Working Capital & Current Asset MgtNet Working CapitalThe Tradeoff Between Profitability & RiskThe Tradeoff Between Profitability & Risk (cont.)Slide 5The Cash Conversion CycleCash Conversion CycleSlide 8Slide 9Calculating the Cash Conversion Cycle (cont.)Slide 11Funding Requirements of the CCCFunding Requirements of the CCC (cont.)Slide 14Slide 15Slide 16Strategies for Managing the CCCInventory Management: Inventory FundamentalsInventory Management: Differing Views About InventoryTechniques for Managing InventoryTechniques for Managing Inventory (cont.)Slide 22Slide 23Slide 24Slide 25Slide 26Slide 27Slide 28Slide 29Inventory Management: International Inventory ManagementAccounts Receivable ManagementAccounts Receivable Management: The Five Cs of CreditAccounts Receivable Management: Credit ScoringAccounts Receivable Management: Changing Credit StandardsChanging Credit TermsCredit MonitoringCredit Monitoring: Average Collection PeriodCredit Monitoring: Collection PolicyCollection PolicyManagement of Receipts & Disbursements: FloatManagement of Receipts & Disbursements: Float (cont.)Management of Receipts & Disbursements: Speeding Up CollectionsManagement of Receipts & Disbursements: Slowing Down PaymentsManagement of Receipts & Disbursements: Cash ConcentrationManagement of Receipts & Disbursements: Zero-Balance AccountsInvesting in Marketable SecuritiesInvesting in Marketable Securities (cont.)Slide 48Working Capital & Current Asset MgtPrepared by Keldon BauerNet Working CapitalWorking 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.CurrentAssetsNet WorkingCapital > 0Fixed AssetsCurrent LiabilitiesLong-TermDebtEquitylow returnhigh returnlow costhigh costhighest costThe Tradeoff Between Profitability & RiskPositive Net Working Capital (low return and low risk)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 costThe Tradeoff Between Profitability & Risk (cont.)The Cash Conversion CycleShort-term financial management—managing current assets and current liabilities—is one 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.Cash Conversion CyclePurpose is to assess how well the firm is managing assetsInventory turnover ratio (IT):56.3009,37924,131InventoryGoods ofCost IT days 0213.56365IT365 DaysInventory Cash Conversion CycleAccounts receivable turnover (ART):05.9735,18565,169Rec. Acct.Sales ART days 0405.9365ART365 Period Collection Average Cash Conversion CycleAccounts payable turnover (APT):22.24448,5924,131Payable Accts.Goods ofCost APT days 5122.24365APT365 PeriodPayment Average Calculating the Cash Conversion Cycle (cont.)Both the OC and CCC may be computed as shown below.OC = Inventory Days + ACPOC = 102 + 40 = 142 daysCCC = OC – Average Payment PeriodCCC = 142 – 15 = 127 daysCash Conversion Cycle0Days 102 142Average Collection Period (ACP)Average Age of Inventory (AAI)Chromcraft Revington’s Operating Cycle0Days 15 142Chromcraft Revington’s Cash Conversion CyclePay Accounts PayableCollect on Sale of Inventory127 Days LaterFunding Requirements of the CCCPermanent vs. Seasonal Funding NeedsIf 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.Funding Requirements of the CCC (cont.)Permanent vs. Seasonal Funding NeedsSemper 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 StrategiesFunding 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.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.Strategies for Managing the CCC1. Turn over inventory as quickly as possible without stock outs that result in lost sales.2. Collect accounts receivable as quickly as possible without losing sales from high-pressure collection techniques.3. Manage, mail, processing, and clearing time to reduce them when collecting from customers and to increase them when paying suppliers.4. Pay accounts payable as slowly as possible without damaging the firm’s credit rating.Inventory Management: Inventory FundamentalsClassification of inventories:Raw materials: items purchased for use in the manufacture of a finished productWork-in-progress: all items that are currently in productionFinished goods: items that have been