WORKING CAPITAL MANAGMENT

Transcription

1 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, work in process, and finished goods; cash: bank deposits (demand and time); marketable securities: commercial paper, T-bills, short-term municipal bonds. current liabilities accounts payable; short-term debt; Net working capital = current assets - current liabilities (usually positive); 1

2 Cash conversion cycle: period between payment for materials and collection on sales Cash Conversion Cycle Inventory period Accounts payable period Accounts receivable period Raw materials purchased Cash is paid to retire A/P Finished goods sold on credit Cash received on A/R $ out $ in cash conversion cycle = inventory period + receivables period - payables period inventory period = average inventory / (annual cost of goods sold / 365) A/R period = average A/R / (annual sales / 365) A/P period = average A/P / (annual cost of goods sold / 365) Example: Income Statement Data Balance Sheet Data Beginning of Year End of Year Sales $3,014 Inventory $371 $376 Cost of goods sold 2,712 Accounts receivable Accounts payable inventory period = ( ) / 2 = 50.3 days 2712 / 365 receivables period = ( ) / 2 = 44.1 days 3014 / 365 payables period = ( ) / 2 = 29.5 days 2712 / 365 cash cycle = inv. period + A/R period - A/P period = =

3 Suppose XYZ Corporation has an average age of inventory of 80 days, average collection period of 70 days, and an average payment period of 60 days. Its estimated annual cash outlays for operations is $180,000,000. a. Calculate the firm s cash cycle b. Calculate the firm s cash turnover. c. Calculate the firm s minimum operating cash. 2. Managing Working Capital Carrying costs: costs of maintaining current assets. opportunity cost of capital; inventory storage and insurance costs; Shortening the cash conversion cycle would reduce the carrying costs. How can a manager shorten the cash cycle? Produce goods as fast as possible and minimize the amounts of raw materials and finished goods in warehouse (but you may run out of inventory). inventory period Collect A/R as fast as possible (but you may lose customers and your sales may be hurt) A/R period Wait as long as possible to pay (but this may hurt your credit) A/P period Shortage costs: costs incurred from shortages in current assets. Working capital management: maintaining optimal amounts of working capital. 3

4 Assume that the above company has an opportunity cost of capital of 14% and decided that : a. increase its payable by 10 days. b. decrease its collection by 15 days. c. decrease its average age of inventory to 60 days. Calculate the company s annual savings. 4

5 CASH MANAGEMENT 1. Float payment float: checks written by a company that have not yet cleared. Example: United Carbon has $1MM in a checking account with its bank. It now pays one of its suppliers by writing and mailing a check for $200,000. Cash Balance before mailing after mailing but before clearing after clearing United s ledger balance $1,000,000 $800,000 $800,000 Bank s ledger balance $1,000,000 $1,000,000 $800,000 Payment float $200,000 availability float: checks already deposited that have not yet cleared. Example: customer. Suppose that the United Carbon receives a check for $120,000 from a before depositing Cash Balance after depositing but before clearing after clearing United s ledger balance $1,000,000 $1,120,000 $1,120,000 Bank s ledger balance $1,000,000 $1,120,000 $1,120,000 Available balance $1,000,000 $1,120,000 Availability float $120,000 If both cases occur simultaneously, Net float = payment float - availability float = 200, ,000 = $80,000 5

6 Suppose your firm writes checks worth $6,000 per day to your suppliers. Suppose it takes 7 days before checks are cleared. What is your average payment float? Average payment float = 7 $6,000 = $42,000 Suppose you also receive checks worth $7,000 per day from your customers. It takes 5 days before checks are cleared. What is your average availability float? Average availability float = 5 $7,000 = $35,000 Calculate the net float. Net float = payment float - availability float = 42,000-35,000 = $7, Managing Float sources of float: check mailed recipient mail float payer sees check received sees delays as processing float same delays collection as payment float availability float presentation float float speeding up collections: concentration banking: customers make payments to a regional collection center which transfers funds to a principal bank. lock-box system: customers send payments to a post office box and a local bank collects and processes checks. controlling disbursements: remote disbursement: make payments by checks written on remote banks. zero-balance account: regional bank account to which just enough funds are transferred daily to pay each day s bills. 6

7 JAC cosmetics is considering opening a lock box in Pittsburgh. Checks cleared through the lock box will amount to $300,000 per month. The lock box will make cash available to the company 3 days earlier. suppose that the bank offers to run the lock box for a $20,000 compensating balance. Is the lock box worth while? average daily collection via lock box = $300,000 / 30 = $10,000 increase in cash available due to lock box = $10,000 3days =$30,000 net increase in cash available = $30,000 - $20,000 = $10,000 > 0 accept suppose that the bank offers to run the lock box for a fee of $0.10 per check cleared instead. What must the average check size be for the fee alternative to be less costly? Assume an interest rate of 6% per year. # of checks written per month = $300,000 / average check size monthly cost under check fee = $0.10 $300,000 / average check size monthly cost under compensating balance = $20,000 monthly interest = = $20,000 (0.06 / 12) = $100 cost under check fee cost under compensating balance if ,000 / average check size 100 average check size 30,000 / 100 = $300 Example: The XYZ Corporation is considering modification of its billing system to a lock box plan At present time it takes about six days for the customers payments to reach the company. Two additional days are required before deposit can be made. The firm has an average daily collection of $7,000,000 and it felt that the installment of the lack box plan will reduce total time of making and processing to 2.5 days if the short term interest rate is 7% and the lock box system will cost $500,000 to install. Find out: 1. How much reduction in each balance could be achieved through installation. 2. Should lock box be introduced? 7