Working Capital, PowerPoint Show.ppt

CHAPTER20WorkingCapitalManagement AlternativeworkingcapitalpoliciesCash inventory andA RmanagementAccountspayablemanagementShort termfinancingpoliciesBankdebtandcommercialpaper BasicDefinitions Grossworkingcapital Totalcurrentassets Networkingcapital Currentassets Currentliabilities Netoperatingworkingcapital NOWC OperatingCA OperatingCL Cash Inv A R Accruals A P More Workingcapitalmanagement Includesbothestablishingworkingcapitalpolicyandthentheday to daycontrolofcash inventories receivables accruals andaccountspayable Workingcapitalpolicy Thelevelofeachcurrentasset Howcurrentassetsarefinanced SelectedRatiosforSKI SKIIndustryCurrent1 75x2 25xQuick0 83x1 20 xDebt Assets58 76 50 00 Turnoverofcash16 67x22 22xDSO 365 daybasis 45 6332 00Inv turnover4 82x7 00 xF A turnover11 35x12 00 xT A turnover2 08x3 00 xProfitmargin2 07 3 50 ROE10 45 21 00 Payablesdeferral30 0033 00 HowdoesSKI sworkingcapitalpolicycomparewiththeindustry Workingcapitalpolicyisreflectedinafirm scurrentratio quickratio turnoverofcashandsecurities inventoryturnover andDSO TheseratiosindicateSKIhaslargeamountsofworkingcapitalrelativetoitslevelofsales Thus SKIisfollowingarelaxedpolicy IsSKIinefficientorjustconservative Arelaxedpolicymaybeappropriateifitreducesriskmorethanprofitability However SKIismuchlessprofitablethantheaveragefirmintheindustry Thissuggeststhatthecompanyprobablyhasexcessiveworkingcapital Thecashconversioncyclefocusesonthetimebetweenpaymentsmadeformaterialsandlaborandpaymentsreceivedfromsales CashInventoryReceivablesPayablesconversion conversion collection deferral cycleperiodperiodperiod CashConversionCycle CashConversionCycle Cont CCC CCC 45 6 30CCC 75 7 45 6 30CCC 91 3days CashManagement Cashdoesn tearninterest sowhyholdit Transactions Musthavesomecashtopaycurrentbills Precaution Safetystock Butlessenedbycreditlineandmarketablesecurities Compensatingbalances Forloansand orservicesprovided Speculation Totakeadvantageofbargains totakediscounts andsoon Reducedbycreditline marketablesecurities What sthegoalofcashmanagement Tohavesufficientcashonhandtomeettheneedslistedonthepreviousslide However sincecashisanon earningasset tohavenotonedollarmore WaystoMinimizeCashHoldings Uselockboxes Insistonwiretransfersfromcustomers Synchronizeinflowsandoutflows Usearemotedisbursementaccount More Increaseforecastaccuracytoreducetheneedforacash safetystock Holdmarketablesecuritiesinsteadofacash safetystock Negotiatealineofcredit alsoreducesneedfora safetystock CashBudget ThePrimaryCashManagementTool Purpose Usesforecastsofcashinflows outflows andendingcashbalancestopredictloanneedsandfundsavailablefortemporaryinvestment Timing Daily weekly ormonthly dependinguponbudget spurpose Monthlyforannualplanning dailyforactualcashmanagement DataRequiredforCashBudget 1 Salesforecast 2 Informationoncollectionsdelay 3 Forecastofpurchasesandpaymentterms 4 Forecastofcashexpenses wages taxes utilities andsoon 5 Initialcashonhand 6 Targetcashbalance SKI sCashBudgetforJanuaryandFebruary NetCashInflowsJanuaryFebruaryCollections 67 651 95 62 755 40Purchases44 603 7536 472 65Wages6 690 565 470 90Rent2 500 002 500 00Totalpayments 53 794 31 44 443 55NetCF 13 857 64 18 311 85 CashBudget Continued JanuaryFebruaryCashatstartifnoborrowing 3 000 00 16 857 64NetCF slide13 13 857 6418 311 85Cumulativecash 16 857 64 35 169 49Less targetcash1 500 001 500 00Surplus 15 357 64 33 669 49 Shoulddepreciationbeexplicitlyincludedinthecashbudget No Depreciationisanoncashcharge Onlycashpaymentsandreceiptsappearoncashbudget However depreciationdoesaffecttaxes whichdoappearinthecashbudget Whataresomeotherpotentialcashinflowsbesidescollections Proceedsfromfixedassetsales Proceedsfromstockandbondsales Interestearned Courtsettlements Howcaninterestearnedorpaidonshort termsecuritiesorloansbeincorporatedinthecashbudget Interestearned Addlineinthecollectionssection Interestpaid Addlineinthepaymentssection Foundasinterestratexsurplus loanlineofcashbudgetforprecedingmonth Note Interestonanyotherdebtwouldneedtobeincorporatedaswell Howcouldbaddebtsbeworkedintothecashbudget Collectionswouldbereducedbytheamountofbaddebtlosses Forexample ifthefirmhad3 baddebtlosses collectionswouldtotalonly97 ofsales Lowercollectionswouldleadtolowersurplusesandhigherborrowingrequirements SKI sforecastedcashbudgetindicatesthatthecompany scashholdingswillexceedthetargetedcashbalanceeverymonth exceptforOctoberandNovember Cashbudgetindicatesthecompanyprobablyisholdingtoomuchcash SKIcouldimproveitsEVAbyeitherinvestingitsexcesscashinmoreproductiveassetsorbypayingitouttothefirm sshareholders WhatreasonsmightSKIhaveformaintainingarelativelyhighamountofcash Ifsalesturnouttobeconsiderablylessthanexpected SKIcouldfaceacashshortfall Acompanymaychoosetoholdlargeamountsofcashifitdoesnothavemuchfaithinitssalesforecast orifitisveryconservative Thecashmaybethere inpart tofundaplannedfixedassetacquisition InventoryManagement CategoriesofInventoryCosts CarryingCosts Storageandhandlingcosts insurance propertytaxes depreciation andobsolescence OrderingCosts Costofplacingorders shipping andhandlingcosts CostsofRunningShort Lossofsales lossofcustomergoodwill andthedisruptionofproductionschedules IsSKIholdingtoomuchinventory SKI sinventoryturnover 4 82 isconsiderablylowerthantheindustryaverage 7 00 Thefirmiscarryingalotofinventoryperdollarofsales Byholdingexcessiveinventory thefirmisincreasingitsoperatingcostswhichreducesitsNOPAT Moreover theexcessinventorymustbefinanced soEVAisfurtherlowered IfSKIreducesitsinventory withoutadverselyaffectingsales whateffectwillthishaveonitscashposition Shortrun Cashwillincreaseasinventorypurchasesdecline Longrun Companyislikelytothentakestepstoreduceitscashholdings AccountsReceivableManagement DoSKI scustomerspaymoreorlesspromptlythanthoseofitscompetitors SKI sdays salesoutstanding DSO of45 6daysiswellabovetheindustryaverage 32days SKI scustomersarepayinglesspromptly SKIshouldconsidertighteningitscreditpolicytoreduceitsDSO CashDiscounts Lowersprice AttractsnewcustomersandreducesDSO CreditPeriod Howlongtopay ShorterperiodreducesDSOandaverageA R butitmaydiscouragesales ElementsofCreditPolicy More CreditStandards Tighterstandardsreducebaddebtlosses butmayreducesales FewerbaddebtsreducesDSO CollectionPolicy TougherpolicywillreduceDSO butmaydamagecustomerrelationships DoesSKIfaceanyriskifittightensitscreditpolicy YES Atightercreditpolicymaydiscouragesales Somecustomersmaychoosetogoelsewhereiftheyarepressuredtopaytheirbillssooner IfSKIsucceedsinreducingDSOwithoutadverselyaffectingsales whateffectwouldthishaveonitscashposition Shortrun Ifcustomerspaysooner thisincreasescashholdings Longrun Overtime thecompanywouldhopefullyinvestthecashinmoreproductiveassets orpayitouttoshareholders BothoftheseactionswouldincreaseEVA Isthereacosttoaccruals Dofirmshavemuchcontroloveramountofaccruals Accrualsarefreeinthatnoexplicitinterestischarged Firmshavelittlecontroloverthelevelofaccruals Levelsareinfluencedmorebyindustrycustom economicfactors andtaxlaws Whatistradecredit Tradecreditiscreditfurnishedbyafirm ssuppliers Tradecreditisoftenthelargestsourceofshort termcredit especiallyforsmallfirms Spontaneous easytoget butcostcanbehigh SKIbuys 506 985net ontermsof1 10 net30 andpaysonDay40 Howmuchfreeandcostlytradecredit andwhat sthecostofcostlytradecredit Netdailypurchases 506 985 365 1 389 Annualgrosspurch 506 985 1 0 01 512 106 Gross NetBreakdown Companybuysgoodsworth 506 985 That sthecashprice Theymustpay 5 121moreiftheydon ttakediscounts Thinkoftheextra 5 121asafinancingcostsimilartotheinterestonaloan Wanttocomparethatcostwiththecostofabankloan Payablesleveliftakediscount Payables 1 389 10 13 890 Payableslevelifdon ttakediscount Payables 1 389 40 55 560 CreditBreakdown Totaltradecredit 55 560Freetradecredit 13 890Costlytradecredit 41 670 NominalCostofCostlyTradeCredit Butthe 5 121ispaidallduringtheyear notatyear end soEARrateishigher Firmloses0 01 512 106 5 121ofdiscountstoobtain 41 670inextratradecredit so NominalCostFormula 1 10 net40 Pays1 01 12 167timesperyear Periodicrate 0 01 0 99 1 01 Periods year 365 40 10 12 1667 EAR 1 Periodicrate n 1 0 1 0101 12 1667 1 0 13 01 EffectiveAnnualRate 1 10 net40 WorkingCapitalFinancingPolicies Moderate Matchthematurityoftheassets