After reading this chapter, students should be able to: • Define basic working capital terminology. • Calculate the inventory conversion period, the receivables collection period, and the payables deferral period to determine the cash conversion cycle. • Briefly explain the basic idea of zero working capital. • Briefly explain how a negative cash conversion cycle works. • Distinguish among relaxed, restricted, and moderate current asset investment policies, and explain the effect of each on risk and expected return. • Explain how EVA methodology provides a useful way of thinking about working capital. • List the reasons for holding cash. • Construct a cash budget, and explain its purpose. • Briefly explain useful tools and procedures for effectively managing cash inflows and outflows. • Explain why firms are likely to hold marketable securities. • State the goal of inventory management and identify the three categories of inventory costs. • Identify and briefly explain the use of several inventory control systems. • Monitor a firm’s receivables position by calculating its DSO and reviewing aging schedules. • List and explain the four elements of a firm’s credit policy, and identify other factors influencing credit policy.
Trang 1After reading this chapter, students should be able to:
• Define basic working capital terminology
• Calculate the inventory conversion period, the receivables collection
period, and the payables deferral period to determine the cash conversion cycle
• Briefly explain the basic idea of zero working capital
• Briefly explain how a negative cash conversion cycle works
• Distinguish among relaxed, restricted, and moderate current asset
investment policies, and explain the effect of each on risk and expected return
• Explain how EVA methodology provides a useful way of thinking about
working capital
• List the reasons for holding cash
• Construct a cash budget, and explain its purpose
• Briefly explain useful tools and procedures for effectively managing
cash inflows and outflows
• Explain why firms are likely to hold marketable securities
• State the goal of inventory management and identify the three categories
of inventory costs
• Identify and briefly explain the use of several inventory control
systems
• Monitor a firm’s receivables position by calculating its DSO and
reviewing aging schedules
• List and explain the four elements of a firm’s credit policy, and
identify other factors influencing credit policy
Chapter 15 Managing Current Assets
LEARNING OBJECTIVES
Trang 2We have never found working capital an interesting topic to students, hence it
is, to us, a somewhat more difficult subject to teach than most Perhaps that’s because it comes near the end of the course, when everyone is tired More likely, though, the problem is that working capital management is really more a matter of operating efficiently than thinking conceptually correctly i.e., it is more practice than theory and theory lends itself better to classroom teaching than practice Still, working capital management is important, and it is something that students are likely to be involved with after they graduate
Since we have only one chapter on current asset management, we try to go all the way through it However, the chapter is modular, so it is easy to omit sections if time pressures require
Assuming you are going to cover the entire chapter, the details of what
we cover, and the way we cover it, can be seen by scanning Blueprints, Chapter
15 For other suggestions about the lecture, please see the “Lecture Suggestions” in Chapter 2, where we describe how we conduct our classes
DAYS ON CHAPTER: 3 OF 58 DAYS (50-minute periods)
LECTURE SUGGESTIONS
Trang 315-1 When money is tight, interest rates are generally high This means that
near-cash assets have high returns; hence, it is expensive to hold idle cash balances Firms tend to economize on their cash balance holdings during tight-money periods
15-2 The two principal reasons for holding cash are for transactions and
compensating balances The target cash balance is not equal to the sum
of the holdings for each reason because the same money can often partially satisfy both motives
15-3 a Better synchronization of cash inflows and outflows would allow the
firm to keep its transactions balance at a minimum, and would therefore lower the target cash balance
b Improved sales forecasts would tend to lower the target cash balance
c A reduction in the portfolio of U S Treasury bills (marketable securities) would cause the firm’s cash balance to rise if the Treasury bills had been held in lieu of cash balances
d An overdraft system will enable the firm to hold less cash
e If the amount borrowed equals the increase in check-writing, the target cash balance will not change Otherwise, the target cash balance may rise or fall, depending on the relationship between the amount borrowed and the number of checks written
f The firm will tend to hold more Treasury bills, and the target cash balance will tend to decline
15-4 A lockbox would probably make more sense for a firm that operated
nationwide Lockboxes reduce the time required for a firm to receive incoming checks, to deposit them, and to get them cleared through the banking system so that the funds are available for use However, even a local firm with enough volume may want its bank to receive and process checks before the firm adjusts its accounts receivable ledgers
15-5 False Both accounts will record the same transaction amount
15-6 The four elements in a firm’s credit policy are (1) credit standards,
(2) credit period, (3) discount policy, and (4) collection policy The firm is not required to accept the credit policies employed by its competition, but the optimal credit policy cannot be determined without considering competitors’ credit policies A firm’s credit policy has an
ANSWERS TO END-OF-CHAPTER QUESTIONS
Trang 4important influence on its volume of sales, and thus on its profitability
15-7 The latest date for paying and taking discounts is May 10 The date by
which the payment must be made is June 9
15-8 a outstandinDays salesg =
Sales/365
receivable
/365 000 , 920 ,
$
000 , 312
$
=
$8,000/day
000 , 312
$
= 39 days
b False While it appears that most customers pay on time (because 39 days is less than the 40 days stipulated in the credit terms), this does not mean that all customers are paying on time In fact, it is very likely that some are not, since some customers are paying on the tenth day and are taking the discount
15-9 False An aging schedule will give more detail, especially as to what
percentage of accounts are past due and what percentage of accounts are taking discounts
15-10 No Although B sustains slightly more losses due to uncollectible
accounts, its credit manager may have a wise policy that is generating more sales revenues (and thus profits) than would be the case if he had
a policy which cut those losses to zero
15-11 A/R Sales Profit
a The firm tightens its credit
standards - - 0
b The terms of trade are
changed from 2/10, net 30,
to 3/10, net 30 0 + 0
c The terms are changed from
2/10 net 30, to 3/10, net 40 0 + 0
d The credit manager gets tough
with past-due accounts - - 0
Explanations:
a When a firm “tightens” its credit standards, it sells on credit more selectively It will likely sell less and certainly will make fewer credit sales Profit may be affected in either direction
b The larger cash discount will probably induce more sales, but they will likely be from customers who pay bills quickly Further, some of the current customers who do not take the 2 percent discount may be induced to start paying earlier The effect of this would be to reduce accounts receivable, so accounts receivable and profits could
go either way
c A less stringent credit policy in terms of the credit period should stimulate sales The accounts receivable could go up or down
Trang 5depending upon whether customers take the new higher discount or delay payments for the 10 additional days, and depending upon the amount of new sales generated
d If the credit manager gets tough with past due accounts, sales will decline, as will accounts receivable
15-12 The firm could have its suppliers ship by air freight, reducing lead
time, or on consignment, reducing the firm’s purchasing costs The firm can reduce its finished goods inventory by manufacturing to meet orders,
or by shipping goods to customers at the firm’s discretion, or by using seasonal dating in its accounts receivable policy
Unless the firm is in a strong bargaining position, or offers some financial incentive, shifting inventory burdens to suppliers and customers may result in higher costs and fewer sales If a supplier has
to carry larger raw material inventory, it may charge a higher price to the firm to cover its increased inventory costs Shifting inventory burdens to customers may result in lost sales if customers can obtain better service from other firms
Trang 615-1 Net Float = Disbursement float - Collections float
= (4 × $10,000) - (3 × $10,000)
= $10,000
15-2 Sales = $10,000,000; S/I = 2×
Inventory = S/2
=
2
000 , 000 , 10
$ = $5,000,000.
If S/I = 5×, how much cash is freed up?
Inventory = S/5
=
5
000 , 000 , 10
$
= $2,000,000
Cash freed = $5,000,000 - $2,000,000 = $3,000,000
15-3 DSO = 17; Credit sales/Day = $3,500; A/R = ?
DSO =
S/365 A/R
17 =
$3,500 A/R A/R = 17 × $3,500 = $59,500
15-4 a Cost = (Number of locations)(Number of transfers)(Cost per transfer)
+ (Monthly cost)(12)
= (10)(260)($9.75) + ($6,500)(12) = $25,350 + $78,000
= $103,350
b Reduction in days of float = 3 days
Benefit = daysReductionof floatin collectionDaily s Opportunitcost y
= (3)($325,000)(0.10) = $97,500
c Net gain (loss) = $97,500 - $103,350 = -$5,850
Malitz should not initiate the lockbox system since it will cost the firm $5,850 more than it will earn on the freed funds
SOLUTIONS TO END-OF-CHAPTER PROBLEMS
Trang 715-5 a 0.4(10) + 0.6(40) = 28 days.
b $912,500/365 = $2,500 sales per day
$2,500(28) = $70,000 = Average receivables
c 0.4(10) + 0.6(30) = 22 days $912,500/365 = $2,500 sales per day
$2,500(22) = $55,000 = Average receivables
Sales may also decline as a result of the tighter credit This would further reduce receivables Also, some customers may now take discounts further reducing receivables
15-6 a Setting up the formula for the cash conversion cycle, sales can be
calculated
CCC =
COGS Daily Avg
Pay
Acct
Sales Daily
Avg
Inv
Sales Daily
Avg
Rec
16.79 = ($47,000/ADS) + ($66,000/ADS) - ($72,000/0.8ADS)
16.79 = ($47,000/ADS) + ($66,000/ADS) - ($90,000/ADS)
16.79 = $23,000/ADS
16.79ADS = $23,000
ADS = $1,369.863
Therefore, annual sales equal $500,000 ($1,369.863 × 365 = $500,000)
b Based upon the given information, the firm's current assets equal
$148,750 ($35,750 + $47,000 + $66,000) Therefore, for its current ratio to increase to 2.0, it must reduce accounts payable to a level such that current liabilities total $74,375 ($148,750/2) If accrued liabilities on the balance sheet equal $13,000, accounts payable must
be reduced to $61,375 ($74,375 - $13,000) The firm's new average daily cost of goods sold would equal $1,369.863 × 0.70 = $958.90 Combined with the original information, the new CCC can be determined
as follows:
CCC = (AR/Avg Daily Sales) + (Inv/Avg Daily Sales) - (AP/Avg Daily COGS)
CCC = ($47,000/$1,369.863) + ($66,000/$1,369.863) - ($61,375/$958.90) CCC = 34.31 + 48.18 - 64.01
CCC = 18.48 days
15-7 a Cash conversion cycle = 22 + 40 - 30 = 32 days
b Working capital financing = 1,500 × 32 × $6 = $288,000
c If the payables deferral period was increased by 5 days, then its cash conversion cycle would decrease by 5 days, so its working capital financing needs would decrease by
Trang 8Decrease in working capital financing = 1,500 × 5 × $6 = $45,000.
d Cash conversion cycle = 20 + 40 - 30 = 30 days
Working capital financing = 1,800 × 30 × $7 = $378,000
15-8 a CCC =
period deferral Payables period
collections Receivable period
conversionInventory + − = 75 + 38 - 30 = 83 days
b Average sales per day = $3,421,875/365 = $9,375
Investment in receivables = $9,375 × 38 = $356,250
c Inventory turnover = 365/75 = 4.87×
15-9 a Inventory conversion period = 365/Inventory turnover ratio
= 365/6 = 60.83 days
Receivables collection period = DSO = 36.5 days
CCC =
period deferral Payables period
collections Receivable period
conversionInventory + − = 60.83 + 36.5 - 40 = 57.33 days
b Total assets = Inventory + Receivables + Fixed assets
= $150,000/6 + [($150,000/365) × 36.5] + $35,000 = $25,000 + $15,000 + $35,000 = $75,000
Total assets turnover = Sales/Total assets
= $150,000/$75,000 = 2×
ROA = Profit margin × Total assets turnover
= 0.06 × 2 = 0.12 = 12%
c Inventory conversion period = 365/7.3 = 50 days
Cash conversion cycle = 50 + 36.5 - 40 = 46.5 days
Total assets = Inventory + Receivables + Fixed assets
= $150,000/7.3 + $15,000 + $35,000
= $20,548 + $15,000 + $35,000 = $70,548
Total assets turnover = $150,000/$70,548 = 2.1262×
ROA = $9,000/$70,548 = 12.76%
Trang 915-10 a Return on equity may be computed as follows:
Tight Moderate Relaxed Current assets
(% of sales × Sales) $ 900,000 $1,000,000 $1,200,000 Fixed assets 1,000,000 1,000,000 1,000,000 Total assets $1,900,000 $2,000,000 $2,200,000 Debt (60% of assets) $1,140,000 $1,200,000 $1,320,000 Equity 760,000 800,000 880,000 Total liab./equity $1,900,000 $2,000,000 $2,200,000 EBIT (12% × $2 million) $ 240,000 $ 240,000 $ 240,000 Interest (8%) 91,200 96,000 105,600 Earnings before taxes $ 148,800 $ 144,000 $ 134,400 Taxes (40%) 59,520 57,600 53,760 Net income $ 89,280 $ 86,400 $ 80,640 Return on equity 11.75% 10.80% 9.16%
b No, this assumption would probably not be valid in a real world situation A firm’s current asset policies, particularly with regard
to accounts receivable, such as discounts, collection period, and collection policy, may have a significant effect on sales The exact nature of this function may be difficult to quantify, however, and determining an “optimal” current asset level may not be possible in actuality
c As the answers to Part a indicate, the tighter policy leads to a higher expected return However, as the current asset level is decreased, presumably some of this reduction comes from accounts receivable This can be accomplished only through higher discounts,
a shorter collection period, and/or tougher collection policies As outlined above, this would in turn have some effect on sales, possibly lowering profits More restrictive receivable policies might involve some additional costs (collection, and so forth) but would also probably reduce bad debt expenses Lower current assets would also imply lower liquid assets; thus, the firm’s ability to handle contingencies would be impaired Higher risk of inadequate liquidity would increase the firm’s risk of insolvency and thus increase its chance of failing to meet fixed charges Also, lower inventories might mean lost sales and/or expensive production stoppages Attempting to attach numerical values to these potential losses and probabilities would be extremely difficult
Trang 1015-11 a Firm’s Bank’s
checkbook records
Day 1 Deposit $1,200,000;
write check for
$1,600,000 -$ 400,000 $1,200,000 Day 2 Write check
for $1,600,000 -$2,000,000 $1,200,000 Day 3 Write check
for $1,600,000 -$3,600,000 $1,200,000 Day 4 Write check
for $1,600,000 -$5,200,000 $1,200,000 Day 5 Write check for
$1,600,000; deposit
$1,600,000 -$5,200,000 $1,200,000 After the firm has reached a steady state, it must deposit $1,600,000 each day to cover the checks written four days earlier
b The firm has four days of float
c The firm should try to maintain a balance on the bank’s records of
$1,200,000 On its own books it will have a balance of minus
$5,200,000
d For any level of sales, the firm will probably have a higher rate of return on assets and equity if it can reduce its total assets By using float, SSC can reduce its cash account, by (4 × $1,600,000)
- $1,200,000 = $5,200,000 However, they actually can reduce equity and debt by $6,000,000 as the firm has gross float of $6,400,000 -
$400,000 (increase in the amount deposited in the bank) = $6,000,000,
so earnings per share will be higher In terms of the Du Pont equation, the rate of return on equity will be higher because of the reduction in total assets
15-12 a Presently, HGC has 5 days of collection float; under the lockbox
system, this would drop to 2 days
$1,400,000 × 5 days = $7,000,000
$1,400,000 × 2 days = 2,800,000
$4,200,000
HGC can reduce its cash balances by the $4,200,000 reduction in negative float
b 0.10($4,200,000) = $420,000 = the value of the lockbox system on an annual basis