Cartwright Fin Mng HSCI 7031 Current Asset Management Chapter 16.

Cartwright Fin Mng HSCI 703 1

Current Asset Management

Chapter 16


Introduction

• Investment and financing policies

• Manage cash and marketable securities

• Manage receivables and inventory

• Short-term financing


Short Term Financial Management

• Current Assets and Liabilities– Found in Financial Statements

• Support operational requirements– Goal is to minimize financial costs– Maintain liquidity– Manage fluctuations in business environment

• Receive payment• Pay bills• Have services ready to meet demand


Uncertainty

• If flows were certain, easy job to plan for known fluctuations in business.

• If flows uncertain, unexpected needs require additional cash and inventories to meet needs of business.

• A low policy provides for minimum cash and inventories stocks. Minimizes cost

• A high policy provides the converse.– Opportunity cost is profit penalty.


Policy Choices

• Aggressive – highest return and risk– Use higher proportion short-term debt and

credit

• Conservative – lowest return and risk– Use higher proportion of marketable securities

and cash, long term debt and equity capital

• Moderate – falls in the middle somewhere.


Financing Policies

• Conservative- use no to very little short-term financing

• Moderate- use some short-term financing

• Aggressive – use much more short-term financing (highest risk and return)

• Long-term debt and equity are adjusted up and down depending on strategy selected.


Policy Choices

• If a firm has low business risk, may choose to follow a higher risk financial strategy. – Higher debt ratio in target capital structure– More aggressive short-term financing

• If a firm has high business risk, may choose to follow a low risk financial strategy– Lower debt ratio – More conservative short term financing.


Cash Management

• The goal of cash management is to hold the minimum amount necessary to meet liquidity requirements. Opportunity costs?

• The primary cash management technique is float management:– Acceleration of receipts– Disbursement control

• The cost of cash management initiatives must be balanced by corresponding benefits.


Cash Management

• Liquidity Ratios – financial analysis

• Cash Budget

• Calculation of alternative financing arrangements

• Managing receivables

• Managing payments– negotiating with vendors

• Negotiating bank loans and lines of credit.


Using Float

• Net float is the difference between the cash amount on the firm’s books and the amount on the bank’s books.– Suppose Colonial Healthcare writes $2,000 in checks

daily. It takes 6 days for these to be received and clear the banking system, so its disbursement float is $12,000.

– Colonial receives $3,000 in checks daily which are cleared in 3 days. Thus, its collections float is $9,000.

• Its net float is $12,000 - $9,000 = $3,000.


Accelerating Receipts

• Net float is maximized by accelerating receipts and slowing disbursements.– Deposit checks received daily

– Lockboxes (perhaps multiple banks and locations)

– Concentration banking (single bank)

– Automated clearinghouses (electronic banking)

– Federal Reserve wire system


Disbursement Control

• Disbursement control for outflows– Payables centralization

• Prompt payment?

– Master and zero-balance accounts– Controlled (remote) disbursement


Economic Decision Making

• Efficiency in Cash Operations

• Make the policy decision on the criteriaThe marginal benefit of policy should exceed

the marginal benefit

In finance, one can often calculate the benefit and costs in dollar terms


Marketable Securities

• Two primary reasons to hold:– As an interest earning substitute for cash.

• Opportunity costs of cash balances is foregone interest

– As a temporary repository for cash being accumulated to meet a specific need.

• Cash management of obligations

• Managers do cash and marketable securities management simultaneously.


Marketable Securities

• Examples are short-term treasury securities, money market funds,

• In general, marketable securities are chosen on the basis of safety.– Protection of principal is primary– Amount of return is secondary

• Specific securities used depend on the:– Expected holding period– Size of the business


Receivables management

• If a service is provided for cash, the revenue is immediately received.

• If the service is provided on credit, the revenue is not received until the receivable is collected.

• Receivables management is fundamental to healthcare providers.


Accumulation of Receivables

• Suppose Colonial contracts with an insurer whose patients use $2,000 in services daily and who pays in 20 days. – Average daily billings ADB of $2,000– Average collection period ACP of 20 days

• The clinic will accumulate receivables at a rate of $2,000 per day.

• However, after 20 days, the receivables balance will stabilize at $40,000:

Receivables balance = ADB x ACP

$2,000 x 20 = $40,000


Receivables Financing

• Suppose Colonial uses bank financing that has an interest rate of 10% to finance its receivables.

• The annual cost of carrying the receivables is $4,000:

$40,000 x 0.10 = $4,000.


Monitoring Receivables

• Healthcare managers must continuously monitor the firm’s receivables.

• Monitoring methods include:– Average collection period (ACP), often called

days in patient accounts receivable (DPAR)– Aging schedules

• Receivables are monitored both in the aggregate and by specific payer.


Supply Chain Management

• Supply chain management is clinically important for healthcare providers, but not as financially motivated as it is for manufacturers, wholesalers, or retailers.

• Inventories consist of base stocks plus safety stocks.

• The goal of inventory management is to meet operational needs at the lowest cost.


Inventory Management

• Management techniques used are:– Just-in-time (or stockless) systems– Point of distribution systems

• In addition, some providers have contracts with suppliers that are priced on the basis of the amount of medical services provided or amount may be even capitated.


Revenue Cycle

• Those recurrent activities associated with billing and collecting for services.

For example:– Preinsurance verification– Patient precertification – Preservice patient financial counseling– Time of service recertification– Third-party claim submission– Claim follow-up – Payment receipt and posting


Revenue Cycle

• In revenue cycle management, each of the identified activities is closely monitored to ensure that:– The correct amount of reimbursement is collected on

each patient.– Reimbursements are collected as quickly as possible.– The costs associated with the revenue cycle are

minimized consistent with rapid and correct collections.

• An important key to good revenue cycle management is electronic claims processing.


Short-term Financing

• Three primary advantages over long-term.– Lower issuance costs

– Fewer restrictive covenants

– Generally lower interest rate

• Major sources for providers– Accruals

– Accounts payable (trade credit)

– Bank loans (notes payable)


ST Financing Disadvantage

• Interest expense can fluctuate much more than LT debt

• Recently short term rates rather low because of the Federal Reserve Policy

• ST comes due on a regular basis.– If deterioration in business, may have difficulty

meeting payments


Accruals

• Accruals consist primarily of wages owed to employees and taxes owed to governments.

Even not-for-profits have accrued taxes

• Accruals are free in the sense that no explicit interest is charged.

• However, managers have little control over the level of accruals, which is influenced more by industry custom and tax laws.


Accounts Payable

• Trade credit is credit furnished by a business’s suppliers.

• Trade credit often is the largest source of short-term credit, especially for small businesses.

• Both accruals and trade credit are spontaneous liabilities in the sense that their levels change spontaneously as patient volume rises and falls.


Colonial Healthcare buys $3,000,000 (invoice price) of medical supplies from one of its vendors on terms of 2/10, net 30.

How much trade credit is available from this vendor and how much does it cost?


Gross/Net Breakdown

• Colonial buys supplies worth $3,000,000 x 0.98 = $2,940,000 because that is the net, or cash, (true) price.

• If Northwest does not take the discount, it must pay $3,000,000 for the supplies. This is the gross, or invoice, price.

• The difference, $60,000, is a financing cost similar to the dollar amount of interest paid on a loan.


• Net Daily Purchases (NDP) NDP = ($3,000,000 x 0.98) /360 = $8,167• Payables level with discount Payables = $8,167 x 10 = $81,670• Payables level without discount Payables = $8,167 x 30 = $245,010• Credit breakdown Total trade Credit = $245,010 Free Trade Credit = 81,670 Costly Trade Credit = $163,340


Approximate Cost Rate of Costly Trade Credit

• Colonial Health Care must pay $60,000 (.02 x $3 mil) to obtain $163,340 in extra trade credit

• Cost Rate = $60,000/$163,340 = 0.367 = 36.7%• The $60,000 in financing charges is paid through

the year rather than at year end, so the Expected Annual Rate (EAR) is higher


Approximate Cost Formula

Discount % 360 Cost = ─────── x ───────────── 1-Discount% Days _ Discount Taken period 2 360 = ──── x ────── = 0.0204 x 18 98 30 – 10 = 0.367 = 36.7%


Effective Annual Rate

• Periodic rate = 2 / 98 = 0.0204

• Periods / year = 360 / (30-10) = 18

• EAR = (1+ Periodic rate)M - 1.0

= (1.0204)18 -1.0 = 0.438 = 43.8%Higher than the nominal cost previously

calculated.


Decision

• Colonial should take $81,670 in free trade credit

• Costly trade credit should not be taken if it can be beaten by a less costly alternative

• If one can obtain a bank loan in the 8 to 12% range, no need to take the $163,340 in costly trade credit.


Bank Loans

• Commercial banks provide short-term credit to healthcare providers.

• Where do these appear on the balance sheet?– Notes payable

• Bank loan features– Promissory note– Compensating balances kept in bank– Line of credit


Secured Short-term Loans

• Borrower pledges an asset as collateral.

• Receivables and inventories are commonly pledged as assets

• Also possible to pledge marketable securities.

• Use fixed assets for long term matching


Receivables Financing

• Receivables may be pledged, gives the lender recourse.

• Receivables may also be factored. This is selling the accounts receivables.

• There is no recourse to the selling business. The lender has purchased the receivables.

• Purchaser needs to check credit of receivables.


Inventory Financing

• Not really used by healthcare providers

• Equipment/devices firms and Pharmaceuticals may use it.

• Inventory secured by– Blanket lean– Trust receipt against specific items– Warehouse receipt


Final Comments

• Borrowing on an unsecured basis is generally cheaper and simpler than a secured loan

• Businesses must often provide collateral in order to borrow.

• In some cases, security will lower the interest rate.

• Accounts receivables may be used as collateral.

Cartwright Fin Mng HSCI 7031 Current Asset Management Chapter 16.

Documents

cartwright fin mng hsci

business slide

goal of cash management

minimum cash

cash operations

additional cash

demand slide

receivables management