working capital management
DESCRIPTION
A presentation that can assist you in your CPA preparation.I prepared this one for my preparation. For other study notesvisit http://cpajournal.blogspot.com/TRANSCRIPT
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Working capital management
A review
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Topics working capital management
1. Managing the firm’s cash conversion cycle
2. Cash management3. Marketable securities management4. Inventory management5. Receivables management6. Financing current assets7. Sources of short-term funds
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what is working capital management?
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Working capital management
• managing and financing
• the current assets and current liabilities of the firm
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1. What is cash conversion cycle?
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Three periods of cash conversion cycle
• Inventory conversion period
• Receivables collection period
• Payables deferral period
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what is it meant by conversion period?
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meaning
• The average time required to convert materials into finished goods and sell those goods.
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Formula for inventory conversion period
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• Inventory conversion period
Average inventory
= ------------------------
sales per day
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what is receivables collection period?
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meaning
• The average time required to collect Accounts Receivable.
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Formula for Receivables collection period
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• Receivables collection period
(days sales outstanding)
Average receivables
= ---------------------------
credit sales per day
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What is payables deferral period?
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• The average length of time between the purchase of materials and Labor and the payment of cash for them.
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Formula for payables deferral period
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• payables deferral period
Average Payables
= ---------------------------
purchases per day
or
Average Payables
= ---------------------------
cost of goods sold /365
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What is cash conversion cycle?
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Cash conversion cycle
• It is the net of (inventory conversion period + receivables
conversion period – payables deferral period)
• It measures the time period from the time the firm pays for its materials and Labor to the time it collects its cash from sales of goods
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What is effective working capital management?
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Goal
• Shortening the cash conversion cycle as much as possible without harming operations
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why should the cash conversion cycle should be
shorter?
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• Because the longer the cash conversion cycle, the greater the need for financing
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Why should the firm maintain a sufficient amount of cash?
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2.Cash management
• To take advantage of trade discounts
• Maintain its credit rating
• Meet its unexpected needs
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For what purpose does the firm hold cash?
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Two basic purposes
• For everyday business operations/transactions
• Compensation to financial institutions (compensating balances)
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What is the purpose of cash budgets?
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Purpose of cash budgets
• To take advantage of trade discounts
• To maintain credit rating
• Take advantage of favourable business opportunities (speculator balances)
• To meet emergencies (precautionary balances)
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What is float?
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• It is time that elapses relating to mailing, processing and clearing checks
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How do you manage float?
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Managing float
• extending the float for disbursements and
• shortening the float for cash receipts.
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What are zero balance accounts?
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• maintaining of regional bank account
• and transferring funds
• just enough to pay the checks presented to the bank
• The bank will notify the amount of cash required to cover the checks.
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Advantages of zero balance accounts
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• Cheques take a longer time to clear and they provide more float for a cash disbursements
• Extra cash doesn’t need to be deposited for contingencies
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What is lockbox system?
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• Customers payments are Sent to Post Office box maintained by bank
• Bank personnel retrieve the payments and deposit them into the firm’s bank account
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What are the benefits of lockbox system ?
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• Cash flow benefit, Cost-effective
• (if the interest cost saved due to obtaining more timely deposits is sufficient to cover the net increasing cost of cash receipt processing)
• Bank fees - internal costs saved from having the bank process receipts
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What is concentration banking?
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• It maintaining a local branch account so that the customers can make payments to the local branch and the local branch transfers those surplus funds to firms primary bank
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What are the advantages of concentration banking ?
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• It speeds up collection of payments, and firm gets the use of the funds more quickly
• The float related to cash receipts is shortened
• Official bank cheques which are preprinted can transfer funds in a less expensive way than transferring funds between accounts
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what is electronic funds transfer?
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• Funds are moved electronically between accounts without the use of a cheque
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what is the advantage of an electronic fund transfer?
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• It can actually take the float out of both the receipts and disbursements processes
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what is international cash management?
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• Managing the cash accounts in different countries by multinational firms
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what are the advantages of international cash management?
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• Transfer funds to a country in which interest rates are higher allowing increased returns on investments
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3. Marketable securities management
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What is Marketable securities management?
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• Marketable securities can be easily converted to cash and also provide the benefit of investment return
• There are many securities to choose from for short-term investment
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What are the factors that are considered in investing in short-
term securities?
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• The requirement of minimum investment
• Safety
• Marketability (liquidity)
• Maturity
• yield
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What are the important considerations with respect to
short-term investments?
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• Liquidity and safety
• because these investments must be available to meet the current cash needs of the firm
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what are the major types of a short-term investments?
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Major types of short term investments
• Treasury Bills,• Treasury Notes, • Treasury Inflation Protected Securities (TIPS ),• Federal Agency Securities,• Certificates Of Deposit (CD),• Commercial Paper,• Banker’s Acceptance,• Eurodollar Certificate Of Deposit,• Money Market Funds,• Money Market Accounts, • Equity And Debt Securities.
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What are Treasury bills?
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T-bills
• T-bills short-term obligations of the federal government
• The they have the maturity of from 91 to 182 days.
• Existing T-bills may be purchased in the market with virtually any maturity date up to 182 days.
• The act to market ensures liquidity for T-bills, so they are very popular.
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Treasury notes
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Treasury notes
• These bills are government obligations
• A suit for short to intermediate term funds
• Their maturity time is from one to 10 years
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What Treasury inflation protected securities?
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TIPS
• when the firm want to minimize interest-rate risk they invest in government obligations which pay interest equals to
Real rate of return specified by the US Treasury
+ principal at maturity (adjusted for inflation)
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What are federal agency securities?
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• Offerings of government agencies
• Example :Federal home loan bank
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Features of the Federal agency securities
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• security, liquidity (an active market)
• Pay slightly higher yields than Treasury issues
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What is certificates of deposit?
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• Savings deposits at financial institutions
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Types of certificates of deposit
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Two tire market
• Small CDs ($500 to $10,000) with lower interest rates
• Large CDs (one hundred thousand dollars or more) with higher interest rates
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Is there any secondary market for large CDs?
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• Yes, they provide some liquidity
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Are CDs insured?
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• CDs are normally insured up to $100,000 by the federal government
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What is commercial paper?
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• Large unsecured short term promissory notes issued to the public by large credit worthy corporations
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What is the maturity period of commercial paper? Is there any secondary market to commercial
paper?
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• Two to nine-month
• held to maturity by the investor because there is no active secondary market
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What is banker’s acceptance?
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• a draft drawn on a bank for payment when present it to the bank
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When does bankers acceptances the generally arise?
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• it arises from payments for goods by corporations in foreign countries
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When does the corporation present and acceptance of a
payment? Do bankers acceptance has
secondary market?
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• The corporation receiving the bankers and acceptance may have to wait 30 to 90 days to present the and acceptance for payment
• Due to waiting secondary market has developed for the sale of the instruments at a discount.
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Banker’s acceptance
• Management may purchase bankers acceptances as the short term investments
• Bankers acceptances involve slightly more risk than government securities but also offers slightly higher yields
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Eurodollar certificate of deposit
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• Eurodollars are US dollars held on deposit by foreign banks and in turn lent by the banks to anyone seeking dollars
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why foreign banks offer Eurodollars certificates of
deposit?
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• To obtain dollars
• As an investment Eurodollar certificates of deposit pay higher yields than Treasury bills or certificates of deposit at large US banks
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What are Money market funds?
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• shares in a fund that purchases higher yielding bank CD’s , commercial paper and other large denomination , higher yielding securities
• They allow smaller investors to participate in these markets
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what are money market accounts?
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• Shares in a fund that purchases higher yielding bank CD’s , commercial paper and other large denomination, higher yielding securities.
• They allow smaller investors to participate in these markets.