Current Asset Management

McGraw-Hill/Irwin Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.

Chapter Outline
What is current asset management Cash management and its importance Management of marketable securities Accounts receivable and inventory management ‡ Inventory management and policy decisions required ‡ Liquidity vis-à-vis returns ‡ ‡ ‡ ‡

Cash Management
‡ Financial managers actively attempt to keep cash (non-earning asset) to a minimum
± It is critical to have sufficient cash to assuage emergencies ± Steps to improve overall profitability of a firm:
‡ Minimize cash balances ‡ Have accurate knowledge of when cash moves in and out of the firm


Reasons for Holding Cash Balances ‡ Transactions balances ± Payments towards planned expenses ‡ Compensative balances for banks ± Compensate a bank for services provided rather than paying directly for them ‡ Precautionary needs ± Emergency purposes 1-4 .

Cash Flow Cycle ‡ Ensure that cash inflows and outflows are synchronized for transaction purposes ± Cash budgets is a tool used to track cash flows and ensuing balances ‡ Cash flow relies on: ± Payment pattern of customers ± Speed at which suppliers and creditors process checks ± Efficiency of the banking system 1-5 .

the extra cash can be ± Used for various payments to lenders. government.Cash Flow Cycle (cont¶d) ‡ Cash inflows are driven by sales and influenced by: ± ± ± ± Type of customers Customers¶ geographical location Product being sold Industry ‡ When the cash balance increases. stockholders. etc ± Used to invest in marketable securities ‡ When there is a need for cash a firm can: ± Sell the marketable securities ± Borrow funds from short-term lenders 1-6 .

Expanded Cash Flow Cycle 1-7 .

E-commerce and Sales ‡ Benefits: faster cash flow ± Credit card companies advance cash to the retailer within 7±10 days against retailer¶s with a 30 day payment terms ‡ Financial managers must pay close attention to the percentage of sales generated: ± By cash ± By outside credit cards ± By the company¶s own credit cards 1-8 .

Float ‡ Difference between firm¶s recorded amount and amount credited to the firm by a bank ‡ Two types of float: ± Mail float: Arises duet to the time it takes to deliver a check. ± Clearing float: Arises due to the time it takes to clear a check once the payment is made ‡ Both these floats do not exist anymore due to: ± Electronic payments ± Check Clearing for the 21st Century Act ‡ Check Clearing for the 21st Century Act (Check 21) ± Allows banks and others to electronically process a check 1-9 .

Improving Collections and Extending Disbursements ‡ Improving collection: ± Setting up multiple collection centers at different locations ± Adopt lockbox system for expeditious check clearance at lower costs ‡ Extending disbursement: ± General trend: ‡ Speedup processing of incoming checks ‡ Slow down payment procedures ± Extended disbursement float ± allows companies to hold onto their cash balances for as long as possible 1-10 .

received by investing on an efficiently maintained cash management program 1-11 .Cost-Benefit Analysis ‡ Allows companies to analyze the benefits.

Cash Management Network 1-12 .

and confidentiality of transaction 1-13 .Electronic Funds Transfer ‡ Funds are moved between computer terminals without the use of a µcheck¶ ± Automated clearinghouses (ACH): Transfers information between financial institutions and between accounts using computer tape ‡ International fund transfer is carried out through SWIFT (Society for Worldwide Interbank Financial Telecommunications) ± Uses a proprietary secure messaging system ± Each message is encrypted ± Every money transaction is authenticated by a code. using smart card technology ± Assumes financial liability for the accuracy. completeness.

and interest rate changes ± Differing banking systems and check clearing processes ± Differing account balance management and information reporting systems ± Cultural.International Cash Management ‡ Factors differentiating international cash management from domestic based systems: ± Differing payment methods and/or higher popularity of electronic funds transfer ± Subject to international boundaries. time zone differences. tax. and accounting differences 1-14 . currency fluctuations.

International Cash Management (cont¶d) ‡ Financial managers try to keep as much cash as possible in a country with a strong currency and vice versa ‡ Sweep account: ± Allows companies to maintain zero balances ± Excess cash is swept into an interest-earning account 1-15 .

An Examination of Yield and Maturity Characteristics ‡ Marketable securities 1-16 .

Marketable Securities ‡ When a firm has excess funds. savings. it should be converted from cash into interest-earning securities ‡ Types of securities: ± Treasury bills: Short-term obligations of the government ± Treasury notes: Government obligations with a maturity of 1-10 years ± Federal agency securities: Offerings of government organizations ± Certificate of deposit: Offered by commercial banks. and other financial institutions ± Commercial paper: Represents unsecured promissory notes issued by large business organizations ± Banker¶s acceptances: Short-term securities that arise from foreign trade 1-17 .

Management of Accounts Receivable ‡ Accounts receivable as an investment ± Should be based on the level of return earned equals or exceeds the potential gain from other investments ‡ Credit policy administration ± Credit standards ± Terms of trade ± Collection policy 1-18 .

Types of Short-Term Investments 1-19 .

and other related factors ‡ 5 Cs of credit: ± Character ± Capital ± Capacity ± Conditions ± Collateral 1-20 .Credit Standards ‡ Determine the nature of credit risk based on: ± Prior records of payment and financial stability. current net worth.

Credit Standards (cont¶d) ‡ Dun & Bradstreet Information Services (DBIS): ± Produces business information analysis tools ± Publishes reference books ± Provides computer access to information ± The Data Universal Number System (D-U-N-S) is a unique nine-digit code assigned by DBIS to each business in its information base 1-21 .

Dun & Bradstreet Report ± An Example 1-22 .

Terms of Trade ‡ Stated term of credit extension: ± Has a strong impact on the eventual size of accounts receivable balance ± Creates a need for firms to consider the use of cash discounts 1-23 .

Collection Policy ‡ A number if quantitative measures applied to asses credit policy ± Average collection period ± Ratio of bad debts to credit sales ± Aging of accounts receivable 1-24 .

An Actual Credit Decision ‡ Brings together various elements of accounts receivable management Accounts receivable = Sales = $10.667 Turnover 6 1-25 .000 = $1.

Inventory Management ‡ Inventory has three basic categories: ± Raw materials ± Work in progress ± Finished goods ‡ Amount of inventory is affected by sales. production. and economic conditions ‡ Inventory is the least of liquid assets ± should provide the highest yield 1-26 .

Level versus Seasonal Production ‡ Level production ± Maximum efficiency in manpower and machinery usage ± May result in high inventory buildup ‡ Seasonal production ± Eliminates inventory buildup problems ± May result in unused capacity during slack periods ± May result in overtime labor charges and overused equipment repair charges 1-27 .

Inventory Policy in Inflation (and Deflation) ‡ Inventory position can be protected in an environment of price instability by: ± Taking moderate inventory positions ± Hedging with a futures contract to sell at a stipulated price some months from now ‡ Rapid price movements in inventory may also have a major impact on the reported income of the firm 1-28 .

The Inventory Decision Model ‡ Carrying costs ± Interest on funds tied up in inventory ± Cost of warehouse space. and material handling expenses ± Implicit cost associated with the risk of obsolescence and perish-ability ‡ Ordering costs ± Cost of ordering ± Cost of processing inventory into stock 1-29 . insurance premiums.

Determining the Optimum Inventory Level 1-30 .

20 = 400 units 1-31 .Economic Ordering Quantity EOQ = 2SO .000 X $8U = $32.20 $0. C Where.000 = 160. S = Total sales in units O = Ordering cost for each order C = Carrying cost per unit in dollars Assuming: EOQ = 2SO = 2 X 2.000 C $0.

Safety Stocks and Stock Outs ‡ Stock out occurs when a firm is: ± Out of a specific inventory item ± Unable to sell or deliver the product ‡ Safety stock reduces such risks ± Increases cost of inventory due to a rise in carrying costs ± This cost should be offset by: ‡ Eliminating lost profits due to stockouts ‡ Increased profits from unexpected orders 1-32 .

20 = $50 1-33 . Average inventory = EOQ + Safety stock 2 Average inventory = 400 + 50 2 The inventory carrying costs will now increase by $50 Carrying costs = Average inventory in units × Carrying cost per unit = 250 × $0.Safety Stocks and Stock Outs (cont¶d) ‡ Assuming that.

Just-in-Time Inventory Management ‡ Basic requirements for JIT: ± Quality production that continually satisfies customer requirements ± Close ties between suppliers. and customers ± Minimization of the level of inventory ‡ Cost Savings from lower inventory: ± On average. manufactures. JIT has reduced inventory to sales ratio by 10% over the last decade 1-34 .

Advantages of JIT ‡ Reduction in space due to reduced warehouse space requirement ‡ Reduced construction and overhead expenses for utilities and manpower ‡ Better technology with the development of electronic data interchange systems (EDI) ± EDI reduces re-keying errors and duplication of forms ‡ Reduction in costs from quality control ‡ Elimination of waste 1-35 .

Areas of Concern for JIT ‡ Integration costs ‡ Parts shortages could lead to lost sales and slow growth ± Un-forecasted increase in sales: ‡ Inability to keep up with demand ± Un-forecasted decrease in sales: ‡ Inventory can pile up ‡ A revaluation may be needed in high-growth industries fostering dynamic technologies 1-36 .

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