Review of Working CapitalReview of Working Capital

Ch. 6Ch. 6

This is concerned with the financing and This is concerned with the financing and management of the current assets of the management of the current assets of the firm.firm.

Working CapitalWorking Capital

Short-term financing is generally less Short-term financing is generally less costly but more risky than long term costly but more risky than long term financing.financing.

Making a decision on financing can be Making a decision on financing can be done by computing the value of various done by computing the value of various financing plans and looking at the risks financing plans and looking at the risks and costs associated with eachand costs associated with each

Ultimate current asset composition and financing Ultimate current asset composition and financing decision should be consistent with firm’s goal of decision should be consistent with firm’s goal of maximizing owner’s wealthmaximizing owner’s wealthAggressive firm will borrow short term and carry Aggressive firm will borrow short term and carry high levels of inventoryhigh levels of inventoryConservative firm will maintain high liquidity and Conservative firm will maintain high liquidity and use long-term financinguse long-term financingChoice of financing will impact a firm’s earnings Choice of financing will impact a firm’s earnings after taxesafter taxes

PPT 7-1FIGURE 7-2Expandedcash flowcycle

Ch. 7Ch. 7

Finance managers try to maximize cash Finance managers try to maximize cash balances by speeding up inflows and balances by speeding up inflows and slowing down outflowsslowing down outflows

Can be done with a lockbox/collection Can be done with a lockbox/collection system, or EFTsystem, or EFT

A/RA/R

Managing accounts receivable is also Managing accounts receivable is also important.important.

A technique to help is to make sure the A technique to help is to make sure the average collection period is acceptable to average collection period is acceptable to the company.the company.

Aging of accounts also provides more in-Aging of accounts also provides more in-depth information.depth information.

A/RA/R

Managing accounts receivable also Managing accounts receivable also required setting credit policy. There are 5 required setting credit policy. There are 5 C’s to consider:C’s to consider:– CharacterCharacter– CapitalCapital– CapacityCapacity– ConditionsConditions– CollateralCollateral

A/RA/R

You can also offer a trade discount to You can also offer a trade discount to bring in receivables fasterbring in receivables faster

Managing Inventory is also important in Managing Inventory is also important in working capital managementworking capital management

Use the EOQ formula to determine optimal Use the EOQ formula to determine optimal order sizeorder size

Safety stock may also be added to the Safety stock may also be added to the EOQEOQ

Chapter 8Chapter 8

There are a number of places to find short There are a number of places to find short term funds for businessesterm funds for businessesCredit extended by supplies is a very Credit extended by supplies is a very popular source. This is called trade credit.popular source. This is called trade credit.Managing trade credit means calculating Managing trade credit means calculating the value of discounts offered to see if the value of discounts offered to see if they should be taken or passed up. This is they should be taken or passed up. This is the cost of not taking the discount. the cost of not taking the discount.

Banks are also a source of funding. Often Banks are also a source of funding. Often fees for services are waived or loans are fees for services are waived or loans are provided if a minimum balance is kept by provided if a minimum balance is kept by the company in the bank. This is called a the company in the bank. This is called a compensating balance. compensating balance.

Interests on loans may also be paid at the Interests on loans may also be paid at the beginning of the loan. This is called beginning of the loan. This is called discounting. discounting.

Both compensating balances and Both compensating balances and discounting affect the effective rate of discounting affect the effective rate of interest paid on a loan. interest paid on a loan.

The interest rate for the most credit-worthy The interest rate for the most credit-worthy borrowers is called the prime rate.borrowers is called the prime rate.

VocabularyVocabulary

permanent current permanent current assetsassets

trade credittrade credit

lock-boxlock-box

aging of accounts aging of accounts receivablereceivable

carrying costcarrying cost

credit termscredit terms

economic ordering economic ordering quantityquantity

safety stocksafety stock

JITJIT

LIBORLIBOR

prime rateprime rate

APRAPR