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1 Chapter 8: Introduction to Working Capital Management Session 4, Module Three: Working Capital Management v Association for Financial Professionals. All rights reserved. Session 4: Module 3, Chapter 8-1

2 Chapter 8: Introduction to Working Capital Management Outline: Overview of Working Capital The Working Capital CCC How Changes in Current Accounts Impact External Financing Working Capital Investment and Financing Strategies Management of Credit and A/R Management of Inventory Management of A/P Multi-National Working Capital Management Tools v Association for Financial Professionals. All rights reserved. Session 4: Module 3, Chapter 8-2

The Cash Conversion of a Business **this is a slide from old AFP materials, and not in your books v3.

Operating Cash Flows Cash inflows (various sources) $ Concentration/ $ funding flows Cash outflows (disbursements) $ Surplus Suitable investments Pay down debt

5 Operating Cash Flows Cash inflows (various sources) $ Concentration/ $ funding flows Cash outflows (disbursements) $ Surplus Suitable investments Pay down debt Liquidity management flows Shortage Sell investments Draw on debt v Association for Financial Professionals. All rights reserved. Session 4: Module 3, Chapter 8-5

6 Purchase-to-Pay Timeline Source Suppliers Select Supplier and Goods Negotiate Payment Terms Arrange Credit Send PO Receive Goods and Invoice Send Payment Reconcile and Account Analyze and Review v Association for Financial Professionals. All rights reserved. Session 4: Module 3, Chapter 8-6

Reconcile and Account Analyze and Review Working Capital v4.

7 Order-to-Cash Timeline Source Customers Quote Price Negotiate Sales Terms Manage Credit Receive PO Ship Goods and Send Invoice Receive Payment Reconcile and Account Analyze and Review Working Capital v Association for Financial Professionals. All rights reserved. Session 4: Module 3, Chapter 8-7

Collection & Application Invoicing Float 40+ days Payment Float 30+ days Disbursement/ Collection Float 1 5

8 Float Timeline Purchases Invoice Received Invoice Paid Payment Posted Entry Ship Invoice Prep Invoice Sent Payable Policy Check Prep Delays Mail Process Availability Order & Invoice Preparation Credit Period Payment Collection & Application Invoicing Float 40+ days Payment Float 30+ days Disbursement/ Collection Float 1 5 days v Association for Financial Professionals. All rights reserved. Session 4: Module 3, Chapter 8-8

Benefits of Float Reduction Sell and Collect Purchase and Build Payment timing changes Price changes (discount offer) Seller adjusts timing (i.e., value date) of payment Seller offers buyer a cash discount for earlier payment v4.

10 Benefits of Float Reduction Sell and Collect Purchase and Build Payment timing changes Price changes (discount offer) Seller adjusts timing (i.e., value date) of payment Seller offers buyer a cash discount for earlier payment v Association for Financial Professionals. All rights reserved. Session 4: Module 3, Chapter 8-10

11 Float Neutral Calculation Discount approach r = 12% TD = 3 days Where: TD = Total days difference between check and electronic payments r = Opportunity cost as annual rate 1 Discount = 1 r 1 + TD = 1 12% = 1 = = = (Rounded) or 0.10% v Association for Financial Professionals. All rights reserved. Session 4: Module 3, Chapter 8-11

12 Elements of Cash Flow Purchase Raw Materials Store and Produce Goods Sell Goods Collect Cash Pay Supplier Cash Conversion Cycle Elapsed Days Holding Period (Inventory Days) Conversion Payment Period + = Period (A/R Days) (A/P Days) Cash Flow Timing Difference v Association for Financial Professionals. All rights reserved. Session 4: Module 3, Chapter 8-12

13 Discussion Question What is a company s CCC and cash turnover given the following? Days inventory = 45 Days receivables = 35 Days payables = 30 a) 50 days; 6.6 times b) 50 days; 7.3 times c) 55 days; 6.6 times d) 55 days; 7.3 times v Association for Financial Professionals. All rights reserved. Session 4: Module 3, Chapter 8-13

14 Discussion Question What is a company s CCC and cash turnover given the following? Days inventory = 45 a) 50 days; 6.6 times Days receivables = 35 b) 50 days; 7.3 times Days payables = 30 c) 55 days; 6.6 times d) 55 days; 7.3 times Answer : b (p.3-20) CCC = Days' Inventory + Days' Receiveables Days' Payables CCC = = 50 days Cash Turnover = = = 7.3 Times CCC 50 v Association for Financial Professionals. All rights reserved. Session 4: Module 3, Chapter 8-14

15 Cash Flow Timeline and Opportunity Cost Short-Term Borrowing Rate Net borrower Prefer stable rate WACC Short-Term Investing Rate Net investor (must sell short-term investments) v Association for Financial Professionals. All rights reserved. Session 4: Module 3, Chapter 8-15

17 Treasury versus Credit Management Credit management Treasury separate but must maintain relationship Credit is sales tool Credit standards Credit extension terms and approvals Set individual/aggregate credit limits A/R management Credit manager responsibility Billing Remittance Monitor payment patterns Collect delinquent v Association for Financial Professionals. All rights reserved. Session 4: Module 3, Chapter 8-17

20 Credit Terms and Customer Discounts Credit limits Penalty fees Discount eligibility Aggregate credit amount per customer Lowest limit for new customers Review payment patterns and adjust Percentage of amount past due Clearly state and disclose on invoice Benchmark eligibility date Date funds received/postmarked v Association for Financial Professionals. All rights reserved. Session 4: Module 3, Chapter 8-20

22 Common Terms of Sale Cash before delivery (CBD) Cash on delivery (COD) Cash terms Net terms Discount terms Monthly billing Draft/bill of lading Seasonal dating Consignment v Association for Financial Professionals. All rights reserved. Session 4: Module 3, Chapter 8-22

Sales Discounting Gross Method method Net method Gross revenues: on income statement and in receivables Discounts: as expense Net revenues: on income

23 Sales Discounting Gross Method method Net method Gross revenues: on income statement and in receivables Discounts: as expense Net revenues: on income statement and in receivables Discounts not taken: as income v Association for Financial Professionals. All rights reserved. Session 4: Module 3, Chapter 8-23

Financing Accounts Receivable Unsecured borrowing Asset-based lending Securitization Captive finance company Third-party financing B2B credit

24 Financing Accounts Receivable Unsecured borrowing Asset-based lending Securitization Captive finance company Third-party financing B2B credit cards Factoring Private-label financing v Association for Financial Professionals. All rights reserved. Session 4: Module 3, Chapter 8-24

25 Elements of Basic Inventory Policy Why companies hold inventory Goods for expected sales Precautionary, speculative or supplier requirements Types of inventory Raw materials, WIP, finished goods, scrap or obsolete items, and stores and supplies Levels of inventory Obsolescence and spoilage Benefits and costs of inventory v Association for Financial Professionals. All rights reserved. Session 4: Module 3, Chapter 8-25

26 Levels of Inventory JIT Inventory Reduce underlying costs or uncertainties Liability, not asset Excess inventory Undesirable Poor planning, location or movement Poor supplier quality Production imbalance With MPS Retailers link to POS Supplier-Managed Supplier maintains tracks, replenishes Paid-on-production Usage, not shipment v Association for Financial Professionals. All rights reserved. Session 4: Module 3, Chapter 8-26

27 Discussion Question In addition to verifying incoming payments and authorizing payments, vouchering has a threeway match of an invoice against what? a) Inventory level and payment receipt b) Inventory level and receiving or shipping information c) Approved PO and payment receipt d) Approved PO and receiving or shipping information v Association for Financial Professionals. All rights reserved. Session 4: Module 3, Chapter 8-27

Discussion Question In addition to verifying incoming payments and authorizing payments, vouchering has a threeway match of an invoice against what?

28 Discussion Question In addition to verifying incoming payments and authorizing payments, vouchering has a threeway match of an invoice against what? a) Inventory level and payment receipt b) Inventory level and receiving or shipping information c) Approved PO and payment receipt d) Approved PO and receiving or shipping information Answer: d (p.3-51) v Association for Financial Professionals. All rights reserved. Session 4: Module 3, Chapter 8-28

29 A/P and Disbursement Systems Advantages Control Centralized General and cash position info. Forecast accuracy Decentralized Field autonomy Relationships Access to short discount terms Disadvantages Payee relations Coordination Payment disputes Info. control Concentration, etc. Unauthorized disbursement Redundant v Association for Financial Professionals. All rights reserved. Session 4: Module 3, Chapter 8-29

Decentralized A/P, Centralized Disbursements with Clearing Actual disbursements No excess balance European Region North American Region South American Region Seems

30 Decentralized A/P, Centralized Disbursements with Clearing Actual disbursements No excess balance European Region North American Region South American Region Seems local Oversight Invoices, A/P Enterprise Software Authorize payments v Association for Financial Professionals. All rights reserved. Session 4: Module 3, Chapter 8-30

treasury management center does FX conversions Net difference transferred Pay/receive net amount in own

31 Types of Netting Bilateral Two subsidiaries purchases periodically netted Payments converted to common currency Multilateral Multiple subsidiaries Payments converted to common currency Payments combined Central treasury management center does FX conversions Net difference transferred Pay/receive net amount in own currency v Association for Financial Professionals. All rights reserved. Session 4: Module 3, Chapter 8-31

34 Re-Invoicing Company-owned subsidiary Title and funds in subsidiary s currency Buys goods from exporting subsidiary Sells goods to importing subsidiary Actual shipment v Association for Financial Professionals. All rights reserved. Session 4: Module 3, Chapter 8-34

38 Key Concepts Cash Conversion Cycle, Cash Turnover Timelines (purchase to pay, order to cash, collection to cash) Floats, floats and more floats! Float reduction, float neutral calculation Opportunity cost (and related calculations) Current Asset investment & financing Cash Flow components/how to optimize

39 Key Concepts Trade Credit & Credit Policies Terms of Sale/Financing A/R Inventory Policies & Inventory Management Centralized vs Decentralized A/P Netting and Reinvoicing Multicurrency Accts Export Financing

WORKING CAPITAL MANAGMENT

WORKING CAPITAL MANAGMENT 1. Working capital Working capital: short-term (current) assets and liabilities. current assets accounts receivable: trade credit + consumer credit; inventory: raw materials,