Working capital management

A review
 Topics
working capital management
1. Managing the firm’s cash conversion
cycle
2. Cash management
3. Marketable securities management
4. Inventory management
5. Receivables management
6. Financing current assets
7. Sources of short-term funds
what is working capital
management?
 Working capital management
• managing and financing
• the current assets and current liabilities of
the firm
1. What is cash conversion
cycle?
 Three periods of cash conversion
cycle
• Inventory conversion period
• Receivables collection period
• Payables deferral period
what is it meant by conversion
period?
 meaning
• The average time required to convert
materials into finished goods and sell
those goods.
 Formula for
inventory conversion period
• Inventory conversion Average inventory
period = ------------------------
sales per day
what is receivables collection
period?
 meaning
• The average time required to collect
Accounts Receivable.
 Formula for
Receivables collection period
• Receivables Average receivables
collection period = ---------------------------
(days sales credit sales per day
outstanding)
What is payables deferral
period?
• The average length of time between the
purchase of materials and Labor and the
payment of cash for them.
 Formula for
payables deferral period
• payables deferral Average Payables
period = ---------------------------
purchases per day
or
Average Payables
= ---------------------------
cost of goods sold
/365
What is cash conversion cycle?
 Cash conversion cycle
• It is the net of
(inventory conversion period + receivables
conversion period – payables deferral period)

• It measures the time period from the time

the firm pays for its materials and Labor to
the time it collects its cash from sales of
goods
What is effective working
capital management?
 Goal
• Shortening the cash conversion cycle as
much as possible without harming
operations
 why should the cash
conversion cycle should be
shorter?
• Because the longer the cash conversion
cycle, the greater the need for financing
Why should the firm maintain
a sufficient amount of cash?
 2.Cash management
• To take advantage of trade discounts
• Maintain its credit rating
• Meet its unexpected needs
For what purpose does the
firm hold cash?
 Two basic purposes
• For everyday business
operations/transactions
• Compensation to financial institutions
(compensating balances)
What is the purpose of cash
budgets?
 Purpose of cash budgets
• To take advantage of trade discounts
• To maintain credit rating
• Take advantage of favourable business
opportunities (speculator balances)
• To meet emergencies (precautionary
balances)
What is float?
• It is time that elapses relating to mailing,
processing and clearing checks
How do you manage float?
 Managing float
• extending the float for disbursements and
• shortening the float for cash receipts.
What are zero balance
accounts?
• maintaining of regional bank account
• and transferring funds
• just enough to pay the checks presented
to the bank
• The bank will notify the amount of cash
required to cover the checks.
 Advantages of
zero balance accounts
• Cheques take a longer time to clear and
they provide more float for a cash
disbursements
• Extra cash doesn’t need to be deposited
for contingencies
What is lockbox system?
• Customers payments are Sent to Post
Office box maintained by bank
• Bank personnel retrieve the payments and
deposit them into the firm’s bank account
What are the benefits of
lockbox system ?
• Cash flow benefit, Cost-effective
• (if the interest cost saved due to obtaining
more timely deposits is sufficient to cover
the net increasing cost of cash receipt
processing)
• Bank fees - internal costs saved from
having the bank process receipts
What is concentration banking?
• It maintaining a local branch account so
that the customers can make payments to
the local branch and the local branch
transfers those surplus funds to firms
primary bank
What are the advantages of
concentration banking ?
• It speeds up collection of payments, and
firm gets the use of the funds more quickly
• The float related to cash receipts is
shortened
• Official bank cheques which are preprinted
can transfer funds in a less expensive way
than transferring funds between accounts
what is electronic funds
transfer?
• Funds are moved electronically between
accounts without the use of a cheque
what is the advantage of an
electronic fund transfer?
• It can actually take the float out of both the
receipts and disbursements processes
what is international cash
management?
• Managing the cash accounts in different
countries by multinational firms
 what are the advantages of
international cash management?
• Transfer funds to a country in which
interest rates are higher allowing
increased returns on investments
3. Marketable securities
management
What is Marketable securities
management?
• Marketable securities can be easily
converted to cash and also provide the
benefit of investment return
• There are many securities to choose from
for short-term investment
 What are the factors that are
considered in investing in short-
term securities?
• The requirement of minimum investment
• Safety
• Marketability (liquidity)
• Maturity
• yield
 What are the important
considerations with respect to
short-term investments?
• Liquidity and safety
• because these investments must be
available to meet the current cash needs
of the firm
what are the major types of a
short-term investments?
 Major types of
short term investments
• Treasury Bills,
• Treasury Notes,
• Treasury Inflation Protected Securities (TIPS ),
• Federal Agency Securities,
• Certificates Of Deposit (CD),
• Commercial Paper,
• Banker’s Acceptance,
• Eurodollar Certificate Of Deposit,
• Money Market Funds,
• Money Market Accounts,
• Equity And Debt Securities.
What are Treasury bills?
 T-bills
• T-bills short-term obligations of the federal
government
• The they have the maturity of from 91 to
182 days.
• Existing T-bills may be purchased in the
market with virtually any maturity date up
to 182 days.
• The act to market ensures liquidity for T-
bills, so they are very popular.
Treasury notes
 Treasury notes
• These bills are government obligations
• A suit for short to intermediate term funds
• Their maturity time is from one to 10 years
What Treasury inflation
protected securities?
 TIPS
• when the firm want to minimize interest-
rate risk they invest in government
obligations which pay interest equals to

Real rate of return specified by the US Treasury

+ principal at maturity (adjusted for inflation)
What are federal agency
securities?
• Offerings of government agencies
• Example :Federal home loan bank
Features of the Federal agency
securities
• security, liquidity (an active market)
• Pay slightly higher yields than Treasury
issues
What is certificates of deposit?
• Savings deposits at financial institutions
Types of certificates of deposit
 Two tire market
• Small CDs ($500 to $10,000) with lower
interest rates
• Large CDs (one hundred thousand dollars
or more) with higher interest rates
Is there any secondary market
for large CDs?
• Yes, they provide some liquidity
Are CDs insured?
• CDs are normally insured up to $100,000
by the federal government
What is commercial paper?
• Large unsecured short term promissory
notes issued to the public by large credit
worthy corporations
 What is the maturity period of
commercial paper? Is there any
secondary market to commercial
paper?
• Two to nine-month
• held to maturity by the investor because
there is no active secondary market
What is banker’s acceptance?
• a draft drawn on a bank for payment
when present it to the bank
When does bankers acceptances
the generally arise?
• it arises from payments for goods by
corporations in foreign countries
 When does the corporation
present and acceptance of a
payment?
Do bankers acceptance has
secondary market?
• The corporation receiving the bankers and
acceptance may have to wait 30 to 90
days to present the and acceptance for
payment
• Due to waiting secondary market has
developed for the sale of the instruments
at a discount.
 Banker’s acceptance
• Management may purchase bankers
acceptances as the short term
investments
• Bankers acceptances involve slightly
more risk than government securities but
also offers slightly higher yields
Eurodollar certificate of deposit
• Eurodollars are US dollars held on deposit
by foreign banks and in turn lent by the
banks to anyone seeking dollars
 why foreign banks offer
Eurodollars certificates of
deposit?
• To obtain dollars
• As an investment Eurodollar certificates of
deposit pay higher yields than Treasury
bills or certificates of deposit at large US
banks
What are Money market funds?
• shares in a fund that purchases higher
yielding bank CD’s , commercial paper
and other large denomination , higher
yielding securities

• They allow smaller investors to participate

in these markets
what are money market
accounts?
• Shares in a fund that purchases higher
yielding bank CD’s , commercial paper
and other large denomination, higher
yielding securities.
• They allow smaller investors to participate
in these markets.