Working+capital+management
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1
Gross working capital: Total current assets. Net working capital: Current assets - Current liabilities. Net operating working capital (NOWC): Operating CA – Operating CL = (Cash + Inv. + A/R) – (Accruals + A/P)
2
Working capital management: Includes both establishing working capital policy and then the day-to-day control of cash, inventories, receivables, accruals, and accounts payable. Working capital policy: The level of each current asset. How current assets are financed.
3
Current Assets are cash and other assets that are expected to be converted to cash with the year.
Cash Marketable securities Accounts receivable Inventory
Current Liabilities are obligations that are expected to require cash payment within the year.
Accounts payable Accrued wages Taxes 4
Raw material purchased
Cash received
Finished goods sold
Order Stock Placed Arrives
Inventory period
Accounts receivable period Time
Accounts payable period Firm receives invoice
Cash paid for materials
Operating cycle Cash cycle 5
Accounts Cash cycle = Operating cycle – payable period In practice, the inventory period, the accounts receivable period, and the accounts payable period are measured by days in inventory, days in receivables and days in payables.
6
The cash conversion cycle focuses on the time between payments made for materials and labor and payments received from sales: Cas h Con vers ion Cy cle
Inv entor y
= Con vers ion + Pe riod
Receiv ables Col lectio n Pe riod
-
Pa yabl es Deferral
.
Pe riod
7
Payables CCC = Days per year + Days sales – deferral Inv. turnover outstanding period
8
There are two elements of the policy that a firm adopts for short-term finance. The Size of the Firm’s Investment in Current Assets Usually measured relative to the firm’s level of total operating revenues.
Flexible Restrictive
Alternative Financing Policies for Current Assets Usually measured as the proportion of short-term debt to long-term debt.
Flexible Restrictive 9
A flexible policy short-term finance policy would maintain a high ratio of current assets to sales. Keeping large cash balances and investments in marketable securities. Large investments in inventory. Liberal credit terms.
A restrictive short-term finance policy would maintain a low ratio of current assets to sales. Keeping low cash balances, no investment in marketable securities. Making small investments in inventory. Allowing no credit sales (thus no accounts receivable).
10
A flexible short-term finance policy means low proportion of short-term debt relative to longterm financing. A restrictive short-term finance policy means high proportion of short-term debt relative to long-term financing.
11
Rs
Temp. NOWC
} Perm NOWC
S-T Loans L-T Fin: Stock & Bonds,
Fixed Assets Years Lower dashed line, more aggressive.
12
Rs
Marketable Securities Zero S-T debt
Perm NOWC
L-T Fin: Stock & Bonds
Fixed Assets Years
13
Low cost-- yield curve usually slopes upward. Can get funds relatively quickly. Can repay without penalty.
14
Higher risk. The required repayment comes quicker, and the company may have trouble rolling over loans.
15
Managing short-term cash flows involves the minimization of costs. The two major costs are: Carrying costs—the interest and related costs incurred by overinvesting in short-term assets such as cash Shortage costs—the cost of running out of short-term assets.
The objective of managing short-term finance and short-term financial planning is to find the optimal tradeoff between these two costs. 16
Rs.
Minimum point
Total costs of holding current assets. Carrying costs
Shortage costs
CA*
Investment in Current Assets (Rs.) 17
Total costs of holding current assets.
Rs.
Minimum point
Carrying costs
Shortage costs
CA*
Investment in Current Assets (Rs.)
18
Rs.
Minimum point
Total costs of holding current assets.
Carrying costs
Shortage costs CA*
Investment in Current Assets (Rs.) 19
A flexible short-term finance policy means low proportion of short-term debt relative to longterm financing. A restrictive short-term finance policy means high proportion of short-term debt relative to long-term financing.
In an ideal economy, the firm could perfectly predict its short-term uses and sources of ash and net working capital could be kept at zero. In the real world, net working capital provides a buffer that lets the firm meet its ongoing obligations. The financial manager seeks the optimal level of each of the current assets.
VINEET JOSHI
22
Gross working capital: Total current assets. Net working capital: Current assets - Current liabilities. Net operating working capital (NOWC): Operating CA – Operating CL = (Cash + Inv. + A/R) – (Accruals + A/P)
2
Working capital management: Includes both establishing working capital policy and then the day-to-day control of cash, inventories, receivables, accruals, and accounts payable. Working capital policy: The level of each current asset. How current assets are financed.
3
Current Assets are cash and other assets that are expected to be converted to cash with the year.
Cash Marketable securities Accounts receivable Inventory
Current Liabilities are obligations that are expected to require cash payment within the year.
Accounts payable Accrued wages Taxes 4
Raw material purchased
Cash received
Finished goods sold
Order Stock Placed Arrives
Inventory period
Accounts receivable period Time
Accounts payable period Firm receives invoice
Cash paid for materials
Operating cycle Cash cycle 5
Accounts Cash cycle = Operating cycle – payable period In practice, the inventory period, the accounts receivable period, and the accounts payable period are measured by days in inventory, days in receivables and days in payables.
6
The cash conversion cycle focuses on the time between payments made for materials and labor and payments received from sales: Cas h Con vers ion Cy cle
Inv entor y
= Con vers ion + Pe riod
Receiv ables Col lectio n Pe riod
-
Pa yabl es Deferral
.
Pe riod
7
Payables CCC = Days per year + Days sales – deferral Inv. turnover outstanding period
8
There are two elements of the policy that a firm adopts for short-term finance. The Size of the Firm’s Investment in Current Assets Usually measured relative to the firm’s level of total operating revenues.
Flexible Restrictive
Alternative Financing Policies for Current Assets Usually measured as the proportion of short-term debt to long-term debt.
Flexible Restrictive 9
A flexible policy short-term finance policy would maintain a high ratio of current assets to sales. Keeping large cash balances and investments in marketable securities. Large investments in inventory. Liberal credit terms.
A restrictive short-term finance policy would maintain a low ratio of current assets to sales. Keeping low cash balances, no investment in marketable securities. Making small investments in inventory. Allowing no credit sales (thus no accounts receivable).
10
A flexible short-term finance policy means low proportion of short-term debt relative to longterm financing. A restrictive short-term finance policy means high proportion of short-term debt relative to long-term financing.
11
Rs
Temp. NOWC
} Perm NOWC
S-T Loans L-T Fin: Stock & Bonds,
Fixed Assets Years Lower dashed line, more aggressive.
12
Rs
Marketable Securities Zero S-T debt
Perm NOWC
L-T Fin: Stock & Bonds
Fixed Assets Years
13
Low cost-- yield curve usually slopes upward. Can get funds relatively quickly. Can repay without penalty.
14
Higher risk. The required repayment comes quicker, and the company may have trouble rolling over loans.
15
Managing short-term cash flows involves the minimization of costs. The two major costs are: Carrying costs—the interest and related costs incurred by overinvesting in short-term assets such as cash Shortage costs—the cost of running out of short-term assets.
The objective of managing short-term finance and short-term financial planning is to find the optimal tradeoff between these two costs. 16
Rs.
Minimum point
Total costs of holding current assets. Carrying costs
Shortage costs
CA*
Investment in Current Assets (Rs.) 17
Total costs of holding current assets.
Rs.
Minimum point
Carrying costs
Shortage costs
CA*
Investment in Current Assets (Rs.)
18
Rs.
Minimum point
Total costs of holding current assets.
Carrying costs
Shortage costs CA*
Investment in Current Assets (Rs.) 19
A flexible short-term finance policy means low proportion of short-term debt relative to longterm financing. A restrictive short-term finance policy means high proportion of short-term debt relative to long-term financing.
In an ideal economy, the firm could perfectly predict its short-term uses and sources of ash and net working capital could be kept at zero. In the real world, net working capital provides a buffer that lets the firm meet its ongoing obligations. The financial manager seeks the optimal level of each of the current assets.
VINEET JOSHI
22
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