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Current Asset Management(Chapter 7)

(Chapter 6 pages 143 145)

Working Capital Management

Current Asset Investment Policy

Temporary and Permanent

Current Assets

Zero Working Capital

Cash Management

Marketable Securities Accounts Receivable Management

Inventory Management

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Working Capital Management:An Overview

Gross Working Capital -(Current Assets)

New Working Capital - (Current Assets - CurrentLiabilities)

Working Capital Management Involves investing in current assets and financing

of current assets:

Current

Liabilities

Long-Term

Financing

Current AssetInvestment

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Current Asset Investment Policy

Everything else remaining the same, higher levelsof current assets mean lower risk and lowerexpected return

Lower Risk

Greater ability to meet short-run obligations. Lower Return

Cash and marketable securities typically yieldlow returns. Furthermore, when current assets

are increased, additional financing costs will beincurred thereby lowering returns.

Lower levels of current assets result in oppositeeffects.

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Alternative Current Asset Investment

Policies

0

2

4

6

8

10

12

14

0 10 20 30 40

Current Asset (millions of $)

Sales (millions of dollars)

Conservative - low risk

Aggressive - high risk

Moderate

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Temporary vs. Permanent Investment

in Current Assets Temporary Investment - Commonly, firms experience

short-run fluctuations in current assets. For example,retail department stores will have high levels of

inventory around Thanksgiving. In January, theinventory should be low.

Permanent Investment - Firms always have someminimum level of investment in current assets (i.e., apermanent investment). As a firm grows over time,

the level of permanent current assets also grows(e.g., a supermarket chain with 70 stores will havemore permanent inventory than a chain with 4stores).

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Temporary and Permanent Current

Assets

0

2

4

6

8

10

12

14

0 3 6 9 12 15 18 21

Millions of dollars

Time Period

Temporary Fluctuations in

Current Assets

Permanent Current Assets

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Cash Management: An Overview

Beginning Cash Balance+ Cash Inflows - - - Speed Up

- Cash Outflows - - - Slow Down

= Ending Cash Balance- Desired Cash Balance

= Surplus or Shortage

If Surplus: Pay off short-term debt or buy marketablesecurities

If Shortage: Short-term borrowing or sell marketablesecurities

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Desired Cash Balance:

Precautionary Demand - Satisfy possible, butas yet indefinite cash needs.

Speculative Demand - Build up current cashbalances in anticipation of future businesscosts being lower.

Risk Preferences

Compensating Balances

Transactions Demand - Cash needs arising inthe ordinary course of doing business.

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Float

Much of cash management is orientedtowards managing the float.

Mail Float

Time lapse from the moment a customermails a remittance check until the firmbegins to process it.

Processing Float

Time required for the firm to processremittance checks before they can bedeposited in the bank.

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Float (Continued)

Transit Float

Time necessary for a deposited check to

clear through the commercial bankingsystem and become usable funds to thecompany.

Disbursing Float

Funds available in the firms bank accountuntil its payment check has clearedthrough the system.

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Electronic Funds Transfer

Substantially reduces float

Some Examples:

Automated teller machinesDirect deposit of payroll checks

Paying the supermarket and others with

bank cards.

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Lock-Box System

Customers mail remittance checks toP.O. Box.

Local bank processes and deposits

checks directly into the companysaccount.

Reduces mail and processing float.

Also reduces transit float if lock-box islocated near Federal Reserve Bank orbranches.

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Marketable Securities

The marketable securities portfolio is typically usedfor temporary investments of excess cash, or as asubstitute for cash (i.e., near cash). Therefore,securities in the portfolio are generally safe, short-term, and highly liquid.

Treasury Bills Short-term obligations of the federal government

with maturities of 91 days to a year. They aretraded on a discount basis in bearer form. Nottaxable at state and local levels, but taxable at the

federal level. Commercial Paper

Unsecured promissory notes issued by largecorporations in amounts of $25,000 or more (No

active secondary market).

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Marketable Securities Continued

Negotiable Certificates of Deposit (CDs) Offered by financial institutions (e.g., banks,

S&Ls). Those big business is interested in have$100,000 minimums.

Bankers Acceptance: Generally arise out of foreigntrade.

Importer (buyer) issues a promise to pay a certainamount to the exporter (seller).

A bank accepts the promise, and commits itself to

pay the amount when due. Exporter (seller) can now sell this acceptance in

the marketplace at a discount (a price that is lessthan the promised amount).

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Accounts Receivable Management

Major Decisions

Credit Standards

Credit Terms

Collection Policy Credit Standards: Will they pay as agreed?

Credit Scoring

Credit Reports

Past Experience

Financial Analysis

Debt Ratios, Liquidity Ratios, Profit Ratios

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Inventory Management(Covered in Detail in Production

Management)

Basic Costs Associated With Inventory

Carrying Costs

storage, insurance, cost of capital used Ordering Costs

placing orders, shipping and handling

Costs of Running Short

lost sales, reduced customer goodwill

Objective

Minimize total costs associated with managinginventory.