Professional Documents
Culture Documents
LECTURES
Gems
CONTENT CAPSULE:
Basic concepts and significance of working capital management
Working capital policy
Cash and marketable securities management
Receivables management
Inventory management
Short-term credit for financing current assets
J.A. Casio
PAGE1
RETURNS
Short Term
Financing
RISKY
Permanent
Financing
Short Term Financing
Permanent
Financing
Marketable Securities
Assets
Permanent Fixed Assets
RETURNS
Temporary CA
Permanent Current Assets
Permanent Fixed Assets
Permanent
Financing
Forecasting cash requirements based on corporate plan and determining all possible sources of cash and costs involved.
Collection float is the period that a customer draws a check and delivers but no actual receipt of cash has been made.
Disbursement Float is the period that the company has drawn a check but no actual disbursement has happened.
Payor
Mails
Payment
MAIL FLOAT
A Banks balance:
P100,000
Payee
Receives
the Mail
Disbursement float
Fund is
actually
available
for use by
the payee
PROCESSING
FLOAT
FLOAT
Payee
deposits
remittance
CLEARING
FLOAT
Books balance:
P80,000
Collection float
B Banks balance:
P75,000
Total Cost of Cash = (Cost per conversion x Number of conversion) + (Opportunity Cost % x Ave Cash Balance)
Average Cash Balance = ECQ/2 + Minimum Balance Requirement
Maximum Inventory = ECQ + Minimum Balance Requirement
Wherein the:
1. The conversion cost is the cost of converting marketable securities to cash. It includes:
a. Fixed cost of placing an order for cash and marketable securities
b. Paperwork costs
c. Brokerage fees
d. Cost of any follow-up action
2. The opportunity cost is the cost of holding cash rather than marketable securities (i.e. the rate of interest that can
be earned on marketable securities)
Receivables management
Objectives, factors in determining accounts receivable policy
Receivables management refers to the formulation and preparation of plans and policies related to credit sales and
maintenance of receivables at reasonable level, and its collection.
In order to establish appropriate credit policies, a study of the days sales outstanding (DSO) and the aging of receivables
must be conducted to determine areas of possible improvement.
Days sales outstanding (DSO) is also sometimes called the average collection period (ACP). The DSO measures the
average length of time it takes a firm's customers to pay off their credit purchases. The DSO is compared to benchmark
credit period to know whether collection policies are enforced.
DSO = Receivables Balance
Average Daily Credit Sales
OR
Average Collection =
Period
Aging of receivables requires the preparation of a schedule showing percentages of receivables as outstanding for a specific
period of time. This reflects the behavior of its customers in making payments. The effectiveness of the credit collection
may be evaluated using the data from the aging schedule.
Costs associated with accounts receivable
The following are costs associated with accounts receivable:
1. Cost of carrying receivables = (DSO x Average Daily Sales x Variable cost ratio) x Cost of Funds7
2. Cost of doubtful accounts = Planned Bad Debts Bad Debts under present plan
Summary of trade-offs in credit and collection policies with incremental analysis of credit policies
Credit Policy is a set of decisions that include the following elements: authorization of credit or credit standards8, firms
credit period, collection procedures, and discounts offered to customers. As much as, most of these are dictated by the
industry, where the entity belongs, the entitys management has to decide whether their credit and collection policies would
be more relaxed or tighter than that of its competitors.
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8
Benefit
Encourage cash transactions ; Reduce
bad debts, increasing income by the
decrease in bad debts net of tax
Increase sales activity, increase income
by as much as its contribution margin
Offering discounts
Costs
Put off large volume sales, reducing
income by as much as its contribution
margin
Increase bad debts, reducing income by
as much as the additional bad debts
expense
Depress sales activity, reducing
income by as much as its contribution
margin
Inventory management
Objectives, reasons for managing inventories
The primary objective for managing inventories is to free cash from investment in inventory as soon as possible without
losing sales from stock outs.
Inventory management techniques
1. ABC System where Group A inventory consists of the highest peso investment but smallest number of inventory;
Group C consists of the smallest peso investment but where the largest percentage in number of inventory lies. Group
B is right in between A and C.
2. EOQ Model where the optimal size of order is determined in order to minimize carrying costs and ordering costs.
Relevant Formula for EOQ determination is listed below:
EOQ =
Just-in-Time System where the investment in inventory is minimized by keeping a significantly low level of
inventory.
Materials requirement planning system where EOQ concepts are coupled with computer software to calculate the
production requirements and the availability of the inventory to satisfy its needs
Cost of Inventory
There are various costs associated with inventories that are needed to be kept at a practical minimum. These relevant costs
are the following:
a. Ordering cost. This includes :
Total Ordering Costs = Number of orders x Cost per order
1. placing of ordering costs
2. receiving of order
3. handling and courier costs.
Total Carrying Costs = Average Inventory level x Annual
b. Carrying Cost. This is composed of :
carrying costs per unit
1. storage costs
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Some companies may apply the red-line method or the 2-bin method.
Safety stock can also be determined by computing the safety stock level which results to cheapest stock out costs
combined with carrying costs. Stock out costs is equal to {(stock-out cost per unit x number of shortage (units) x number of
orders x probability x per unit/time)}.
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Stock-out cost. Costs that a company will suffer from if it does not keep adequate level of inventory to respond to the
demands of customers. This cost is relevant in determining the appropriate safety stock level. This include costs of
dissatisfied customers, possible trade discounts passed out, hampering of production runs, incurrence of rush delivery
charges, among others.
2. Accruals
3. Bank loans
4. Commercial paper
5. Factoring of Accounts
Receivable
Major Features
Spontaneous; free credit (for Accounts
payable accumulated, within discount period);
costly credit (for Accounts payable
accumulated, beyond discount period up to
payment date)
Spontaneous; free
May require compensating balances; may
include a formal line of credit or revolving
line of credit which charges a commitment
fee; for less than a year loan, interest charged
or advanced is computed for the specific loan
period.
Cost
Approximate Cost of =
Discount Rate
Foregoing discount
(1- Discount Rate)
x 360
N
360/N
}-1
APR =
CREDIT PERIOD}
7. Warehouse Inventory
Financing