Managing Current Asset Ch.8

8/7/2019 Managing Current Asset Ch.8

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BLEX Program

Financial

Management

Prepared By:

Mr.Aiman Ahmed Ibrahim


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CHAPTER 8

Managing Current Asset


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Working Capital

Working Capital = Current Assets

NetWorking Capital = Current Assets CurrentLiabilities

EquityWorking Capital = Current Assets CurrentLiabilities Long-term Debt


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What is Net Working Capital

Net working capital is calculated as :

current assets minus current liabilities.

If current assets are less than current liabilities,an entity has aworking capital deficiency,

also called aworking capital deficit

.


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What Does Current Assets

Mean? A balance sheet account that represents the

value of all assets that are reasonably

expected to be converted into cash withinone year in the normal course of business.

In personal finance, current assets are all

assets that a person can readily convert to

cash to pay outstanding debts and coverliabilities without having to sell fixed assets


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What Does Current Assets

Mean?

Cash & Cash Equivalents

Short-Term Investments

Inventory

Accounts Receivable

Prepaid Expenses


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An increase in working capital indicates that

the business has either increased current

assets (that is has increased its receivables, orother current assets) or has decreased current

liabilities, for example has paid off some

short-term creditors.


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Cash Operating Cycle


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Working capital management

Decisions relating to working capital and shortterm financing are referred to as working capitalmanagement. These involve managing therelationship between a firm's short-term assetsand its short-term liabilities. The goal of workingcapital management is to ensure that the firm is

able to continue its operations and that it hassufficient cash flow to satisfy both maturingshort-term debt and upcoming operationalexpenses.


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Management of working

capital Working capital also gives investors an idea of

the company's underlying operational efficiency.Money that is tied up in inventory or money that

customers still owe to the company cannot beused to pay off any of the company's obligations.So, if a company is not operating in the mostefficient manner (slow collection), it will show up

as an increase in the working capital. This can beseen by comparing the working capital from oneperiod to another; slow collection may signal anunderlying problem in the company's operations.


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Current Asset Management

Working Capital Management

Current Asset Investment Policy

Temporary and PermanentCurrent Assets

ZeroWorking Capital

Cash Management

Marketable Securities

Accounts Receivable Management

Inventory Management


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Working Capital Management:

GrossWorking Capital -(Current Assets)

Net Working Capital - (Current Assets - CurrentLiabilities)

Working Capital Management

Involves investing in current assets and financing of

current assets:

Current

Liabilities

Long-Term

Financing

Current Asset

Investment


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Current Asset Investment Policy

Everything else remaining the same, higher levels ofcurrent assets mean lower risk and lower expectedreturn

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 incurredthereby lowering returns.

Lower levels of current assets result in oppositeeffects.


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Alternative Current Asset Investment

Policies

0

2

4

6

8

10

12

14

0 10 20 30 40

Current Asset (millions of $)

Sales (millions of dollars)

Conservative - low risk

Aggressive - high risk

Moderate


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Temporary vs. Permanent Investment

in Current Assets

Temporary Investment - Commonly, firms experienceshort-run fluctuations in current assets. For example,retail department stores will have high levels of inventory

around Thanksgiving. In January, the inventory should below.

Permanent Investment - Firms always have someminimum level of investment in current assets (i.e., apermanent investment). As a firm grows over time, the

level of permanent current assets also grows (e.g., asupermarket chain with 70 stores will have morepermanent inventory than a chain with 4 stores).


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Cash Management:

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


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Desired Cash Balance:

Precautionary Demand - Satisfy possible, but asyet indefinite cash needs.

Speculative Demand - Build up current cash

balances in anticipation of future business costsbeing lower.

Risk Preferences

Compensating Balances

Transactions Demand - Cash needs arising in theordinary course of doing business.


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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


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(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 AssetsRatio, Credit Sales to Receivables Ratio.


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Inventory Management

Basic Costs AssociatedWith 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 managinginventory.


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Decision criteria

working capital management entails short

term decisions - generally, relating to the

next one year period - which are "reversible".Positive working capital means that the

company is able to pay off its short-term

liabilities. Negative working capital means

that a company currently is unable to meet itsshort-term liabilities with its current assets(cash, accounts receivable and inventory).


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Cash Conversion Cycle

One measure of cash flow is provided by thecash conversion cycle - the net number of daysfrom the outlay of cash for raw material to

receiving payment from the customer. As amanagement tool, this metric makes explicit theinter-relatedness of decisions relating toinventories, accounts receivable and payable,and cash. Because this number effectively

corresponds to the time that the firm's cash istied up in operations and unavailable for otheractivities, management generally aims at a lownet count.


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Cash Conversion Cycle

CCC = # days between disbursing cash and collectingcash in connection with undertaking a discrete unit ofoperations.

=Inventory conversionperiod

+ Receivablesconversion

period

- Payables conversion period

Avg. Inventory COGS /365

+ Avg. AccountsReceivable

Credit Sales /365

- Avg. Accounts PayableCOGS / 365


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More businesses fail for lack of cash

than for want of profit.

If you ....... Then ......

Collect receivables (debtors)

faster Collect receivables (debtors)

slower

Get better credit (in terms of

duration or amount) from

suppliers

Shift inventory (stocks) faster

Move inventory (stocks)slower

You release cash from the

cycle Your receivables soak up

cash

You increase your cash

resources You free up cash

You consume more cash


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Solution:

XYZ's Cash-to-Cash Cycle for the Period January 1 Through January 31

Component Computation Result

Inventory - Average

number of days

($500 + $300 / 2) / ($700 / 31 days) = 17.7

Receivables - Averagenumber of days

uncollected

($400 + $600 / 2) / ($1,000 / 31 days) = 15.5

Days Cash Is Free

Because the Business

Has Not Paid Its Bills

(-$300 + -100 / 2) / ($700 / 31 days) = -8.8

Cash-to-Cash Cycle (in days) 24.4


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FACTORS INFLUENCING WORKING CAPITAL

NEEDS:

Nature of Business.

Seasonality of Operations:

Production Cycle. Production Policy.

Credit Policy.

Market Conditions. Conditions of Supply.


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CONCLUSION:

The objective of financial management is tomaximize the shareholders wealth by generatesufficient profits. The profits generated depend

mainly on sales volume.When the goods arebeing sold on credit as is the normal practice ofbusiness firms today to cope with increasedcompetition the sale of goods cannot beconverted into cash instantly because of time lag

between sales and realization of cash. Furtherthis is possible only through evolving effectiveworking capital policy and better administrationon current assets financing.

Managing Current Asset Ch.8

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