Sld07 Current Asset Mgmt

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Current AssetManagement

McGraw-Hill Ryerson McGraw-Hill Ryerson Limited 2000

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McGraw-Hill Ryerson Limited 2000

Foundations of FinancialManagement CANADIAN

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Table 7-1The use of float to provide funds

Bank Books (usable funds)Corporate Books (amounts actually cleared)

Initial amount $ 100,000 $ 100,000Deposits + 1,000,000 + 800,000Cheques 900,000 400,000

Balance + $ 200,000 + $ 500,000

+ $300,000 float

PPT 7-1

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Table 7-2Playing the float

PPT 7-1

Bank Books (usable funds)Corporate Books (amounts actually cleared)

Initial amount $ 100,000 $ 100,000Deposits + 1,000,000 + 800,000Cheques 1,200,000 800,000

Balance $ 100,000 + $ 100,000

+ $200,000 float

* Assumed to remain the same as in Table 7-1.

* *

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Figure 7-1Cash management network

LocalOffice

LocalOffice

LocalOffice

LocalOffice

Local Office

Local Office

LocalOffice

LocalOffice

Local Office

Local Office

Local bank branch

Local bank branch

Local bank branch

Local bank branch

Local bank branch

Central bank account

Corporate headquarters

Central bank account

Corporate headquarters

Reduce remittancetime 1.5 days

Increase disbursementtime 1 day

2.5 days freed-upcash balance

2.5 days freed-up cash balance$2 million average cash movement per day$5 million available funds

Distantdisbursement centre

PPT 7-2

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Federal government securities:Treasury bills 91days $1,000 Excellent Excellent 13.13% 4.86%Treasury bills 182 1,000 Excellent Excellent 13.25 4.95

Provincial government securitiesTreasury bills 91 25,000 Excellent Excellent 13.18 4.92

Nongovernment securities:Term deposits (large) 90 100,000 Good None 12.75 4.60Term deposits (small) 90 5,000 Good None 10.00 4.00Commercial paper 90 100,000 Good Fair 13.33 5.16Bankers acceptances 90 None Good Good 13.27 5.10Eurodollar deposits (bid) 90 25,000 Good Excellent 12.81 5.12LIBOR (London Interbank Offered Rate) 90 100,000 Good Excellent 12.94 5.30Savings accounts Open None Excellent None 8.75 .25-1.00Bank swap deposits 90 100,000 Excellent None 13.23 5.03Money market deposits (financial institutions) Open 500 Excellent None 10.15 3.20-4.40Overnight (call) money 1 day 100,000 Excellent Excellent 5.00

* Many of these securities can be purchased with different maturities than those indicated. Though not marketable, these investments are highly liquid and can often be withdrawn without penalty.Quoted yields are often for wholesale amounts above $1 million

Table 7-3Types of short-term investments

Yield YieldMinimum Mar. 22, Mar. 22,

Maturity* Amount Safety Marketability 1990 1999

PPT 7-3

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Figure 7-3Financing growth in accounts receivable

Marketable securities

Inventory

Accounts receivable

Bank loan

Accounts payable

Forgo8%return

Forgo10%return

Buildup12%return

7.5%cost 7%

cost

PPT 7-4

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Table 7-4Dun & Bradstreet credit rating system

Key to RatingsComposite Credit Appraisal

Estimated Financial Strength High Good Fair Limited

5A . . . Over $50,000,000 1 2 3 44A . . . $10,000,000 to 50,000,000 1 2 3 43A . . . 1,000,000 to 10,000,000 1 2 3 42A . . . 750,000 to 1,000,000 1 2 3 41a . . . 500,000 to 750,000 1 2 3 4BA . . . 300,000 to 500,000 1 2 3 4BB . . . 200,000 to 300,000 1 2 3 4CB . . . 125,000 to 200,000 1 2 3 4CC . . 75,000 to 125,000 1 2 3 4DC . . 50,000 to 75,000 1 2 3 4DD . . 35,000 to 50,000 1 2 3 4EE . . 20,000 to 35,000 1 2 3 4FF . . 10,000 to 20,000 1 2 3 4GG . . 5,000 to 10,000 1 2 3 4HH . . Up to 5,000 1 2 3 4

PPT 7-5

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Figure 7-4Determining the optimum inventory level

Cost of ordering and carrying inventory ($)

40

80

400

M

Carrying costs

Order size (units)

Ordering costs

Total costs

PPT 7-6

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Chapter 7 - Outline LT 7-1

What is Current Asset Management?

Cash Management

Optimum Level of Cash

Ways to Improve Collections

Ways to Extend Disbursements

Marketable Securities

Types of Securities

Yield Calculation

3 Primary Variables of Credit Policy

Credit Policy Decision

Inventory Management

Economic Ordering Quantity

Just-In-Time Inventory Systems

Level vs. Seasonal Production

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What is Current Asset Management? LT 7-2

Current asset management is essentially an extension ofworking capital management

It is concerned with the current assets of a firm (cash, A/R,marketable securities, and inventory)

A financial manager needs to remember that the less liquidan asset is, the higher the required return

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Cash Management

Use cash budgets

Speed up collections

Extend disbursements

Maintain optimum level of cash

Invest excess cash

LT 7-3

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Optimum Level of Cash

How much to keep incash? transaction needs?

cash flows predictable?

borrowingarrangements?

interest rates?

Keep safety level in cash,invest excess

Low-risk, liquidinvestments

Savings accounts

Money market funds

Term deposits

Treasury bills

US $ deposits

Earn small return onexcess funds

LT 7-4

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Ways to Improve Collections LT 7-5

Timely processing and deposit of cheques received

Regional Collection Centres

speeds up collection of A/R and reduces mailing time

Lockbox System

when customers mail payment to a local post office boxinstead of to the company headquarters

Electronic Funds Transfer / Electronic Data Interchange

exchange of payments and information betweencompanies computers

Use of debit cards (Interac) and preauthorized cheques

a system where payments are automatically deductedfrom a bank account

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Ways to Extend Disbursements

Mail cheques from remote locations

Play the Float

Electronic Funds Transfer

LT 7-6

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3 Primary Variables of Credit Policy LT 7-7

3 things to consider in deciding whether to extend credit:

Credit Standards

determine credit rating of customers

4 Cs of credit

credit agencies, bureaus

Terms of Trade

ex.; 2% / 10days / net 30 days

Collection Policy

Average Collection Period

Ratio of Bad Debts to Credit Sales

Aging of Accounts Receivable

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Inventory Management LT 7-8

Inventory is divided into 3 categories:

Raw Materials

Work in Progress (WIP) or Unfinished Goods

Finished Goods

There are 2 basic costs associated with inventory:

Ordering Costs

Carrying Costs

Optimum level of inventory will satisfy customer demand /production requirements while minimizing ordering andcarrying costs

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Economic Ordering Quantity LT 7-9

Economic Ordering Quantity (EOQ):

the optimal (best) amount for the firm to order eachtime

occurs at the low point on the total cost curve

the order size where total carrying costs equal totalordering costs (assuming no safety stock)

Safety Stock:

extra inventory the firm keeps in stock in case ofunforeseen problems

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Just-In- Time Inventory Systems

FeaturesMinimum levels of inventory

Orders in small lot sizes

Computerized order andinventory systems

Electronic data interchange

Short delivery times

Small number of suppliers

Quality control programs

BenefitsLower carrying costs

Automatic ordering

Fewer accounting errors

Lower quality control costs

Elimination of waste

LT 7-10

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Level vs. Seasonal Production LT 7-11

Level Production:

producing the same (equal) amount each month

inventory costs are higher

operating costs are lower

Seasonal Production:

producing a different amount each month (based on theseason)

inventory costs are lower

operating costs are higher

Sld07 Current Asset Mgmt

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