PeriodThe average collection period is the average number of days that credit sales are outstanding and has two parts:The time from sale until the customer places the payment in the mail, andThe time to receive, process, and collect payment.52Copyright © 2006 Pearson Addison-Wesley. All rights reserved.Credit Monitoring:Aging of Accounts Receivable53Copyright © 2006 Pearson Addison-Wesley. All rights reserved.Credit Monitoring:Collection PolicyThe firm’s collection policy is its procedures for collecting a firm’s accounts receivable when they are due.The effectiveness of this policy can be partly evaluated by evaluating at the level of bad expenses.As seen in the previous examples, this level depends not only on collection policy but also on the firm’s credit policy.54Copyright © 2006 Pearson Addison-Wesley. All rights reserved.Collection Policy55Copyright © 2006 Pearson Addison-Wesley. All rights reserved.Management of Receipts & Disbursements: FloatCollection float is the delay between the time when a payer deducts a payment from its checking account ledger and the time when the payee actually receives the funds in spendable form.Disbursement float is the delay between the time when a payer deducts a payment from its checking account ledger and the time when the funds are actually withdrawn from the account.Both the collection and disbursement float have three separate components.56Copyright © 2006 Pearson Addison-Wesley. All rights reserved.Mail float is the delay between the time when a payer places payment in the mail and the time when it is received by the payee.Processing float is the delay between the receipt of a check by the payee and the deposit of it in the firm’s account.Clearing float is the delay between the deposit of a check by the payee and the actual availability of the funds which results from the time required for a check to clear the banking system.Management of Receipts & Disbursements: Float (cont.)57Copyright © 2006 Pearson Addison-Wesley. All rights reserved.Management of Receipts & Disbursements: Speeding Up CollectionsLockboxesA lockbox system is a collection procedure in which payers send their payments to a nearby post office box that is emptied by the firm’s bank several times a day.It is different from and superior to concentration banking in that the firm’s bank actually services the lockbox which reduces the processing float.A lockbox system reduces the collection float by shortening the processing float as well as the mail and clearing float.58Copyright © 2006 Pearson Addison-Wesley. All rights reserved.Management of Receipts & Disbursements: Slowing Down PaymentsControlled DisbursingControlled Disbursing involves the strategic use of mailing points and bank accounts to lengthen the mail float and clearing float respectively.This approach should be used carefully, however, because longer payment periods may strain supplier relations.59Copyright © 2006 Pearson Addison-Wesley. All rights reserved.Management of Receipts & Disbursements: Cash ConcentrationDirect Sends and Other TechniquesWire transfers is a telecommunications bookkeeping device that removes funds from the payer’s bank and deposits them into the payees bank—thereby reducing collections float.Automated clearinghouse (ACH) debits are pre-authorized electronic withdrawals from the payer’s account that are transferred to the payee’s account via a settlement among banks by the automated clearinghouse.ACHs clear in one day, thereby reducing mail, processing, and clearing float.60Copyright © 2006 Pearson Addison-Wesley. All rights reserved.Management of Receipts & Disbursements: Zero-Balance AccountsZero-balance accounts (ZBAs) are disbursement accounts that always have an end-of-day balance of zero. The purpose is to eliminate non-earning cash balances in corporate checking accounts.A ZBA works well as a disbursement account under a cash concentration system.61Copyright © 2006 Pearson Addison-Wesley. All rights reserved.Investing in Marketable Securities62Copyright © 2006 Pearson Addison-Wesley. All rights reserved.Investing in Marketable Securities (cont.)63Copyright © 2006 Pearson Addison-Wesley. All rights reserved.Investing in Marketable Securities (cont.)64Copyright © 2006 Pearson Addison-Wesley. All rights reserved.