essential learning for ctp candidates new york cash...
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1
Essential Learning for CTP CandidatesNew York Cash Exchange: 2016 – Session #03
Copyright © 2016 – The Treasury Academy, Inc.All Rights Reserved – www.treasuryacademy.org
New York Cash Exchange: 2016Essential Learning for CTP CandidatesSession #3: Wed. Afternoon (6/01)
ETM4-Chapter 8:Introduction to Working Capital Management
ETM4-Chapter 9:Working Capital Metrics
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Essentials of Treasury Management, 4th Ed. (ETM4) is published by the AFP which holds the copyright and all rights to the related materials.
As a prep course for the CTP exam, significant portions of these lectures are based on materials from the Essentials text.
Overview of Chapter 8 Overview of Working Capital The Working Capital Cash
Conversion Cycle (CCC) How Changes in Current
Accounts Impact External Financing
Working Capital Investment and Financing Strategies
Management of Credit and A/R Management of Inventory Management of A/P Multinational Working Capital
Management Tools
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Overview of Working CapitalWorking capital can be obtained by: Collection cash flow from operations
Increasing debt
Selling assets and investments
Selling equity
And it can be reduced by: Using cash flow in operations
Repaying debt
Purchasing assets and investments
Paying dividends and buying back stock/equity
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Essential Learning for CTP CandidatesNew York Cash Exchange: 2016 – Session #03
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Cash Conversion Cycle
Build Inventory
Provide/Sell Services & Products
Collect Revenues (A/R)
Purchase Supplies, Facilities, Etc.
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Borrow orLiquidate
Investments
Invest orPay Down
Borrowings
Operating Cash Flows
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CashInflows
CashInflows
CashInflows
Concentration Account
ConcentrationFlows
ConcentrationFlows
Cash Outflows
Cash Outflows
Cash Outflows
FundingFlows
FundingFlows
Short-Term Investments
Short-Term Borrowing
LiquidityMgmt Flows
LiquidityMgmt Flows
5
Purchase-to-Pay Cycle
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Source: ETM4 - © AFP
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Essential Learning for CTP CandidatesNew York Cash Exchange: 2016 – Session #03
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Focus of Treasury on Cash Flow Timeline
Treasury focus is on the payment portion of the cycle
Calculation: Float Neutral Calculation◦ TD = total days difference in payment timing◦ r = Opportunity cost as an annual rate
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1Discount 1
r1 TD
365
7
Float Neutral Calculation Assume r = 12% and TD = 3 days
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1Discount 1
12%1 3
365
11 1 0.99901467
1.0009863
0.00098533
0.001 (Rounded) or 0.10%
If the buyer is allowed to take a discount of 0.10 %, they would be indifferent (in present value terms) between paying by check or by electronic transfer (a speedup of 3 days in loss of value)
8Source: ETM4 - © AFP
Group Exercise Working in your groups,
answer the following questions: What is the difference between
collection float and disbursement float?
What are the key components of each of these float concepts?
What is the most important component to manage for your company?
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Essential Learning for CTP CandidatesNew York Cash Exchange: 2016 – Session #03
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Collection/Disbursement Float
Components◦ Mail Float Mail Time
◦ Processing Float Deposit Preparation Time
◦ Availability Float Check Availability Time
◦ Clearing Float Check Clearing Time
Measurement of Float◦ Dollar-Days
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The working capital cash conversion cycle(CCC)
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Day 1 Day 30 Day 45 Day 80
PurchaseOf Materials
Payment ForMaterials
Sale ofProduct
CollectAccounts
Receivable
Days Inventory
Days Receivables
Days Payables
Cash Conversion Cycle
Source: ETM4 - © AFP
The Working Capital Cash Conversion Cycle (CCC)
◦ Days’ Inventory orInventory Conversion Period
◦ Days’ Receivables orReceivables Conversion Period
◦ Days’ Payables orPayables Conversion Period
◦ Calculating the CashConversion Cycle (CCC)
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Essential Learning for CTP CandidatesNew York Cash Exchange: 2016 – Session #03
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More on Cash Conversion Cycle (CCC)
Assume the following◦ Days’ Inventory = 45 days◦ Days’ Receivables = 35 days◦ Days’ Payables = 30 days◦ Then: CCC = 45 + 35 – 30 = 50 days
Now assume the company can reduce inventory and A/R, while extending payables◦ Days’ Inventory = 40 days◦ Days’ Receivables = 32 days◦ Days’ Payables = 33 days◦ Then New CCC = 40 + 32 – 33 = 39 days
Cash Turnover = 365 / CCC◦ At CCC = 50 days, Cash Turnover = 7.3 times◦ At CCC = 39 days, Cash Turnover = 9.4 times
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CCC = Days’ Inventory + Days’ Receivables – Days’ Payables
Problems in “Managing” CCC Components
Potential lost sales
Production stoppages
Stretched payables
Foregone cost-saving trade discounts
Higher prices assessed by vendors on smaller orders or slow payments
Refusal to sell to weak customers
Excessive reliance on A/P rather than S/T bank credit
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Working Capital Investment and Financing Strategies
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AssetBreakdown
MaturityMatching
ConservativePolicy
AggressivePolicy
Fixed AssetsPermanent
Current AssetsFluctuating
Current Assets
Long-Term SourcesShort-Term
Sources
Long-Term SourcesS/T
Sources
Long-Term SourcesShort-Term
Sources
Selecting a Current Asset Investment Strategy◦ Restrictive current asset investment
◦ Relaxed current asset investment
Selecting a Current Asset Financing Strategy
Source: ETM4 - © AFP
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Essential Learning for CTP CandidatesNew York Cash Exchange: 2016 – Session #03
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Group Exercise Working in your groups,
answer the following questions: For the practitioners: What are some
of the key issues related the management and financing of working capital at your company?
For the bankers: What kinds of products/services to you offer to help your customers in this area?
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Management of Credit and Accounts Receivable (A/R) Relationship Between Treasury and Credit Management
Trade Credit Policies
Billing and Collection Methods
Forms of Credit Extension
Cash Application
Considerations Pertaining to Terms of Sale
Financing Accounts Receivable (A/R)
Cross-Border Trade Management
Developments in Credit and Accounts Receivable (A/R)
Legislation Affecting on Credit and Collections in the U.S.
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Relationship Between Treasury and Credit Management
Separate functions
Credit manager administers policies that establish credit standards, define terms of sale, approve credit sales, and set individual and aggregate credit limits
A/R is created once a sale is made and trade credit is extended
A/R management includes billingand processing payments,monitoring payment patterns, and collecting delinquent accounts
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Essential Learning for CTP CandidatesNew York Cash Exchange: 2016 – Session #03
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Credit Information Sources
Company must consider the type, quantity and cost of information when establishing a method for analyzing credit requests
Credit information is gathered in stages from both internal and external sources
At each stage, costs are weighedagainst expected benefits
Sources include:◦ Internal payment history◦ Financial statements◦ Trade references◦ Credit reports or ratings
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The Five C’s of Credit
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Character An intent or willingness to pay as evidenced by payment history
CapacityCurrent and future financial resources that can be committed to pay obligations
CapitalShort- and long-term financial resources to supplement insufficient cash flow for payments
CollateralAssets or guarantees available to secure an obligation if payment is not made
ConditionsGeneral economic environment and economic conditions for the customer and the seller
Quantitative Credit Analysis Most often used measures:◦ Liquidity and WC ratios◦ Debt management and
coverage ratios◦ Profitability measures
Consumer Credit Scoring Process 1. Differentiating risks2. FICO Score3. Set cutoff score4. Applying further analysis
where necessary
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Essential Learning for CTP CandidatesNew York Cash Exchange: 2016 – Session #03
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Group Exercise
Working in your groups,answer the following questions:
Why might quantitative credit scoring be less effective for B2B sales than it is for B2C sales?
What are some of the other factors that should be considered in B2B credit and sales?
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Why Quantitative Credit Analysis is Not as Effective for B2B
The available databases are much smaller for B2B
The per-transaction exposure is usually much larger
Impact of one large default Difficult to obtain financial info
for some customers, especially for smaller, private companies
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Billing and Collection Methods Major objective of collection
policy is to convert A/R into cash quickly while minimizing collection expense and bad debt losses
Effective A/R management includes reducing invoicing float as much as possible
Clear collection policies should be established and enforced
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Essential Learning for CTP CandidatesNew York Cash Exchange: 2016 – Session #03
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Credit & Payment Application
Forms of Credit Extension◦ Open account◦ Installment credit◦ Revolving credit◦ Letter of credit (L/C)
Offering Discounts◦ Evaluate costs
versus benefits Cash Application◦ Open item◦ Balance forward
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Common Terms of Sale
Cash before delivery (CBD) Cash on delivery (COD) Cash terms Net terms Discount terms Monthly billing Draft/Bill of lading Seasonal dating Consignment
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Financing Accounts Receivable
Borrow unsecured funds to support A/R
Pledge A/R as collateral for secured loan
Securitize receivables
Use captive finance subsidiary
Third-party financing
Card Payments
Factoring
Private-label financing
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Essential Learning for CTP CandidatesNew York Cash Exchange: 2016 – Session #03
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Financing A/R – Card Payments Advantages◦ No direct costs of running a credit department
◦ Seller doesn’t have to finance A/R
◦ Credit card issuer absorb debt losses
◦ Sales increased
◦ Payback more quickly
Disadvantages◦ Seller relinquishes control over credit decision
◦ Seller loses promotional opportunities
◦ Seller incurs discount costs and transaction fees.
◦ Maintenance expense
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Elements of Basic Inventory Policy Inventory policy of most
companies includes elements such as:◦ Reasons for holding inventory◦ Types of inventory held◦ Levels of inventory◦ Obsolescence and Spoilage◦ Costs and benefits associated with
holding inventory◦ Financing of inventory
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Management of Inventory
Management of Accounts Payable (A/P)
A/P is a major source of s-t financing for many companies
A/P manager’s primary responsibility is to verify incoming invoices and authorize payments –sometimes referred to as “vouchering”
Three-way Match Treasury & A/P Coordination◦ How & when invoices are paid◦ Reconciliation of cleared (paid) items
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Essential Learning for CTP CandidatesNew York Cash Exchange: 2016 – Session #03
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Disbursement System Considerations
Four Considerations◦ Information Access
◦ Fraud Prevention
◦ Relationship Maintenance with Payees
◦ Timing of Payments
Centralized vs. Decentralized
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Three-Way Match
Purchase Order
ReceivingAdvice
Invoice
ApprovedVendorList ??
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Considerations for Global Management of Working Capital
Global Working Capital Management Tools and Techniques
Multicurrency Accounts Netting Leading and Lagging Re-invoicing Center Internal Factoring In-House Banking Export Financing
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Essential Learning for CTP CandidatesNew York Cash Exchange: 2016 – Session #03
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Before Netting
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Source: ETM4 - © AFP
With Multilateral Netting
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Source: ETM4 - © AFP
Benefits/Costs of Netting System
Benefits◦ A reduction in the number of FX transactions and
cross-border wire transfers, and benefits from natural hedging
◦ More favorable FX rates due to the potential for larger FX trades resulting from consolidation
◦ Improved cash and currency exposure forecasting for both the subsidiary and the parent company as a result of the ability to preplan cross-border payments
Costs◦ Setup, administration and maintenance expenses
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Essential Learning for CTP CandidatesNew York Cash Exchange: 2016 – Session #03
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Leading and Lagging
Lagging• Executing cross-border
payments between subsidiaries behind the scheduled payment date
• Used when a subsidiary country’s currency is expected to appreciate relative to the parent company’s currency
Leading• Executing cross-border
payments between subsidiaries ahead of the scheduled payment date
• Used when a subsidiary country’s currency is expected to depreciate relative to the parent company’s currency
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Re-invoicing Center Purpose
Buys goods from an exporting subsidiary
Resells the goods to an importing subsidiary
Company Owned Subsidiary
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Source: ETM4 - © AFP
Before Re-invoicing
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Source: ETM4 - © AFP
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Essential Learning for CTP CandidatesNew York Cash Exchange: 2016 – Session #03
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With Re-invoicing
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Source: ETM4 - © AFP
Overview of Chapter 9 Topics Introduction Basic Financial Concepts Fundamental Working
Capital Metrics Calculation of the Cash
Conversion Cycle(CCC) Cash Discount Calculation Accounts Receivable(A/R)
Monitoring and Control Collections and
Concentration Calculation
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Time Value of MoneyThe value of cash flow is determined by:
• Amount of the cash flows.• Appropriate interest rate.• At what future period the
cash flow is expected to occur.
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Essential Learning for CTP CandidatesNew York Cash Exchange: 2016 – Session #03
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Concept of Opportunity Cost
What is the appropriate rate to use for time value analysis?◦ Investors look to alternative investments in a
particular risk class to discover the best rate of return available
◦ By investing in one particular company or investment, the investor loses the opportunity to invest in other securities
◦ The firm must provide a return that equals the investors’ opportunity cost
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Cost of Capital This refers to the permanent sources of
capital such as LT debt, preferred stock and common equity
All costs of capital should be determined on an after-tax basis
Equity costs are already on an after-tax basis, so only debt costs need to be adjusted for marginal income taxes
Concept of Weighted Average Cost of Capital (WACC)
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Fundamental Working Capital Metrics
Current Ratio Quick Ratio Cash Flow to Total Debt Ratio Total Working Capital
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Essential Learning for CTP CandidatesNew York Cash Exchange: 2016 – Session #03
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Liquidity or Working CapitalCurrent Ratio
Measures the degree to which current obligations are covered by current
assets
Total Current AssetsCurrent Ratio =
Total Current Liabilities
$8,000= = 2.35
$3,400
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Source: ETM4 - © AFP
Liquidity or Working Capital: Quick Ratio
Measures the degree to which a company’s current liabilities are covered by its most liquid current assets
(Cash) + (S-T Investments) + (A/R)Quick Ratio =
Total Current Liabilities
($1,500 + $1,300 + $1,700)= = 1.32
$3,400
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Source: ETM4 - © AFP
Liquidity or Working Capital: Cash Flow to Total Debt Ratio
Measures ability to repay debt (a relatively low ratio indicates an inability to repay debt and can predict financial failure; a higher ratio would imply more safety)
(Net Income + Depreciation)CF to Total Debt Ratio =
Short-Term Debt + Long-Term Debt
($850 + $200) $1,050= = = 0.184
$1,800 + $3,900 $5,700
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Source: ETM4 - © AFP
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Essential Learning for CTP CandidatesNew York Cash Exchange: 2016 – Session #03
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Liquidity or Working Capital: Working Capital
Indicates the dollar amount by which current assets exceed current liabilities
Working Capital = Current Assets Current Liabilities
= $8,000 $3,400 = $4,600
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Source: ETM4 - © AFP
Cash Conversion Cycle (CCC)Days’ InventoryDays’ ReceivablesDays’ PayablesCash Conversion Cycle (CCC)Cash Turnover Ratio
Days’ Inventory Days’ Receivables
Days’ Payables Cash Conversion Cycle
“Working Capital Gap”
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Source: ETM4 - © AFP
Cash Conversion Cycle
Elements in the cash conversion cycle:
Days’ Inventory
Days’ Receivables
Days’ Payables
Inventory365
Cost of G oods Sold
Accounts Receivable 365Sales
Accounts Payable365
Cost of G oods Sold
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Source: ETM4 - © AFP
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Essential Learning for CTP CandidatesNew York Cash Exchange: 2016 – Session #03
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Cash Conversion Cycle
Elements in the cash conversion cycle:
Days’ Inventory
Days’ Receivables
Days’ Payables
Days 103.15 3659,200
2,600 365
COGS
Inv
Days 41.36 36515,000
1,700 365
Sales
A/R
Days 63.48 3659,200
1,600 365
COGS
A/P
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Source: ETM4 - © AFP
Cash Conversion Cycle (CCC)
Calculates the time required to convert cash outflows (necessary to produce goods) into cash inflows (through the collection of accounts receivable)
Days 81.03 63.48 - 41.36 103.15
Pay. Days' - Rec. Days' Inv. Days' CCC
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Cash Turnover RatioIf a company has a cash
conversion cycle of 81.03 days, how many cash conversion cycles does the company go through in a year (cash turnover)?
365 DaysCash Turnover =
Cash Conversion Cycle
365= 81.03 Days
= 4.5 Times© 2016 - The Treasury Academy, Inc. - All Rights Reserved 54
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Essential Learning for CTP CandidatesNew York Cash Exchange: 2016 – Session #03
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Cash Conversion Efficiency If the cash flow of a company is $550
and its revenue is $15,000, then its Cash Conversion Efficiency will be:
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Cost of a Buyer Not Taking a Cash Discount (Terms: 2/10, net 30)
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D 365Discount Cost = 100 D N T
2 365= 100 2 30 10
2 365= = .0204 18.25 =.3723 or 37.23%98 20
WhereD = Discount percentage is 2%N = Net period is 30 daysT = Discount period is 10 days
The cost of not taking the discount can be compared with the organization’s opportunity cost to borrow short-term funds. If we assume a rate of 8% for this example, then borrowing cost would be less than the cost of not taking the discount – so the organization should borrow the funds and TAKE the discount.
56Source: ETM3 - © AFP
Group Exercise
Working in your groups,answer the following questions:
Under what circumstances would a buyer forego (not take) a cash discount if offered?
Why would a seller be willing to offer a cash discount in the first place?
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Essential Learning for CTP CandidatesNew York Cash Exchange: 2016 – Session #03
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When Should a Buyer Forgo an Offered Discount
Short-term investment rates above annualized discount rate
Buyer’s cost of short-term borrowing greater than annualized discount rate
Buyer can “stretch” payables enough to sufficiently lower annualized discount rate
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Benefit to Seller of Offering a Cash Discount
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Disc Pmt
Total Amount of Full Pmt × 1 Disc RatePV
Annual Opp Cost1 Days in Disc Period ×
365
Disc Pmt
$100 1 .02 $98PV
.08 1 .00221 10
365
$98$97.78
1.0022
Assume credit terms of 2/10, net 30 and opp. cost = 8%
Present Value of Receiving Discounted Payment Amount
59Source: ETM3 - © AFP
Benefit to Seller of Offering a Cash Discount
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Assume credit terms of 2/10, net 30 and opp. cost = 8%
Present Value of Receiving Full Payment Amount
Full Pmt
Total Amount of Full PmtPV
Annual Opp Cost1 Days in Net Period ×
365
Full Pmt
$100 $100PV
.08 1 .00661 30
365
$100$99.34
1.0066
NPV = PVDay 10 – PVDay 30 = $97.78 – $99.34 = – $1.56
60Source: ETM4 © AFP
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Essential Learning for CTP CandidatesNew York Cash Exchange: 2016 – Session #03
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Accounts Receivable (A/R) Monitoring and Control
Days’ Sales Outstanding (DSO)
A/R Aging Schedule
Accounts Receivable (A/R) Balance Pattern
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Days’ Sales Outstanding (DSO) Assume that a company has outstanding receivables of $285,000 at the end of the first quarter and credit sales of $310,000 for the quarter. Using a 90-day averaging period, the DSO for this company can be computed as follows:
Sales During Period $310,000Avg. Daily Credit Sales = = = $3,444.44Number of Days in Period 90
Outstanding A/R $285,000DSO = = = 82.74 DaysAvg. Daily Credit Sales $3,444.44
Average Past Due = DSO Avg. Days of Credit Terms
= 82.74 Days 60 Days = 22.74 Days
If the company’s credit terms are net 60, the average past due is computed as follows:
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Source: ETM4 - © AFP
A/R Aging ScheduleSeparates A/R into current and past-due receivables in 30-day increments (on a customer or aggregate basis) and can determine the percent past due
Age of A/R Amount of A/R % of Total A/R
Current $1,750,000 70%
1-30 Days Past Due 375,000 15%
31-60 Days Past Due 250,000 10%
Over 60 Days Past Due 125,000 5%
Total $2,500,000 100%
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Source: ETM4 - © AFP
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Essential Learning for CTP CandidatesNew York Cash Exchange: 2016 – Session #03
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A/R Balance Pattern for March
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Source: ETM4 - © AFP
Cash Concentration Break-Even Analysis Two frequently used concentration systems in
U.S.◦ EDT: Electronic Depository Transfer◦ Wire Transfer
Assume the following:◦ ACH Cost = $1.00; Wire Cost = $10.00◦ Opp Cost = 3.5%; 1-day speed-up with wire
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Wire Cost ACH CostMin. Transfer =
Opportunity CostDays Accelerated
365 Days
$10.00 $1.00 $9.00= = $93,857
1 .000095890.0351 Day
365 Days
Source: ETM4 - © AFP
Session Wrap-upSession 3: Working Capital Management
What did we learn in this session?
What topics do we need to learn more about?
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Essential Learning for CTP CandidatesNew York Cash Exchange: 2016 – Session #03
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New York Cash Exchange: 2016Essential Learning for CTP Candidates
End of This Session
We will reconvene after a short break.
The topic will be:
More Key ConceptsFinancial Statements, Analysis & Decisions
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