chap 017
TRANSCRIPT
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17-1Copyright © 2011 by the McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin
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Key Concepts and Skills
Understand – How firms manage cash and various
collection, concentration, and disbursement techniques
– How to manage receivables, and the basic components of credit policy
– Various inventory types, different inventory management systems, and what determines the optimal inventory level
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Chapter Outline
17.1 Float and Cash Management
17.2 Cash Management: Collection, Disbursement, and Investment
17.3 Credit and Receivables
17.4 Inventory Management
17.5 Inventory Management Techniques
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Reasons for Holding CashJohn Maynard Keynes
• Speculative motive = take advantage of unexpected opportunities
• Precautionary motive = in case of emergencies
• Transaction motive = to pay day-to-day bills
• Trade-off: opportunity cost of holding cash vs. transaction cost of converting
marketable securities to cash
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Understanding Float• Float = difference between cash balance
recorded in the cash account and the cash balance recorded at the bank
• Disbursement float– Generated when a firm writes checks– Available balance at bank – book balance > 0
• Collection float– Checks received increase book balance before
the bank credits the account– Available balance at bank – book balance < 0
• Net float = disbursement float + collection floatReturn to Quick Quiz
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Managing Float
• Management concern = net float and available balance
• Collections and disbursement times
1. Mailing time
2. Processing delay
3. Availability delay
To speed collections, decrease one or more
To slow disbursements, increase one or more
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Float Issues
• “Kiting”– Systematic overdrafting – Writing checks for no economic reason other
than to exploit float
• Electronic Data Interchange & Check 21– EDI = direct, electronic information exchange– Check 21 = bank receiving a customer check
may transmit an electronic image and receive immediate payment
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Example: Types of Float
• You have $3,000 in your checking account. You just deposited $2,000 and wrote a check for $2,500.– What is the disbursement float?– What is the collection float?– What is the net float?– What is your book balance?– What is your available balance?
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Cash Collection
Payment Payment Payment CashMailed Received Deposited Available
Mailing Time Processing Delay Availability Delay
Collection Delay
Float management goal = reduce collection delay
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Cash Collection
• “Over-the-counter-collection”– Point of sale collection
• Preauthorized payment system– Payment amount and dates fixed in advance– Payments automatically transferred
• Payments via mailed checks– One mailing address– Various collection points
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Lockboxes & Cash Concentration
• Customer checks mailed to a P.O box• Local bank picks up checks several times each
day– Lockbox maintained by local bank– Checks deposited to firm’s account
• Firms may have many lockbox arrangements around the country– Funds end up in multiple accounts
• Cash concentration = procedure to gather funds into firm’s main accounts
• Reduces mailing and processing times
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Overview of Lockbox ProcessingFigure 17.1
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Lockboxes and Cash Concentration
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Cash Disbursements
• Disbursement float = desirable
• Slowing down payments can increase disbursement float – Mail checks from distant bank or post office– May not be ethical or optimal
• Controlling disbursements– Zero-balance account– Controlled disbursement account
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Zero-balance Accounts
• Firm maintains– A master bank account– Several subaccounts
• Bank automatically transfers funds from main account to subaccount as checks presented for payment
• Requires safety stock buffer in main account only
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Zero-balance AccountsFigure 17.3
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Investing Idle Cash• Money market = financial instruments
with original maturity ≤ one year
• Temporary Cash Surpluses– Seasonal or cyclical activities
• Buy marketable securities with seasonal surpluses
• Convert back to cash when deficits occur
– Planned or possible expenditures• Accumulate marketable securities in
anticipation of upcoming expenses
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Seasonal Cash DemandsFigure 17.4
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Characteristics of Short-Term Securities
• Maturity – firms often limit the maturity of short-term investments to 90 days to avoid loss of principal due to changing interest rates
• Default risk – avoid investing in marketable securities with significant default risk
• Marketability – ease of converting to cash
• Taxability – consider different tax characteristics when making a decision
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Credit Management: Key Issues
• Granting credit increases sales
• Costs of granting credit– Chance that customers won’t pay– Financing receivables
• Credit management = trade-off between increased sales and the costs of
granting credit
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Cash Flows from Granting Credit
Credit Sale Check Mailed Check Deposited Cash Available
Cash Collection
Accounts Receivable
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Components of Credit Policy
• Terms of sale – Credit period (usually 30-120 days)– Cash discount and discount period– Type of credit instrument
• Credit analysis – Distinguishing between “good” customers that
will pay and “bad” customers that will default
• Collection policy – Effort expended on collecting receivables
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Credit Period Determinants
Factor Effect on Credit Period
1. Perishable goods with low collateral value
credit period
2. Low consumer demand credit period
3. Low cost, low profitability, and
high standardization
credit period
4. High credit risk credit period
5. Small account size credit period
6. Competition credit period
7. Customer type Varied
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Terms of Sale
• Basic Form: 2/10 net 45– 2% discount if paid in 10 days– Total amount due in 45 days if discount is not
taken
• Buy $500 worth of merchandise with the credit terms given above– Pay $500(1 - .02) = $490 if you pay in 10 days– Pay $500 if you pay in 45 days
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Example: Cash Discounts
• Finding the implied interest rate when customers do not take the discount
• Credit terms of 2/10 net 45 and $500 loan– $10 interest (= .02*500)– Period rate = 10 / 490 = 2.0408%– Period = (45 – 10) = 35 days– 365 / 35 = 10.4286 periods per year
• EAR = (1.020408)10.4286 – 1 = 23.45%• The company benefits when customers choose
to forgo discounts
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Credit Instruments
• Basic evidence of indebtedness
• Open account– Most basic form– Invoice only
• Promissory Note– Basic IOU– Not common– Signed after goods delivered
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Credit InstrumentsCommercial Draft
• Sight draft = immediate payment required
• Time draft = not immediate
• When draft presented, buyer “accepts” it– Indicates promise to pay– “Trade acceptance”
• Seller may keep or sell acceptance
• Banker’s acceptance = bank guarantees payment
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Optimal Credit Policy• Carrying costs
– Required return on receivables– Losses from bad debts– Cost of managing credit & collections
• If restrictive credit policy:– Carrying costs low– Credit shortage = opportunity costs
• More liberal credit policy likely if:– Excess capacity– Low variable operating costs– Repeat customers
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Optimal Credit PolicyFigure 17.5
Amount of credit extended ($)
Cost ($)
Carrying Cost
Opportunity costs
Optimal amount of
credit
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Credit Analysis
• Process of deciding which customers receive credit
• Credit information– Financial statements– Credit reports/past payment history– Banks– Payment history with the firm
• Determining creditworthiness– 5 Cs of Credit– Credit Scoring Return to
Quick Quiz
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Five Cs of Credit
• Character = willingness to meet financial obligations
• Capacity = ability to meet financial obligations out of operating cash flows
• Capital = financial reserves• Collateral = assets pledged as security• Conditions = general economic
conditions related to customer’s business
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Collection Policy
• Monitoring receivables– Watch average collection period relative to
firm’s credit terms– Use aging schedule to monitor percentage
of overdue payments
• Collection policy– Delinquency letter– Telephone call– Collection agency– Legal action
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Inventory Management
• Inventory = large percentage of firm assets
• Inventory costs:– Cost of carrying too much inventory– Cost of not carrying enough inventory
• Inventory management objective = find the optimal trade-off between carrying too much inventory versus not enough
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Types of Inventory
• Manufacturing firm– Raw material – production starting point – Work-in-progress– Finished goods – ready to ship or sell
• One firm’s “raw material” = another’s “finished good”
• Derived vs. Independent demand• Different types of inventory vary
dramatically in terms of liquidity
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Inventory Costs
• Carrying costs = 20–40% of inventory value per year– Storage and tracking– Insurance and taxes– Losses due to obsolescence,
deterioration, or theft– Opportunity cost of capital
• Shortage costs– Restocking costs– Lost sales or lost customers
Return to Quick Quiz
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Inventory Management
• Classify inventory by cost, demand, and need– Maintain larger quantities of items that
have substantial shortage costs
– Maintain smaller quantities of expensive items
– Maintain a substantial supply of less expensive basic materials
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EOQ Model
• EOQ = Economic Order Quantity
• EOQ minimizes total inventory cost
• Q = inventory quantity in each orderQ/2 = Average inventory
• T = firm’s total unit sales per yearT/Q = number of orders per year
• CC = Inventory carrying cost per unit
• F = Fixed cost per order
Return to Quick Quiz
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EOQ Model
• Total carrying cost = (Average inventory) x (Carrying cost per unit)
= (Q/2)(CC)
• Total restocking cost
= (Fixed cost per order) x (Number of orders)
= F(T/Q)
• Total Cost = Total carrying cost + Total restocking cost
= (Q/2)(CC) + F(T/Q)
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EOQ Model
• Total Cost = Total carrying cost + Total restocking cost
= (Q/2)(CC) + F(T/Q)
• Q* Carrying costs = Restocking costs
(Q*/2)(CC) = F(T/Q*)
CC
TF2Q *
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Example: EOQ
• Consider an inventory item that has carrying cost = $1.50 per unit. The fixed order cost is $50 per order and the firm sells 100,000 units per year.– What is the economic order quantity?
582,250.1
)50)(000,100(2* Q
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Extensions to EOQ
• Safety stocks– Minimum level of inventory kept on
hand
– Increases carrying costs
• Reorder points– Inventory level at which you place an
order to account for delivery time
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Derived-Demand Inventories
• Materials Requirements Planning (MRP)– Computer-based ordering/scheduling – Works backwards from set finished goods
level to establish levels of work-in-progress required
• Just-in-Time Inventory– Reorder and restock frequently– Japanese system
• Keiretsu = industrial group• Kanban = card signaling reorder time
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Quick Quiz
1. What is the difference between disbursement float and collection float? (Slide 17.5)
2. What is credit analysis and why is it important? (Slide 17.30)
3. What are the two main categories of inventory costs? (Slide 17.35)
4. What components are required to determine the economic order quantity? (Slide 17.37)
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Chapter 17
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