Financial Management Chap16 William Lasher

Chapter 16

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CHAPTER 16

THE MANAGEMENT OF WORKING CAPITAL

FOCUS Day to day business runs on working capital. We can't do without it, but we'd like to use as little as possible. Our focus is on understanding what's what's involved in running the routine aspects aspects of a  business effectively effectively without wasting wasting resources. hat !eans understanding understanding the i!plications i!plications of decisions about each of the working capital accounts and about how working capital is financed. PEDAGOGY Our approach is especially practical in this area. We stay away fro! opti!i"ation !odels !odels and concentrate on trade#offs that are generally generally analy"ed with a little !ath and a lot of intuition. We provide a special insight into internal relations and co!pany politics in the area of receivables. TEACHING OBJECTIVES $n this chapter students should gain an insight into the short ter! operating nature of working capital and its i!portance in running any co!pany. co!pany. $n particular they should understand understand that working capital re%uires financing and appreciate the short ter! sources of funds available to support operating needs. &urther they should have a detailed understanding understanding of the issues and proble!s associated with !anaging each of the three !aor working capital assets( cash, receivables and inventories.

OUTLINE

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WO)* WO)*$+ $+  C-$ C-$ -/ 0-$ 0-$C C he short ter! nature of the assets and liabilities that arise fro! routine operations. -. Working Working Capital, &unding )e%uire!ents, and the Current -ccounts -ccounts he conceptual relationship relationship between working capital and the current accounts. accounts. he need to fund net working working capital. pontaneous financing. financing. 0. he Obecti Obective ve of Working orking Capit Capital al 2anage! 2anage!ent ent )unning the fir! effectively with as little as possible tied up in W3C. C. Operation Operationss # he Cash Conversio Conversion n Cycle Cycle wo wo graphic portrayals of how cash flows in and out of a co!pany and through the working capital accounts. D. er!anent er!anent and e! e!porary porary Wor Working king Capital Capital he variation in W3C with business activity. 4. &inanc &inancing ing +et Working rking Capita Capitall W3C lends itself to short ter! financing. &inancing policies with respect to per!anent and te!porary W3C. &. Workin rking g Capit Capital al oli olicy cy he ele!ents of W3C policy defined.

$$. O5)C4 O5)C4  O& O) O) 4)2 4)2 &$+-+ &$+-+C$+ C$+  -. ponta pontaneo neous us &inanc &inancing ing he nature of accruals and payables. payables. Credit ter!s, pro!pt pay!ent pay!ent discounts 0. 5nse 5nsecu cure red d 0ank 0ank /oan /oanss +otes, lines, revolvers, co!pensating balances. C. Co!! Co!!er erci cial al ape aper  r  he nature of co!!ercial paper and its issuers.

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Chapter 16 D. hort#e hort#er! r! Credit Credit ecured ecured by Current Current -ss -ssets ets ledging and factoring receivables. receivables. $nventory financing, liens and warehousing. warehousing.

$$$. C- 2-+-424 2-+-424+ + -. Defini Definitio tions ns and and Obect Obective ivess he !otives for holding cash and the obective of achieving ade%uate li%uidity while while tying up !ini!u! resources. 0. 2arket 2arketabl ablee ecuri ecuritie tiess  +ear cash li%uidity with with a !odest return. C. Check Disburse Disburse!ent !ent and Collectio Collection n rocedures rocedures he check collection3clearing collection3clearing syste! and how it works. D. -ccele -ccelerat rating ing Cash Cash )eceip )eceipts ts /ock bo8es, concentration banking, wire transfers. 4. 2ana 2anagi ging ng Cash Cash Outf Outflo low w Central vs. local cash !anage!ent, re!ote disbursing. &. 4valuating 4valuating the Cost of Cash Cash 2anage!en 2anage!entt ervices ervices Cost benefit analyses to deter!ine if cash !anage!ent syste!s are worthwhile. $9. $9. 2-+-$+ -CCO5+ -CCO5+ )4C4$9)4C4$9-0/4 -. Obect Obective ivess and olicy olicy he balance between !ore revenue with easy custo!er relations and potential bad debt losses. - shared responsibility with sales. 0. Deter!ina Deter!inants nts of the )eceivabl )eceivables es 0alance 0alance Credit policy, policy, ter!s of sale, collection policy, policy, and the conflict with sales. C. u!!ary u!!ary and Conclusion# Conclusion# - ractical ractical 2anage!ent 2anage!ent War Warning ning he politics of uncollected receivables can be a career pitfall for the C&O. 9. $+94+ $+94+O) O): : 2-+- 2-+-424 424+ + &inance generally has an oversight responsibility responsibility for inventory !anage!ent. -. Who Who $s )espon )esponsib sible le for $nvent $nventory ory he pri!ary responsibility is generally in !anufacturing or operations. &inance has an oversight function. 0. he 0enefits 0enefits and Costs of Carrying Carrying $nventory $nventory 0usiness runs s!oother with !ore inventory but the costs include interest, storage, insurance, and ta8es along with e8posure to shrinkage and obsolescence. C. $nvent $nventory ory Contr Control ol and 2ana 2anage! ge!ent ent 0alancing the costs and benefits of inventory. D. he 4cono!ic 4cono!ic Order ;uantity ;uantity $ and the practical li!itations on its use.

QUESTIONS

1. 48plai 48plain n the the diffe differen rentt circ circu!s u!stan tances ces und under er which which fir!s fir!s sho should uld use sho short# rt#ter ter! ! or or long long#te #ter! r! financing.

he 2anage!ent of Working Capital

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ANSWER: Whether financing should be long or short ter! depends on the longevity of the things it's used to support. /ong#ter! !oney is used to ac%uire things that re!ain with the fir! for substantial  periods such as fi8ed assets or e8tended proects. hese things are generally funded with !oney that doesn't have to be paid back for si!ilarly long periods like e%uity and long ter! loans. hort#ter! ite!s like inventory and receivables co!e and go %uickly. hey @turn over@ constantly