WORKING CAPITAL MANAGEMENT. Current Assets & Current Liabilities are collectively known as WORKING CAPITAL Components of Working Capital Accounts Receivable:

WORKING CAPITAL MANAGEMENT

Current Assets & Current Liabilities are collectively known as

WORKING CAPITAL

Components of Working Capital

Accounts Receivable:

arise because of companies do not usually expect customers to pay for their purchases immediately.

These unpaid bills are a valuable asset that companies expect to be able to turn into cash in the near future.

TRADE CREDIT : Unpaid bills from sales to other companies.

CONSUMER CREDIT : Sales of goods to the final customers.

Cash & Marketable Securities:

Cash: Dollar Bills & Bank Deposits.

DEMAND DEPOSITS: Money in checking accounts that the firm can pay out immediately.

TIME DEPOSITS: Money in saving accounts that the firm can pay out only with a delay.

Marketable Securities: Commercial Paper & Tresury Bills

Components of Working Capital

Accounts Payable: Unpaid Bills

Outstanding payments due to other companies

One firm’s credit is another firm’s debit

NET WORKING CAPITAL

CURRENT ASSETS – CURRENT LIABILITIES

Generally called as

WORKING CAPITAL

CASH CONVERSION CYCLE =

(Inventory Period + Receivables Period) – Accounts Payable Period

CASH CONVERSION CYCLE

CASH

FINISHED GOODS

RECEIVABLES INVENTORY

CASH CONVERSION CYCLE =

(Inventory Period + Receivables Period) – Accounts Payable Period

CASH CONVERSION CYCLE :

Period between firm’s payment for materials and collection on its sales

Inventory Period = Average Inventory / [Cost of Goods Sold / 365]

Receivables Period = Average Accounts Receivables / [Sales / 365]

Payable Period = Average Payable / [Sales / 365]

Working Capital Trade-offCarrying Costs:

Costs of maintaining Current Assets; including opportinity cost of capital.

Investment in CASH & RECEIVABLES may cause an interest loss and

Investment in INVENTORY has opportinity cost of capital; storage & insurance costs

Shortage Costs:

Costs incurred from shortages in Current Assets

Shortage in CASH may incur unnecassary transaction costs of selling marketable securities and

Shortage in RECEIVABLES may cause to lose customers because of credit sales’ restrictions

Shortage in INVENTORY may have shut down production & unable to to fill orders promptly

Carrying Costs encourage firm to hold current assets to a MINIMUM

Shortage Costs encourage firm to hold current assets to a MAXIMUM

It’s an art to find the LEVEL of CURRENT ASSETS that minimizes the sum of

Carrying Costs & Shortage Costs

Links between

LONG-TERM & SHORT-TERM fınancıng

Short-Term financing

Time

Long -Term financing

Seasonal component of required assets

Total Capital Requirement

STRATEGIES:

1. Matching Maturities: Long-Lived assets with long-term debt & Current Assets with short-term debt

2. Permanent Working Capital Requirements: A positive amount of WORKING CAPITAL

3. The Comforts of Surplus Cash:The firm is always a short-term lender (Relaxed Strategy)

Firm’s Total Capital Requirement: The Cost of Assets

TRACING CHANGES IN CASH & NWC

Cash Budgeting:

Forecasting future sources and uses of cash

Alerts for future cash needs & provides a standart

Three Common Steps to preparing Cash Budget

1. Forecast the sources of cash

3. Calculate whether the firm is facing a cash shortage or plus

2. Forecast the uses of cash

DETAILS:

The Steps of Calculating Sources of Cash

1. Receivables at the start of period

2. Forecast Sales

3. Forecast Collections

• Sales in current period (%?)

• Sales in last period (%?)

TOTAL COLLECTIONS

4. Receivables at the end of period

5. Other sources of cash (Dispose of land, machine, stock)

Ending Accounts Receivable = Beginning Acc. Rec. + Sales - Collections

DETAILS:

The Steps of Calculating Uses of Cash

1. Payments for Accounts Payable

2. Labor, Administrative and Other Expenses (Regular Business Expenses)

3. Capital Expenditures (Pay for long-lived assets)

4. Taxes, Interest and Dividend Payments

Prepare SOURCES & USES CASH LIST each period

Determine Short-Term Financing Requirements

DYNAMIC MATTRESS'S FINANCING PLAN

1. Quarter 2. Quarter 3. Quarter 4. Quarter TOTAL

Cash Inputs 86,5 80,3 121,0 128,0 415,8

Cash Outputs 131,5 95,3 95,0 93,0 414,8

Cash Balance 45,0 15,0 26,0 35,0 1,0

Marketable Securities 5,0 5,0

Bank Loan 2% 40,0 8,6 31,4 40,0

Interest Payment 0,8 1,6 0,6 3,0

Stretch 5% 15,8 15,8 0

Cash Balance 45,0 15,0 26,0 32,0 2,0

Additions to Cash Balance 3,0 3,0

QUESTIONS:

1. Cash or Marketable Securities enough or expand?

2. Does plan cahnge Current & Quick Ratios?

3. Hidden costs to stretching payables?

4. Does plan leave DYNAMIC in good financial shape for 2005?

5. What about log-term financing and capital expenditures?

6. Can the firm’s operating and investment plans be adjusted

to make the short-term financing problem easier?

SHORT-TERM FINANCING PLANS MUST BE DEVELOPED BY

TRIAL & ERROR !...

SOURCES OF SHORT-TERM FINANCING

Bank Loans:

Line of Credit: Aggrement by a bank that a company may borrow at any time up to an established limit.

Revolving Credit Aggrement: If the firm wants to be sure it will able to borrow; it can enter a RCA. ( RCA usually last for a few years and formally commit the bank to an aggreed limit. A committment fee is required on any unused amount.)

Term Loans: Conditional Credit (Loans are paid when the goods are sold)

Syndicate Credit: Banks combined to provide cash

Commercial Paper:

Short-Term unsecured notes issued by firms

SOURCES OF SHORT-TERM FINANCING

Secured Loans:

Accounts Receivables Financing

1. Some companies solve their financing problem by borrowing on the strength of their current assets!...

When a loan is secured by receivables, the firm assigns the receivables to the bank.

The risk of default on the receivables is therefore borne by the firm

2. Others solve it by selling their current assets!...

An alternative procedure is to sell the receivables at a discount to a financial institution known as FACTOR and let it collect the money.

Once the firm has sold receivables, the factor bears all the responsibility for collecting on the accounts!...

Inventory Financing

Bank also lend on the security of inventory; but they are choosy about the inventory they will accept!...

THE COST OF BANK LOANS

Simple Interest

1. Simple Interest: The interest rate on bank loans frequently is quoated on APR

2. Discount Interest : The interest rate on bank is often calculated on a discount basis.

3. Interest with Compensating Balances: Occasionally, bank loans require the firm to maintain some amount on balance at the bank, which is called as Compensating Balance.

The reason is that borrower must pay interest on full amount borrowed but has access only part of the funds.

In each case; the face value of the interest has to be converted to effective interest rate in order to learn the actual burden on the loan.

CASH & INVENTORY MANAGEMENT

Cash Collection; Disbursement & Float

Cash & Inventory Management

Company’s Ledger Balance800,000

Payment Float200,000

Banks Ledger Balance1,000,000

+

PAYMENT FLOAT: Checks written by a company that have not yet cleared.

Available Balance1,000,000

Availability Float120,000

Banks Ledger Balance1,120,000

+

AVAILABILITY FLOAT: Checks already deposited that have been cleared

NET FLOAT: Difference between Payment & Availability Float

NET FLOAT = 200,000 - 120,000 = 80,000

Valuing Float:

Float results from delay between your writing a check and the reduction in your bank balance.

The amounf depends on the size of check & delay in collection.

Playing the float: To hold more funds in interest earning accounts!..

Delays that help the payer hurt the receipent.Receipents try to speed up collections.Payers try to slow down disbursements.

Both attempt to minimize NET FLOAT

Managing Float

Check Mailed

Mail Float

Check Received

Processing Float

Check Deposited

Check Available to receipent Check charged to payer’s account

Check clears Check clears

Receipents see delays a availability

float

Payers see delays as

payment float

Concentration Banking:System whereby customers make payments to a regional collection center

which transfers funds to a principal bank.

SPEEDING UP COLLECTIONS

Lock-box system:System whereby customers make send payments to a post office box and

a local bank collects and processes checks.

Controlling DisbursementsSpeeding up collections is not only way to increase the net float.

You can also do this by slowing down disbursements.•Increase Mail Time

•Remote Disbursement•Zero Balance Account:

(Regional Bank Account to which just enough funds are transferred daily to pay each day’s bills)

•Electronic Fund Transfer(About %14 of business to business payments, especially big companies use electronic payments)

•ACH (Automated Clearing House) : (Bulk payments such as wages; dividends; payments to suppliers travel through ACH)

(ACH is easy, transaction costs are very low, float is drastically reduced.)

Cash Management involves a Trade-offIf the cash is invested in securities, it would earn interest.

On the other hand, you can’t use securities everytime to pay firm’s bills.If you had to sell those securities everytime you needed to pay a bill,

you would incur heavy transaction costs.

The art of cash management is to balance these costs and benefits!..

INVENTORIES & CASH MANAGEMENT

Managing InventoriesTotal Costs = Order Costs + Carrying Costs

When Orders increases; Order costs increases but Carrying costs decreases

0

10

20

30

40

50

60

70

80

1 2 3 4 5 6 7 8 9 10Number of Orders

Total Costs

Carrying Costs

Order Costs

Level Orders

Carrying costs3 TL

Order costs 3 TL Total

24 1 72 3 75

12 2 36 6 42

8 3 24 9 33

6 4 18 12 30

4,8 5 14,4 15 29,4

4 6 12 18 30

3,4 7 10,3 21 31,3

3 8 9 24 33

2,7 9 8 27 35

2,4 10 7,2 30 37,2

ECONOMIC ORDER QUANTIY = Order size that minimizes total inventory costs!...= [ ( 2 * Annual Sales * Cost Per Order * ) / Carrying Costs ]^(1/2)

Cash Management involves a Trade-offIf the cash is invested in securities, it would earn interest.

On the other hand, you can’t use securities everytime to pay firm’s bills.If you had to sell those securities everytime you needed to pay a bill,

you would incur heavy transaction costs.

The art of cash management is to balance these costs and benefits!..

INVENTORIES & CASH MANAGEMENT

Managing Inventories of CashSimple Inventory Models can tell us something about the management of Cash Balances

Total Costs = Cost of per sale of securities + Interest rates

INITIAL CASH BALANCE = [ ( 2 * Annual Cash Outflows * Cost Per Sale of Securities ) / Interest Rates ]^(1/2)

Basic Trade-offs of Cash Management

•When the cost of selling securities is high, you should hold larger average cash balances

•When interest rates are high, you should hold smaller cash balances

•When annual cash outflows increase, the optimal level of cash incresases less than

proportionally

Uncertain Cash FlowsIf cash flows are unpredictable, the cash balance should be allowed to

meander until it hits an upper or lower limit.

Upper Limit

Return Point

Lower Limit

At this point the firm buys or sells securities to restore the balance to the return point.The lower limit plus one-third of the spread between the upper and lower limits.

Time

Cash

Balance

Money Market:

Market for short-term financial assets.

Only fixed income securities with maturities less than ONE year!...

These securities are highly marketable or liquid.

INVESTING IDLE CASH

Managing Inventories of CashSimple Inventory Models can tell us something about the management of Cash Balances

Total Costs = Cost of per sale of securities + Interest rates

MAIN TYPES OF MONEY MARKET SECURITIES

COMMERCIAL PAPER: Registrated by SEC with maturities of less than 2 months

CERTIFICATES OF DEPOSIT: CDs are time deposits at bank, usually in denominations

greater than $ 100,000

REPURCHASE AGGREEMENTS : Repos, repurchase aggreements are in effect

collateralized loans and are usually very short-term, with maturities of only a few days.

CREDIT MANAGEMENT & BANKRUPTCY

TERMS OF SALECredıt, discount, and payment terms offered on a sale

In many cases payment is not made after delivery, so the buyer receives CREDIT

To encourage the customer to pay before final date, a cash discount is offered for prompt settlement!.. And this is expressed as

5 / 10; net 30

% discount for early payment

Number of days that discount is available

Number of days before payment is due

Depending these conditions customer receives 5% discount for a payment within 10 days, or else must pay in full within 30 days!



CREDIT AGGREEMENTSOpen account: Aggreement whereby sales are made with no formal debt contract!..

Commercial Draft: jargon for an order to payThe seller prepares a draft ordering payment by the customer and sends this draft to customer’s bank.

For immediate payment it is called as “sight draft”For delay payment it is called as “time draft”

The customer tells the bank to pay and acknowledges “accepted” and “signature”When accepted a time draft is like postdated check and is called a “trade acceptance”

This trade acceptance is forwarded to the seller, who holds it until the payment becomes due!..In case of suspicion seller ask the customer to organize the bank whether to accept the time draft.

If the bank guarantees then is called as “banker’s acceptance”Banker’s acceptances are actively bought and sold in money market.

Conditional sale: to avoid any unfortunate situations; the ownership of the goods

remains with the seller until full payment is made!...


CREDIT ANALYSISProcedure to determine the likelihood a customer will pay its bills !..

To carry out Credit Analysis:•Promptly payments in the past (be aware of the high credit limit for small payments!)•Rating Services (customer!s full credit report upon request)•The other firms’ experience•Your Bank•For public companies cheque Moody’s or S&Poors•Customer’s Stock Price

Financial Ratio Analysis

Numerical Credit Scoring (Analyzing credit risk is like a detective work)•The Customer’s character•The Customer’s capacity to pay•The Customer’s capital•The Collateral provided by customer•The Condition of customer’s business

•Z Score: A discriminant analysis at distinguishing bankrupt and nonbankrupt firms.If Z < 2,7 bankrupt possibility is 94%If Z > 2,7 nonbankrupt possibility is 97%CREDIT ANALYSIS IS WORTHWHİLE ONLY IF THE EXPECTED SAVINGS

EXCEED THE COST!...


CREDIT DECISIONThe decision to offer credit depends on the probability of payment!..

You should grant credit if the expected profit from doing so is greater than the profit from refusing!...

Credit Policy: Standarts set to determine the amount and nature of credit to extend to customers.

Offer Credit

Refuse Credit

Customer pays (p)

Customer defaults (1 - p)

REVENUES - COST

- COST

Refuse Credit : 0

Grant Credit : [p * PV(REVENUES – COST)] – [(1 - p) * PV ( COST)] if positive!...

If one sale may lead to profitable repeat sales, the firm should be inclined to grant credit on the initial purchase.


Some General Principles:•Maximize Profit: Main job is not to minimize the bad accounts; it is to maximize PROFITS!

•Concentrate on the dangerous accounts: Set credit limits for each customer and WHEN THE

CUSTOMER EXCEEDS TAKE CARE!•Look beyond the immediate order: Sometimes take care the growth in sales in the LONG-RUN.

Collection Policy:•Procedures to collect and monitor receivables.

Account Receivable = Daily Sales X Average Collection PeriodWhen customers stretch payables you end up a longer collection period!..

Never forget the formula and establish a COLLECTION POLICY:

Aging Schedule:•Classification of accounts receivable by time outstanding!

Customer’s Name 1 month 1-2 months 2-3 months 3 months over TOTAL

A $10,000 $ 10,000B $ 8,000 $3,000 $ 11,000...Z $ 15,000 $ 15,000TOTAL $ 18,000 $ 3,000 $ 15,000 $ 36,000

Good collection policy balances conflicting goals. The company wants cordial relations with customers and also wants them to pay the bills on time!...


BANKRUPTCY: •The reorganization or liquidation of a firm that can not pay its

debts.

WORKOUT: • Agreement between a company and its creditors establishing the steps

the company must take to avoid bankruptcy.• The advantage of a negotiated agreement is that the costs and delays of

formal bankruptcy are avoided.• If the firm cannot get an agreement, then it may have no alternative but

to file for bankruptcy. Then the firm’s assets are liquidated - that is, sold –

and the proceeds are used to pay creditors. LIQUIDATION: Sale of bankrupt firm’s assets.

• Priorities:

1. No firm in bankruptcy proceedings could not continue to operate

2. Wages and employee benefits

3. Taxes and other governmental debts

4. Unsecured bonds


REORGANIZATION •Restructruring of financial claims on falling firm to allow it to keep operating. It is an

alternative for liquidation!...

THE REORGANIZATION PLAN•To design a new capital structure for the firm to satisfy the creditors•Allow the firm to solve the business problems

The reorganization plan goes into effect if it is accepted by creditors and confirmed by

the court!..

CLEARING INFLATIONARY EFFECTS

ON FINANCIAL STATEMENTS


INFLATIONThe continous increase in the general level of prices

Inflation distorts the historical data on financial statements

Inflation causes the asset values to be seen higher than they have in fact!...For Example : Stocks; although the same quantity exists; monetary value seems higher

SO IT IS UNAVOIDABLE TO CLEAR UP INFLATIONARY EFFECTS.

There are two basic approach •General Price Level (GPL)

•Current Replacement Cost (CRC)

•General Price Level (GPL): •To correct the historical data by using an appropriate INDEX

Corrected Value = Historical Value X [ Index Value at the end ]Index Value at the beginning

Before correction it is needed to determine the inflationary effect on each financial item!...


Items of Fin. Stat. Monetary Non -MonetaryCash X

Bonds & Similiars X

Stocks & Similiars X

Recivables X

Inventory X

Fixed Assets & Accumulated Depreciation X

Short & Long-Term Debts X

Sales and all revenue accounts X

COGS and all expense accounts X

Retained Earnings X

Generally it can be said; Cash & Cash equivalents; receivables and payables are monetary and the other s are non-monetary

The correction of inflationary effects on financial statements depends on the power of choosen INDEX.

CLEARING INFLATIONARY EFFECTS (EXAMPLE)

BALANCE SHEET FOR XYZ CORPORATION (31,12,2002) 2002 Type of Item Cleared Value

Current Assets 3.000

Cash 500,00 Monetary 500,00

Receivables 1000,00 Monetary 1.000,00

Inventories 1500,00 Non-monetary X 150/125 1.800,00

Net Fixed Assets 2700,00

Gross Machinery 3000,00 Non-monetary X 150/100 4.500,00

(-) Acc. Depreciation 300,00 Non-monetary X 150/100 450,00

TOTAL ASSETS 5700,00 7.350,00

Current Liabilities 1200,00

Acc. Payable 200,00 Monetary 200,00

Notes Payable 1000,00 Monetary 1.000,00

Long-term Debt 0,00

Shareholders' equity 4000,00 Non-monetary X 150/100 6.000,00

Retained Earnings 500,00 150,00

TOTAL LIABILITIES & SHAREHOLDER'S EQUITY 5700,00 7.350,00


INCOME STATEMENT FOR THE YEAR OF 2002

Net Sales 4500,00 Non-monetary X 150/125 5.400,00

Cost of Goods Sold 3000,00 Non-monetary X 150/125 3.600,00

Sales & Administrative Expenses 400,00 Non-monetary X 150/125 480,00

Depreciation 300,00 Non-monetary X 150/100 450,00

Taxable Income 800,00 Non-monetary X 150/125 870,00

Taxes 100,00 Non-monetary X 150/125 120,00

Inflationary Loss 360,00

Net Income 700,00 390,00

Dividends 200,00 Non-monetary X 150/125 240,00

To Retained Earnings 500,00 150,00

Inflation Index

31,12,2001 100

31,12,2002 150

Average for 2002 125


Calculation of Inflationary LossHistorical Data Total Transaction

Corrected Value Difference

Cash at the beginning 2200,00 X150/100 3300,00

Cash Inputs 3500,00 X150/125 4200,00

Sales 4500,00

Receivables 1000,00

Cash Outputs 5200,00 X150/125 6240,00

Cost of Goods Sold 3000,00

Inventory 1500,00

Sales & Adm. Expenses 400,00

Taxes 100,00

Dividends 200,00

Cash at the end 500,00 1260,00 760,00

Receivables 1000,00 X150/125 1200,00 200,00

Acc. Payable 200,00 X150/100 300,00 100,00

Notes Payable 1000,00 X150/100 1500,00 500,00

TOTAL (Inflation Loss) 360,00

WORKING CAPITAL MANAGEMENT. Current Assets & Current Liabilities are collectively known as WORKING CAPITAL Components of Working Capital Accounts Receivable:

Documents

cash receivables

cash shortage

sources of cash

working capital slide

cash nwc cash budgeting

cash alerts

uses of cash slide

current assets shortage