Managing Current Assets

1
Managing Current Assets

• Definitions
• Gross Working Capital (W.C.) Total current
  assets.
• Net W.C. Current assets Current liabilities.
• W.C. Policy Decisions as to (1) the level of
  each type of current asset, and (2) how current
  assets will be financed.
• W.C. Management Controlling cash, inventories,
  and A/R, plus S-T liability management.
• Working capital policy is reflected in current
  ratio, quick ratio, turnover of cash and
  securities, inventory turnover, and DSO.

2
Working Capital

• Operations Cycle

Cash
Raw materials inventory
Receivables
Finished goods inventory
3
Cash Conversion Cycle

• Cash Conversion Cycle - Period between firms
  payment for materials and collection on its
  sales.

Purchase - Payable
Pay Payable
Sale - Receivable
Collect Receivable
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Working Capital

• Example - Cash Conversion Cycle
• Given the aggregate balance sheet and income
  statement for US Manufacturing firms, calculate
  the cash conversion cycle.
• 1999 Income Statement
• 1999 Balance Sheet

Sales 3,968
COGS 3,518
1999 1998
Inventory 468 470
Acc Rec 481 471
Acc Pay 303 304
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Working Capital
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• Cash Conversion Cycle
• Inventory Period Receivable Period
• - Payable Period

7
The Working Capita Tradeoff

• Carrying Costs - Costs of maintaining current
  assets, including opportunity cost of capital.
• Shortage Costs - Costs incurred from shortages in
  current assets.

8
Working Capital Financing Policies

• Moderate Match the maturity of the assets with
  the maturity of the financing.
• Aggressive Use short-term financing to finance
  permanent assets.
• Conservative Use permanent capital for
  permanent assets and temporary assets.

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Moderate Financing Policy

Temp. C.A.

S-T Loans
L-T Fin Stock, Bonds, Spon. C.L.
Perm C.A.
Fixed Assets
Years
Lower dashed line, more aggressive. Higher, more
conservative
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• Continue with Excel file

11
Cash Balances

• Transactions Must have some cash to operate.
• Precaution Non predictable cash flow
  fluctuation. Need is reduced by line of credit,
  marketable securities.
• Compensating balances For loans and/or services
  provided, bank required.
• Speculation To take advantage of bargains, to
  take discounts, etc. Reduced by credit lines,
  securities.

12
Cash Budget The Primary Cash Management Tool

• Purpose Forecasts cash inflows, outflows, and
  ending cash balances. Used to plan loans needed
  or funds available to invest.
• Timing Daily, weekly, or monthly, depending
  upon purpose of forecast. Monthly for annual
  planning, daily for actual cash management.
• Information needed for Cash Budget
• Sales forecast.
• Information on collections delay.
• Forecast of purchases and payment terms.
• Forecast of cash expenses, taxes, etc.
• Initial cash on hand.
• Target cash balance.