financial management liliya n. zhilina, world economy and inrernational relations department,...
TRANSCRIPT
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Financial Management
Liliya N. Zhilina, World Economy and Inrernational Relations Department, Vladivostok State University of Economic and Services (VSUES).
10. Current Asset Management.
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• Alternative working capital policies
• Cash management
• Inventory management
• Accounts receivable management
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Basic Definitions
• Gross working capital:
• Total current assets.
• Net working capital:
• Current assets - Current liabilities.
• Working capital policy:
• The level of each current asset.
• How current assets are financed.
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• Working capital management:
• Includes both establishing working capital policy and then the day-to-day control of:
• Cash
• Inventories
• Receivables
• Short-term liabilities
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Selected Ratios for MicroDrive Inc. MicroDrive Inc. Industry AverageLiquidity ratios
Current Ratio 3,2 4,2 Quick Ratio 1,2 2,1
Asset Management ratios Inventory Turnover 4,9 9 Days Sales Outstanding 45 36 Fixed Asset Turnover 3 3 Total Asset Turnover 1,5 1,8
Debt Management ratios Debt Ratio 0,5 0,4 Times Interest Earned 3,2 6 EBITDA Coverage Ratio 3,0 8
Profitability ratios Profit Margin 0,0 0,1 Basic Earning Power 0,1 0,2
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How does MicroDrive’s working capital policy compare with the industry?
• Working capital policy is reflected in a firm’s current ratio, quick ratio, turnover of cash and securities, inventory turnover, and DSO.
• These ratios indicate MicroDrive has large amounts of working capital relative to its level of sales. Thus, MicroDrive is following a relaxed (fat cat) policy.
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Alternative Current AssetInvestment Policies
Current Assets ($)
Sales ($)
Restricted
Moderate
Relaxed
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Is MicroDrive inefficient or just conservative?
• A relaxed policy may be appropriate if it reduces risk more than profitability.
• However, MicroDrive is much less profitable than the average firm in the industry. This suggests that the company probably has excessive working capital.
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The cash conversion cycle focuses on the time between payments made for materials and labor and payments received from sales:
Cash Inventory Receivables Payables
conversion = conversion + collection - deferral .
cycle period period period
Cash Conversion Cycle
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Cash Conversion Cycle
CCC = + –
CCC = + 45 – 30
CCC = 75 + 45 – 30
CCC = 90 days.
Days per yearInv. turnover
Payablesdeferralperiod
Days salesoutstanding
3604.9
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The cash conversion cycle focuses on the time between payments made for materials and labor and payments received from sales:
Cash Inventory Receivables Payables
conversion = conversion + collection - deferral .
cycle period period period
What does the cash conversion cycle tell us about working capital management?
Cash Conversion Cycle
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Cash Management:Cash doesn’t earn interest,
so why hold it?
• Transactions: Must have some cash to pay current bills.
• Precaution: “Safety stock.” But lessened by credit line and marketable securities.
• Compensating balances: For loans and/or services provided.
• Speculation: To take advantage of bargains, to take discounts, and so on. Reduced by credit line, marketable securities.
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What’s the goal of cash management?
• To have sufficient cash on hand to meet the needs listed on the previous slide.
• However, since cash is a non-earning asset, to have not one dollar more.
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Ways to Minimize Cash Holdings
• Insist on wire transfers from customers.
• Synchronize inflows and outflows.
• Use a remote disbursement account.
• Increase forecast accuracy to reduce the need for a cash “safety stock.”
• Hold marketable securities instead of a cash “safety stock.”
• Negotiate a line of credit (also reduces need for a “safety stock”).
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Cash Budget: The Primary Cash Management Tool
• Purpose: Uses forecasts of cash inflows, outflows, and ending cash balances to predict loan needs and funds available for temporary investment.
• Timing: Daily, weekly, or monthly, depending upon budget’s purpose. Monthly for annual planning, daily for actual cash management.
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Data Required for Cash Budget
1. Sales forecast.
2. Information on collections delay.
3. Forecast of purchases and payment terms.
4. Forecast of cash expenses: wages, taxes, utilities, and so on.
5. Initial cash on hand.
6. Target cash balance.
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Inventory Management:Categories of Inventory Costs
• Carrying Costs: Storage and handling costs, insurance, property taxes, depreciation, and obsolescence.
• Ordering Costs: Cost of placing orders, shipping, and handling costs.
• Costs of Running Short: Loss of sales, loss of customer goodwill, and the disruption of production schedules.
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Effect of Inventory Size on Costs
Reducing the average amount of inventory held generally:
• Reduces carrying costs.
• Increases ordering costs.
• Increases probability of a stockout.
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Accounts Receivable Management:Do MicroDrive’s customers pay more or less
promptly than those of its competitors?
• MicroDrive’s days’ sales outstanding (DSO) of 45 days is well above the industry average (36 days).
• MicroDrive’s customers are paying less promptly.
• MicroDrive should consider tightening its credit policy to reduce its DSO.
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• Cash Discounts: Lowers price. Attracts new customers and reduces DSO.
• Credit Period: How long to pay? Shorter period reduces DSO and average A/R, but it may discourage sales.
• Credit Standards: Tighter standards reduce bad debt losses, but may reduce sales. Fewer bad debts reduces DSO.
• Collection Policy: Tougher policy will reduce DSO, but may damage customer relationships.
Elements of Credit Policy
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Does MicroDrive face any risk if it tightens its credit policy?
YES! A tighter credit policy may discourage sales. Some customers may choose to go elsewhere if they are pressured to pay their billssooner.
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If MicroDrive succeeds in reducing DSO without adversely affecting sales, what effect would this have on its cash
position?
• Short run: If customers pay sooner, this increases cash holdings.
• Long run: Over time, the company would hopefully invest the cash in more productive assets, or pay it out to shareholders. Both of these actions would increase EVA.