Working capital management

A review

Topics working capital management

1. Managing the firm’s cash conversion cycle

2. Cash management3. Marketable securities management4. Inventory management5. Receivables management6. Financing current assets7. Sources of short-term funds

what is working capital management?

Working capital management

• managing and financing

• the current assets and current liabilities of the firm

1. What is cash conversion cycle?

Three periods of cash conversion cycle

• Inventory conversion period

• Receivables collection period

• Payables deferral period

what is it meant by conversion period?

meaning

• The average time required to convert materials into finished goods and sell those goods.

Formula for inventory conversion period

• Inventory conversion period

Average inventory

= ------------------------

sales per day

what is receivables collection period?

meaning

• The average time required to collect Accounts Receivable.

Formula for Receivables collection period

• Receivables collection period

(days sales outstanding)

Average receivables

= ---------------------------

credit sales per day

What is payables deferral period?

• The average length of time between the purchase of materials and Labor and the payment of cash for them.

Formula for payables deferral period

• payables deferral period

Average Payables

= ---------------------------

purchases per day

or

Average Payables

= ---------------------------

cost of goods sold /365

What is cash conversion cycle?

Cash conversion cycle

• It is the net of (inventory conversion period + receivables

conversion period – payables deferral period)

• It measures the time period from the time the firm pays for its materials and Labor to the time it collects its cash from sales of goods

What is effective working capital management?

Goal

• Shortening the cash conversion cycle as much as possible without harming operations

why should the cash conversion cycle should be

shorter?

• Because the longer the cash conversion cycle, the greater the need for financing

Why should the firm maintain a sufficient amount of cash?

2.Cash management

• To take advantage of trade discounts

• Maintain its credit rating

• Meet its unexpected needs

For what purpose does the firm hold cash?

Two basic purposes

• For everyday business operations/transactions

• Compensation to financial institutions (compensating balances)

What is the purpose of cash budgets?

Purpose of cash budgets

• To take advantage of trade discounts

• To maintain credit rating

• Take advantage of favourable business opportunities (speculator balances)

• To meet emergencies (precautionary balances)

What is float?

• It is time that elapses relating to mailing, processing and clearing checks

How do you manage float?

Managing float

• extending the float for disbursements and

• shortening the float for cash receipts.

What are zero balance accounts?

• maintaining of regional bank account

• and transferring funds

• just enough to pay the checks presented to the bank

• The bank will notify the amount of cash required to cover the checks.

Advantages of zero balance accounts

• Cheques take a longer time to clear and they provide more float for a cash disbursements

• Extra cash doesn’t need to be deposited for contingencies

What is lockbox system?

• Customers payments are Sent to Post Office box maintained by bank

• Bank personnel retrieve the payments and deposit them into the firm’s bank account

What are the benefits of lockbox system ?

• Cash flow benefit, Cost-effective

• (if the interest cost saved due to obtaining more timely deposits is sufficient to cover the net increasing cost of cash receipt processing)

• Bank fees - internal costs saved from having the bank process receipts

What is concentration banking?

• It maintaining a local branch account so that the customers can make payments to the local branch and the local branch transfers those surplus funds to firms primary bank

What are the advantages of concentration banking ?

• It speeds up collection of payments, and firm gets the use of the funds more quickly

• The float related to cash receipts is shortened

• Official bank cheques which are preprinted can transfer funds in a less expensive way than transferring funds between accounts

what is electronic funds transfer?

• Funds are moved electronically between accounts without the use of a cheque

what is the advantage of an electronic fund transfer?

• It can actually take the float out of both the receipts and disbursements processes

what is international cash management?

• Managing the cash accounts in different countries by multinational firms

what are the advantages of international cash management?

• Transfer funds to a country in which interest rates are higher allowing increased returns on investments

3. Marketable securities management

What is Marketable securities management?

• Marketable securities can be easily converted to cash and also provide the benefit of investment return

• There are many securities to choose from for short-term investment

What are the factors that are considered in investing in short-

term securities?

• The requirement of minimum investment

• Safety

• Marketability (liquidity)

• Maturity

• yield

What are the important considerations with respect to

short-term investments?

• Liquidity and safety

• because these investments must be available to meet the current cash needs of the firm

what are the major types of a short-term investments?

Major types of short term investments

• Treasury Bills,• Treasury Notes, • Treasury Inflation Protected Securities (TIPS ),• Federal Agency Securities,• Certificates Of Deposit (CD),• Commercial Paper,• Banker’s Acceptance,• Eurodollar Certificate Of Deposit,• Money Market Funds,• Money Market Accounts, • Equity And Debt Securities.

What are Treasury bills?

T-bills

• T-bills short-term obligations of the federal government

• The they have the maturity of from 91 to 182 days.

• Existing T-bills may be purchased in the market with virtually any maturity date up to 182 days.

• The act to market ensures liquidity for T-bills, so they are very popular.

Treasury notes

Treasury notes

• These bills are government obligations

• A suit for short to intermediate term funds

• Their maturity time is from one to 10 years

What Treasury inflation protected securities?

TIPS

• when the firm want to minimize interest-rate risk they invest in government obligations which pay interest equals to

Real rate of return specified by the US Treasury

+ principal at maturity (adjusted for inflation)

What are federal agency securities?

• Offerings of government agencies

• Example :Federal home loan bank

Features of the Federal agency securities

• security, liquidity (an active market)

• Pay slightly higher yields than Treasury issues

What is certificates of deposit?

• Savings deposits at financial institutions

Types of certificates of deposit

Two tire market

• Small CDs ($500 to $10,000) with lower interest rates

• Large CDs (one hundred thousand dollars or more) with higher interest rates

Is there any secondary market for large CDs?

• Yes, they provide some liquidity

Are CDs insured?

• CDs are normally insured up to $100,000 by the federal government

What is commercial paper?

• Large unsecured short term promissory notes issued to the public by large credit worthy corporations

What is the maturity period of commercial paper? Is there any secondary market to commercial

paper?

• Two to nine-month

• held to maturity by the investor because there is no active secondary market

What is banker’s acceptance?

• a draft drawn on a bank for payment when present it to the bank

When does bankers acceptances the generally arise?

• it arises from payments for goods by corporations in foreign countries

When does the corporation present and acceptance of a

payment? Do bankers acceptance has

secondary market?

• The corporation receiving the bankers and acceptance may have to wait 30 to 90 days to present the and acceptance for payment

• Due to waiting secondary market has developed for the sale of the instruments at a discount.

Banker’s acceptance

• Management may purchase bankers acceptances as the short term investments

• Bankers acceptances involve slightly more risk than government securities but also offers slightly higher yields

Eurodollar certificate of deposit

• Eurodollars are US dollars held on deposit by foreign banks and in turn lent by the banks to anyone seeking dollars

why foreign banks offer Eurodollars certificates of

deposit?

• To obtain dollars

• As an investment Eurodollar certificates of deposit pay higher yields than Treasury bills or certificates of deposit at large US banks

What are Money market funds?

• shares in a fund that purchases higher yielding bank CD’s , commercial paper and other large denomination , higher yielding securities

• They allow smaller investors to participate in these markets

what are money market accounts?

• Shares in a fund that purchases higher yielding bank CD’s , commercial paper and other large denomination, higher yielding securities.

• They allow smaller investors to participate in these markets.