Current Asset Management

(Chapter 7)
(Chapter 6 – pages 143 – 145)

 Working Capital Management

 Current Asset Investment Policy
 Temporary and Permanent
Current Assets
 Zero Working Capital
 Cash Management
 Marketable Securities
 Accounts Receivable Management
 Inventory Management
 Working Capital Management:
An Overview
 Gross Working Capital -(Current Assets)
 New Working Capital - (Current Assets - Current
Liabilities)
 Working Capital Management
 Involves investing in current assets and financing
of current assets:

C u rre n t A s s e t
In v e s tm e n t

C u rre n t L o n g -T e rm
L ia b ilit ie s F in a n c in g
 Current Asset Investment Policy
 Everything else remaining the same, higher levels
of current assets mean lower risk and lower
expected return
 Lower Risk
 Greater ability to meet short-run obligations.
 Lower Return
 Cash and marketable securities typically yield
low returns. Furthermore, when current assets
are increased, additional financing costs will be
incurred thereby lowering returns.
 Lower levels of current assets result in opposite
effects.
Alternative Current Asset Investment
Policies
Current Asset (millions of $)
14
Conservative - low risk
12
10 Moderate
8
Aggressive - high risk
6
4
2
0
0 10 20 30 40

Sales (millions of dollars)

 Temporary vs. Permanent Investment
in Current Assets
 Temporary Investment - Commonly, firms experience
short-run fluctuations in current assets. For example,
retail department stores will have high levels of
inventory around Thanksgiving. In January, the
inventory should be low.
 Permanent Investment - Firms always have some
minimum level of investment in current assets (i.e., a
permanent investment). As a firm grows over time,
the level of permanent current assets also grows
(e.g., a supermarket chain with 70 stores will have
more permanent inventory than a chain with 4
stores).
Temporary and Permanent Current
Assets
Millions of dollars
14 Temporary Fluctuations in
12 Current Assets

10
8
6
4 Permanent Current Assets
2
0
12

15

18

21
0

Time Period
Cash Management: An Overview
 Beginning Cash Balance
+ Cash Inflows - - - Speed Up
- Cash Outflows - - - Slow Down
= Ending Cash Balance
- Desired Cash Balance
= Surplus or Shortage
 If Surplus: Pay off short-term debt or buy marketable
securities
 If Shortage: Short-term borrowing or sell marketable
securities
 Desired Cash Balance:
 Precautionary Demand - Satisfy possible, but
as yet indefinite cash needs.
 Speculative Demand - Build up current cash
balances in anticipation of future business
costs being lower.
 Risk Preferences
 Compensating Balances
 Transactions Demand - Cash needs arising in
the ordinary course of doing business.
 Float

 Much of cash management is oriented

towards managing the float.
 Mail Float
 Time lapse from the moment a customer
mails a remittance check until the firm
begins to process it.
 Processing Float
 Time required for the firm to process
remittance checks before they can be
deposited in the bank.
 Float (Continued)

 Transit Float
 Time necessary for a deposited check to
clear through the commercial banking
system and become usable funds to the
company.
 Disbursing Float
 Funds available in the firm’s bank account
until its payment check has cleared
through the system.
 Electronic Funds Transfer

 Substantially reduces float

 Some Examples:
 Automated teller machines
 Direct deposit of payroll checks
 Paying the supermarket and others with
bank cards.
 Lock-Box System

 Customers mail remittance checks to

P.O. Box.
 Local bank processes and deposits
checks directly into the company’s
account.
 Reduces mail and processing float.
 Also reduces transit float if lock-box is
located near Federal Reserve Bank or
branches.
 Marketable Securities
 The marketable securities portfolio is typically used for
temporary investments of excess cash, or as a substitute
for cash (i.e., near cash). Therefore, securities in the
portfolio are generally safe, short-term, and highly liquid.
 Treasury Bills
 Short-term obligations of the federal government with
maturities of 91 days to a year. They are traded on a
discount basis in bearer form. Not taxable at state and
local levels, but taxable at the federal level.
 Commercial Paper
 Unsecured promissory notes issued by large
corporations in amounts of $25,000 or more (No active
secondary market).
Marketable Securities Continued
 Negotiable Certificates of Deposit (CDs)
 Offered by financial institutions (e.g., banks,
S&Ls). Those big business is interested in have
$100,000 minimums.
 Banker’s Acceptance: Generally arise out of foreign
trade.
 Importer (buyer) issues a promise to pay a certain
amount to the exporter (seller).
 A bank accepts the promise, and commits itself to
pay the amount when due.
 Exporter (seller) can now sell this acceptance in
the marketplace at a discount (a price that is less
than the promised amount).
Accounts Receivable Management
 Major Decisions
 Credit Standards
 Credit Terms
 Collection Policy
 Credit Standards: Will they pay as agreed?
 Credit Scoring
 Credit Reports
 Past Experience
 Financial Analysis
 Debt Ratios, Liquidity Ratios, Profit Ratios
Accounts Receivable Management
(Continued)
 Credit Terms
 Example: 2/10, net 30
 Collection Policy
 Standard Operating Procedures
 Be professional, firm, and do not bluff.
 Vary procedures with slow payers.
 Evaluating Collection Efforts
 Average Collection Period, Bad Debt to Sales
Ratio, Aging Accounts Receivable, Receivables
to Assets Ratio, Credit Sales to Receivables
Ratio.
 Inventory Management
(Covered in Detail in Production
Management)
 Basic Costs Associated With Inventory
Carrying Costs
 storage, insurance, cost of capital used

 Ordering Costs
 placing orders, shipping and handling

 Costs of Running Short

 lost sales, reduced customer goodwill

 Objective
 Minimize total costs associated with managing
inventory.