《ACCA考试之财务管理-FINANCIAL-MANAGEMENT》课件-6-Working-Capital-Finance

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FinancialManagement

AccountingSchool

1WorkingcapitalfinanceChapter62TopiclistThemanagementofcashCashflowforecastsTreasurymanagementCashmanagementmodelsInvestingsurpluscashWorkingcapitalfundingstrategies3ExamguideThematerialcoveredinthischapterishighlyexaminable.Anyofthecalculationcouldformpartorallofaquestionandyouneedtoalsobeabletoexplainthemeaningofyouranswers.41ThemanagementofcashThetermCashmaybedefinedascurrencyheldbythefirmplusthefirm’sdemanddeposits

Cash,whichcanbebroadlydefinedasencompassingnear-cashsuchasmarketablesecuritiesandunusedshort-termborrowingcapacity,maybeheldforvariousreasonMarketablesecuritiesaredefinedasshort-term,highlyliquid,interest-bearingfinancialassets,suchasTreasurybillsorhigh-gradecommercialpaper51.1Whyorganizationholdcash(Motivesforholdingcash)Transactionmotive–tomeetcurrenttransactions(payingitsA/P,employees’wages,tax;dividend)Precautionarymotive–thismeansthatthereisaneedtomaintaina‘buffer’ofcashforunforeseencontingencies.Themorepredictabletheinflowsandoutflowsofcashforafirm,thelesscashthatneedstobeheldforprecautionarymotiveneed.Readyborrowingpower(overdrafts)Speculativemotive–takeadvantageofspecialsituations(salepriceonrawmaterial–buymorenow)61.1Whyorganizationholdcash(Motivesforholdingcash)Cashmanagementinvolves:determiningthecashbalancesthatwilladequatelysustainthefirm’soperationefficientpaymentandcollectioninvestingtemporarysurplusfundsinliquidassets.

objectives:reducetheopportunitycostofholdingidlecash(investinSTmarketablesecurities)ensureallobligationsarepaidontime/duedate(notearly)collectmoneyowedassoonasitbecomesdue7ThecashManagementActivityShort-TermfinancingstrategiesforcashshortagesMarketablesecurityinvestmentstrategiesforcashsurplusesEstablishinganoptimalcashbalanceManagementofcashflowCashbudgetingSpeedingupreceiptsSlowingdowndisbursementsMaintainingsoundbankingrelationship8FlowoffundsMarketablesecuritiesCashbalanceReceivableInventoryFixedassetsDepreciationCreditsalespurchaseLaborandmaterialpurchase

salesalecashsalescollectionsCreditorsShareholdersCreditorsShareholdersGovernments91.1WhyorganizationholdcashliquidityvprofitabilityProfitabilityvariesinverselywithliquidity.Increasedliquiditygenerallycomesattheexpenseofreducedprofitability.Thereisatrade-offbetweenliquiditywithprofitability101.2CashflowproblemsMakinglossesInflationGrowthSeasonalbusinessOne-offitemsofexpenditure112CashflowforecastsFastforwardCashflowforecastsshowtheexpectedreceiptsandpaymentsduringaforecastperiodandareavitalmanagementcontroltool,especiallyduringtimesofrecession.Keyterm

acashflowforecastisadetailedforecastofcashinflowsandoutflowsincorporatingbothrevenuesandcapitalitems.12

2CashflowforecastsCashreceiptsCashdisbursementsNetcashflowCashshortfallsandsurplusesBeginningcashbalance+Netcashflow=EndingcashbalanceMinimumcashbalanceShort-termfinancingrequiredorrepayment(minimumcashbalanceminusendingcashbalance).OrInvestmentorpurchaseatmarketablesecurities(endingcashbalance-minimumcashbalance)132.1Theusefulnessof

cashflowforecastsOneofthemostimportantplanningtoolsGivingmanagementanindicationofpotentialproblemsthatcouldariseandallowsthemtheopportunitytotakeactiontoavoidsuchproblems.142.1Theusefulnessof

cashflowforecastsManagementwillneedtotakeappropriateactiondependingonthepotentialpositionCashpositionAppropriatemanagementactionShorttermsurplusPayA/Pearlytoobtaindiscount;AttempttoincreasesalesbyincreasingA/Randinventories;MakeshortterminventionShorttermdeficitIncreaseA/P;ReduceA/R;ArrangeanoverdraftlongtermsurplusMakelongterminvestment;expand;diversify;Update/replacenon-currentassetsLongtermdeficitRaisinglongtermfinanceConsidershutdown/disinvestmentopportunities152.2whattoincludein

acashflowforecastAcashflowforecastispreparedtoshowtheexpectedreceipts,andpaymentsofcashduringabudgetperiod.ProfitvcashflowNotallcashflowreceiptsaffectincomestatementincome.NotallcashpaymentaffectincomestatementexpenditureSomecostsintheincomestatementsuchasprofitorlossonsalesofnon-currentassetsordepreciationarenotcashitemsbutarecostsderivedfromaccountingconventionsThetimingofcashreceiptsandpaymentsmaynotcoincidewiththerecordingofincomestatementtransactions.Toensurethatthereissufficientcashinhandtocopeadequatelywithplannedactivities,managementshouldprepareandpaycloseattentiontoacashflowforecastratherthanaincomestatement.162.6MethodofeasingcashshortagesFastforwardCashshortagecanbeeasedbypostponingcapitalexpenditure,sellingassetstakinglongertopayA/PandpressingA/Rforearlierpayment.172.6MethodofeasingcashshortagesMeasuresPostponingcapitalexpenditureAcceleratingcashinflowsReversingpastinvestmentdecisionsbysellingassetspreviouslyacquiredNegotiatingareductionincashoutflows,topostponeorreducepayment.LongercreditLoanrepaymentsDeferralcorporatetaxReducingdividendpayment182.7Deviationsfromexpectedcashflow

AcashflowforecastmodelSensitivityProbabilitydistribution19BoardofdirectorsChiefExecutiveofficerVicepresidentoperationsVicepresidentmarketingChieffinanceofferControllersCostaccountingCostmanagementDataprocessingGeneralprocessingInternalcontrolPreparingfinancialstatementsPreparingbudgetsPreparingforecastTreasurerCapitalbudgetCashmanagementCreditmanagementDividenddisbursementFinanceanalysis&planningInvestorrelationPensionsmanagementRiskmanagement203Treasurymanagement

FastforwardAlargeorganizationwillhaveatreasurydepartmenttomanageliquidity,shortterminvestment,borrowings,foreignexchangeriskandother,specialized,areassuchasforwardcontractsandfutureetc.KeytermTreasurymanagementcanbedefinedas:‘thecorporatehandingofallfinancialmatters,thegenerationofexternalandinternalfundsforbusiness,themanagementofcurrenciesandcashflowsandthecomplexstrategies,policiesandprocedureoffinance.’213.1Centralizationonthe

treasurydepartment

Advantageofcentralization

:CentralizedliquiditymanagementAvoidhavingamixofcashsurplusesandoverdraftsindifferentlocalizedbankaccountsFacilitatesbullcashflows,sothatlowerbankchargescanbenegotiated.Largervolumesofcashflowareavailabletoinvest,givingbettershortterminvestmentopportunity.Anyborrowingcanbearrangedinbulk,atlowerinterestratesthanforsmallerborrowings,andperhapsontheEurocurrencyorEurobondmarkets.223.1Centralizationonthe

treasurydepartment

Advantageofcentralization

:Foreignriskmanagementislikelytobeimprovedinagroupofcompany.EmployingexpertsReducingthecashneedofprecautionarypurpose.Throughhavingaseparateprofitcentre,attentionwillbefocusedonthecontributiontogroupprofitperformancethatcanbeachievedbygoodcash,funding,investmentandforeigncurrencymanagement.233.1Centralizationonthe

treasurydepartment

Advantageofdecentralized:Sourceoffinancecanbediversifiedandcanmatchlocalassets.GreaterautonomyMoreresponsiveMorelimitedopportunitiestoinvestsuchbalancesonashorttermbasis.244CashmanagementmodelsFastforwardOptimumcashholdinglevelscanbecalculatedfromformalmodels,suchastheBaumolmodelandMiller-Orrmodel.Cashmanagementmodelsattempttominimizingthetotalcostsassociatedwithcashmovementsbetweenacurrentaccountandshortterminvestment–the‘opportunity’costoflostinterestplustransactioncosts-bydeterminingwhen,andhowmuch,cashflowshouldbetransferredeachtime.254.1TheBaumolmodelTheBaumolmodelassumesthatcashissteadilyconsumedovertimeandafirmholdsastockofmarketablesecuritiesthatcanbesoldwhencashisneeded.Thecostofholdingcashistheopportunitycost,i.e.foregonefromnotinvestingthatcash.Thecostofplacinganorderistheadministration(conversion)costincurredwhensellingthesecurities.264.1TheBaumolmodelDrawbacksoftheBaumolmodelInreality,itisunlikelytobepossibletopredictamountsrequiredoverfutureperiodwithmuchcertainty.Nobufferinventoryofcashisallowedfor.Theremaybecostsassociatedwithrunningoutofcash.Theremaybeothernormalcostsofholdingcostwhichincreasewiththeaverageamountheld.TheproblemwiththeMaumolmodelisitsunrealisticassumptionthatfirmsfaceaconstantdemandforcash.274.2TheMiller-OrrmodelCashbalanceThefirmbuyssecuritiesThefirmsellssecuritiestimeABUpperlimitReturnpointLowerlimitTheMiller-Orrmodelcontrolsirregularmovementsofcashbyusesofupperandlowerlimitsoncashbalance.284.2TheMiller-OrrmodelTheformulaofMiller-OrrmodelWheretransactioncosts=transferredcostsforeachbuyingandsellingsecuritiesvarianceofcashflow=expecteddailyvarianceofcashflowbalanceinterestrate=dailyinterestrateofsecurity295Investingsurpluscash

FastforwardTemporarysurplusesofcashcanbeinvestedinavarietyoffinancialinstruments.Longtermsurplusesshouldbereturnedtoshareholdersifthereisalackofinvestmentopportunities.305Investingsurpluscash

TheobjectivesofinvestingsurpluscashLiquidity:thecashmustbeavailableforusewhenneededSafety:noriskofcapitallossmustbetakenProfitability:subjecttotheabove,theaimistoearnthehighestpossibleaftertaxreturns.315Investingsurpluscash

Otherfactorsneededtobeconsidered:fixedorfloatinginterestratesTermtomaturityMarketabilityMinimumamountWhethertoinvestoninternationalmarkets325Investingsurpluscash

Surpluscashlackofinvestmentopportunitymaybereturnedtoshareholdersby:increasingtheusualleveloftheannualdividendMakingaone-offspecialdividendpaymentBuyingbackitsownshares335.1shortterminvestments

DepositBankdepositMoneymarketlendingLocalauthoritydepositFinancehousedepositsShorttermdebtinstrumentCertificateofdepositsTreasurybillsLongertermdebtinstrumentShareoflistedcompanies345.1shortterminvestmentsCertificatesofdepositsACDisasecuritythatisissuedbyabank,acknowledgingthatacertainamountofmoneyhasbeendepositedwithitforacertainperiodoftime(usually,ashortterm)CDsarenegotiableandtradedontheCDmarket(amoneymarket),soifaCDholderwishestoobtainimmediatecash,hecanselltheCDonthemarketatanytime.TreasurybillsTreasurybillsareissuedweeklybythegovernmenttofinanceshorttermcashdeficienciesinthegovernment’sexpenditureprogram.Treasurybillshaveatermof91daystomaturity,afterwhichtheholderispaidfullvalueofthebill.356Workingcapitalfundingstrategies

FastforwardWorkingcapitalcanbefundedbyamixtureofshortandlongtermfunding.Businessshouldbeawareofthedistinctionbetweenfluctuatingandpermanentassets.366.1Theworkingcapitalrequirement

Workingcapital

(overaoneyearperiod)

=currentassets–currentliabilities376.3ThelevelofworkingcapitalAconservativeapproachAconservativeworkingcapitalmanagementpolicyaimstoreducetheriskofsystembreakdownbyholdinghighlevelsofworkingcapital.Thecumulativeeffectonthesepoliciescanbethatthefirmcarriesahighburdenofunproductiveassets,resultingafinancingcostthatcandestroyprofitability.Aperiodofrapidexpansionmayalsocauseseverecashflowproblemsasworkingcapitalrequirementsoutstripavailablefinance.Furtherproblemsmayarisefrominventoryobsolescenceandlackofflexibilitytocustomerdemands.386.3ThelevelofworkingcapitalAnaggressiveapproachAnaggressiveworkingcapitalmanagementpolicyaimstoreducethisfinancingcostandincreaseprofitabilitybycuttinginventories,speedingupcollectionfromcustomer,anddelayingpaymenttosuppliers.Thepotentialdisadvantageofthispolicyisanincreaseinthechancesofsystembreakdownthroughrunningoutofinventoryorlossofgoodwillwithcustomersandsuppliers.396.3ThelevelofworkingcapitalAnmoderateapproachAnmoderateworkingcapitalmanagementpolicyisamiddlewaybetweentheaggressiveandconservativeapproaches.Thedecisionregardingthelevelofoverallinvestmentinworkingcapitalisarisk/returntrade-off:-liquidityvprofitability;-profitabilityvriskLiquidity-theabilityofanassettobeconvertedintocashwithoutasignificantpriceconcession406.3ThelevelofworkingcapitalliquidityvprofitabilityProfitabilityvariesinverselywithliquidity.Increasedliquiditygenerallycomesattheexpenseofreducedprofitability.profitabilityvriskProfitabilitymovestogetherwithrisk(i.e.thereisatrade-offbetweenriskandreturn).Insearchofhigherprofitability,wemustexpecttotakegreaterrisks.416.3ThelevelofworkingcapitalCurrentassetsPolicyAPolicyBPolicyCAssetlevelOutputunit0426.3Thelevelofworkingcapital436.4Permanentandfluctuating

currentassetsNon-current(fixed)assetsarelongtermassetsfromwhichanorganizationexpectstoderivebenefitoveranumberofperiodsPermanentcurrentassetaretheamountrequiredtomeetlongtermminimumneedsandsustainnormaltradingactivity.Fluctuatingcurrentassetsarethecurrentassetswhichvaryaccordingtonormalbusinessactivity.Forexampleduetoseasonalvariations.446.4Permanentandfluctuating

currentassetsPermanentcurrentassettogetherwithFluctuatingcurrentassetsformpartoftheworkingcapitalofthebusiness,whichmaybefinancedbyeitherlongtermfundingorbycurrentliabilities(shorttermfunding)456.5WorkingcapitalfinancingShorttermsources

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