Short-Term Financial ManagementTVU Reading CollegeMBA Managerial Finance Lecture 3

BasicsWorking Capital BasicsThe assets/liabilities that are required to operate a business on a day-to-day basisCashAccounts ReceivableInventoryAccounts PayableAccrualsThese assets/liabilities are short-term in nature and turn over regularly

Working Capital, Funding Requirements, and the Current AccountsGross Working Capital (GWC) represents the investment in assetsWorking Capital Requires FundsMaintaining a working capital balance requires a permanent commitment of fundsExample: Your firm will always have a minimum level of Inventory, Accounts Receivable, and Cashthis requires funding

Working Capital, Funding Requirements, and the Current Accounts Spontaneous Financing Your firm will also always have a minimum level of Accounts Payablein effect, money you have borrowedAccounts Payable (and Accruals) are generated spontaneouslyOffset the funding required to support assetsNet working capital is Gross Working Capital Current Liabilities (or spontaneous financing)Reflects the net amount of funds needed to support routine operations

Objective of Working Capital ManagementTo run the firm efficiently with as little money as possible tied up in Working CapitalInvolves trade-offs between easier operation and the cost of carrying short-term assetsBenefit of low working capitalAble to funnel money into accounts that generate a higher payoffCost of low working capitalRisky

The Cash Conversion Cycle

Cost Tradeoffs in Working Capital Accounts

Cost Trade-offs in Short-Term Financial Management

Chart1

1112113

299101

48791

77683

116677

165773

224971

294271

373673

463177

562783

672491

7922101

9220112

10619125

12118139

Cost 1

Cost 2

Total Cost

Account Balance

Cost

Trade-off of Short-Term Financial Costs

Sheet1

20

0000

0.10.056234132535.565588200835.6218223333

0.20.13374806129.906975624430.0407236854

0.30.222024841327.024003096127.2460279375

0.40.318108291525.148668593725.4667768852

0.50.420448207623.784142300124.2045905077

0.60.528067042122.724387329423.2524543714

0.70.640283853521.865302278622.505586132

0.80.756593287221.147425268821.904018556

0.90.876603371820.533801921621.4104052934

112021

1.11.12652505819.529081793520.6556068515

1.21.255962167319.108855844120.3648180114

1.31.388126964118.730275164120.1184021282

1.41.522860228318.386454304519.9093145328

1.51.660022879618.072040072219.7320629517

1.61.799492240617.782794100419.582286341

1.71.941159187217.515307463419.4564666507

1.82.084925933517.266800427419.3517263609

1.92.230704283317.034978721619.2656830049

22.3784142316.817928305119.1963425351

2.12.527982821416.614036948819.1420197702

2.22.679343228416.421934873419.1012781018

2.32.832433974516.240449173519.072883148

2.42.98719829116.068568378919.0557666699

2.53.143583574215.905414575319.0489981495

2.63.301540924415.750221242219.0517621666

2.73.461024751815.602315462119.0633402139

2.83.621992437315.461103513919.0830959512

2.93.784404039415.326059108819.1104631482

33.948222038915.19671371319.1449357519

3.14.113411115415.072648529719.186059645

3.24.279937951814.953487812219.2334257641

3.34.447771061314.838893254719.286664316

3.44.616880633614.728559258119.3454398917

3.54.787238399514.622208914219.4094473137

3.64.958817508814.519590582319.4784080911

3.75.131592421514.420474956319.5520673778

3.85.305538810314.324652540919.6301913512

3.95.480633472314.231931471819.7125649441

45.656854249514.142135623719.7989898732

4.15.834179956514.05510296419.8892829206

4.26.012590315513.970684113219.9832744287

4.36.192065896213.888741082920.0808069791

4.46.372588061513.809146166520.181734228

4.56.55413891813.731780959420.2859198774

4.66.736701270513.656535492120.3932367626

4.76.920258579413.583307461920.5035660413

4.87.104794923113.512001548120.6167964712

4.97.290294962113.442528801620.7328237637

57.476743906113.374806099520.8515500056

5.17.66412748413.308755655920.9728831399

5.27.852431915613.24430458221.0967364976

5.38.041643885813.181384491221.223028377

5.48.231750520113.119931141821.3516816619

5.58.422739362413.059884114521.4826234769

5.68.614598353913.001186520721.6157848746

5.78.807315813512.94378473721.7511005504

5.89.000880419512.887628164521.888508584

5.99.195281192812.832669009922.0279502027

69.390507480412.778862084922.1693695654

6.19.586548941112.726164623922.312713565

6.29.783395530712.67453611722.4579316476

6.39.981037489112.623938156522.6049756456

6.410.179465328212.574334296822.753799625

6.510.378669819612.525689925522.9043597451

6.610.57864198412.477972144223.0566141282

6.710.779373080512.431149659523.2105227401

6.810.980854597312.38519268223.3660472792

6.911.183078241712.340072833123.5231510747

711.386035931912.29576305923.6817989909

7.111.589719788612.252237551123.8419573396

7.211.794122126912.209471671624.0035937985

7.311.999235449212.167441885624.1666773348

7.412.205052437912.12612569724.3311781349

7.512.411565948712.085501589424.4970675381

7.612.618769004312.045548971424.6643179757

7.712.826654788512.006248124724.8329029132

7.813.0352166411.967580156725.0027967968

7.913.244448047511.92952695625.1739750035

813.454342644111.8920711525.3464137941

8.113.664894202111.855196066925.5200902691

8.213.876096629111.818885698525.6949823275

8.314.087943962411.783124666225.8710686286

8.414.300430365611.747898189426.048328555

8.514.51355012411.713192054926.2267421788

8.614.727297640511.67899258926.4062902295

8.714.941667432511.645286631326.5869540637

8.815.156654127411.612061509226.7687156365

8.915.372252459811.57930501526.9515574748

915.588457268111.547005383827.1354626519

9.115.805263491111.515151272427.3204147635

9.216.02266616511.483731740127.5063979051

9.316.240660420611.452736230127.6933966507

9.416.459241480511.42215455227.8813960326

9.516.678404656411.391976865528.070381522

9.616.898145346411.362193664728.2603390111

9.717.118459032611.332795763328.451254796

9.817.339341278811.303774281228.64311556

9.917.56078772811.275120630528.8359083585

1017.782794100411.246826503829.0296206042

10.118.005356191211.218883861829.224240053

10.218.228469868511.191284922529.419754791

10.318.452131071511.164022150229.6161532217

10.418.676335808211.137088245629.8134240538

10.518.901080154311.11047613630.0115562904

10.619.126360250611.084178966730.2105392173

10.719.352172301811.058190091730.4103623935

10.819.578512574911.032503065530.6110156404

10.919.805377397211.007111635830.812489033

1120.032763155210.982009735531.0147728907

11.120.26066629310.957191475831.2178577688

11.220.489083310710.932651139331.42173445

11.320.718010763310.908383173631.6263939368

11.420.947445258910.884382185131.831827444

11.521.177383458210.860642933332.0380263914

11.621.407822072310.837160324732.244982397

11.721.638757862410.81392940832.4526872703

11.821.870187637810.790945368632.6611330064

11.922.102108255410.768203523832.8703117792

1222.334516618510.745699318233.0802159367

12.122.567409675210.723428319133.2908379943

12.222.800784418210.701386212233.5021706304

12.323.034637883110.679568797633.7142066807

12.423.268967147910.657971985833.9269391337

12.523.503769331810.636591793934.1403611257

12.623.739041594410.615424342134.3544659365

12.723.974781134710.594465850334.569246985

12.824.210985190510.573712634434.7846978249

12.924.447651037210.553161103635.0008121408

1324.684775987510.53280775735.2175837445

13.124.9223573910.512649180835.4350065708

13.225.160392628810.492682045735.6530746746

13.325.39887912310.472903103835.8717822268

13.425.637814325310.453309186236.0911235115

13.525.87719572210.433897200536.3110929225

13.626.117020831810.414664128536.5316849603

13.726.357287205510.395607023736.7528942292

13.826.597992425210.376723009336.9747154345

13.926.839134103710.358009275837.1971433795

1427.080709883710.339463079137.4201729629

14.127.322717437710.321081738837.6437991765

14.227.565154466910.302862635537.8680171024

14.327.808018700910.284803210138.0928219109

14.428.05130789710.266900960838.3182088579

14.528.295019840110.249153442538.5441732826

14.628.539152341610.231558264438.770710606

14.728.783703239110.214113088838.997816328

14.829.028670396210.196815629539.2254860257

14.929.274051701710.179663650139.4537153518

1529.51984506910.162654963139.6825000321

15.129.766048436110.145787427839.911835864

15.230.01265976510.129058949840.1417187148

15.330.259677040910.11246747940.3721445199

15.430.507098272310.096011008740.603109281

15.530.754921490210.079687574540.8346090647

15.631.003144747910.063495253141.0666400009

15.731.251766120510.047432160841.2991982813

15.831.500783704910.031496452941.5322801578

15.931.750195618510.015686322741.7658819412

16321042

16.132.25019500829.984435750542.2346307587

16.232.50077882199.968991874842.4697706967

16.332.75174963979.953666707542.7054163471

16.433.00310567959.938458616242.9415642956

16.533.25484517839.923366000743.178211179

16.633.50696639179.908387292343.415353684

16.733.75946759389.89352095343.6529885468

16.834.01234707689.878765474243.891112551

16.934.26560315069.864119376944.1297225276

1734.51923414289.849581210144.3688153529

17.134.77323839799.835149550544.6083879485

17.235.02761427789.820823001944.8484372797

17.335.28236016079.806600194145.0889603548

17.435.53747444149.792479782845.3299542242

17.535.79295553089.778460448745.5714159795

17.636.04880185589.764540896845.8133427525

17.736.30501185889.750719855946.0557317147

17.836.56158399779.736996078346.2985800759

17.936.81851674559.723368338746.5418850842

1837.07580859039.709835434146.7856440245

18.137.33345803489.696396183347.0298542182

18.237.59146359629.683049426147.2745130222

18.337.84982380599.669794022847.5196178286

18.438.10853720949.65662885447.7651660634

18.538.36760236619.643552820248.0111551862

18.638.6270178499.630564840848.2575826898

18.738.88678224469.617663854248.5044460988

18.839.14689415249.604848817348.7517429697

18.939.40735218529.592118704748.99947089

1939.66815496879.579472508949.2476274775

19.139.92930114099.566909239249.4962103801

19.240.19078935279.55442792249.7452172747

19.340.4526182679.542027600149.9946458671

19.440.7147865599.529707332250.2444938912

19.540.97729291589.517466192850.4947591087

19.641.24013603649.505303271950.7454393083

19.741.50331463139.493217674350.9965323056

19.841.76682742249.481208519851.2480359421

19.942.0306731439.469274942351.4999480853

2042.29485053769.4574160951.7522666277

20.142.55935836179.44563112552.0049894867

20.242.82419538149.433919222652.258114604

20.343.08936037399.422279571552.5116399454

20.443.35485212659.410711373452.7655634999

20.543.62066943729.399213842753.0198832799

20.643.88681111439.387786205953.2745973202

20.744.1532759769.376427702153.5297036781

20.844.42006285079.36513758253.7852004327

20.944.68717057659.353915108254.0410856848

2144.95459800159.342759554654.2973575561

21.145.2223439839.331670206254.5540141892

21.245.49040738829.320646359254.8110537474

21.345.75878709349.309687320455.0684744138

21.446.02748198429.298792407355.3262743914

21.546.29649095539.287960947555.5844519028

21.646.56581291049.27719227955.8430051895

21.746.83544676229.266485749656.1019325119

21.847.10539143219.255840716856.3612321489

21.947.375645859.245256547856.6209023978

2247.64620895479.234732618956.8809415736

22.147.91707969319.224268315857.1413480089

22.248.18825702079.213863033357.4021200539

22.348.45973990119.203516174757.6632560757

22.448.7315273069.193227152257.9247544582

22.549.00361821539.182995386658.1866136019

22.649.27601161679.172820306958.4488319236

22.749.54870650599.162701350258.711407856

22.849.82170188619.152637961758.9743398478

22.950.09499676839.142629594759.237626363

2350.36859017129.132675709959.5012658811

23.150.64248112079.122775775959.7652568966

23.250.91666865029.112929268660.0295979188

23.351.19115180059.103135671160.2942874716

23.451.46592961959.09339447460.5593240934

23.551.74100116219.083705174760.8247063368

23.652.01636549069.074067277661.0904327682

23.752.29202167389.064480294161.3565019679

23.852.56796878789.054943741961.6229125297

23.952.84420591539.045457145661.8896630609

2453.12073214569.036020036162.1567521817

24.153.39754657499.026631950762.4241785256

24.253.67464830589.017292432862.6919407386

24.353.95203644759.00800103262.9600374795

24.454.22971011548.998757304163.2284674195

24.554.50766843168.989560810463.497229242

24.654.78591052428.980411118363.7663216425

24.755.06443552758.971307800964.0357433284

24.855.34324258218.962250436764.3054930188

24.955.62233083468.953238609964.5755694444

2555.90169943758.9442719164.8459713475

25.156.18134754948.935349931965.1166974813

25.256.46127433478.926472275765.3877466104

25.356.74147896368.917638546765.6591175103

25.457.0219606128.90884835565.9308089671

25.557.30271846168.900101316266.2028197777

25.657.58375169958.891397050266.4751487497

25.757.86505951868.882735182166.7477947007

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25.958.4284956998.86553716367.2940328621

2658.71062247328.857000285467.5676227586

26.158.99302065418.848504352167.8415250062

26.259.27568946168.84004901168.1157384726

26.359.55862812058.831633914368.3902620348

26.459.8418358618.823258718668.6650945796

26.560.12531191818.814923084768.9402350028

26.660.40905553238.806626677369.2156822096

26.760.69306594878.798369165569.4914351142

26.860.97734241758.790150222269.7674926397

26.961.26188419398.781969524470.0438537183

2761.54669053788.77382675370.3205172908

27.161.83176071398.765721592670.5974823065

27.262.11709399178.757653731770.8747477234

27.362.40268964548.749622862471.1523125079

27.462.6885469548.741628680671.4301756346

27.562.97466520078.733670885771.7083360864

27.663.26104367388.725749180671.9867928544

27.763.54768166568.717863271872.2655449374

27.863.83457847338.710012869272.5445913424

27.964.12173339828.70219768672.8239310842

2864.40914574628.694417438973.1035631851

28.164.69681482748.686671847773.3834866751

28.264.98473995638.678960635773.663700592

28.365.27292045178.67128352973.9442039806

28.465.56135563648.663640257174.2249958935

28.565.85004483758.656030552574.5060753901

28.666.13898738648.648454150974.7874415373

28.766.42818261838.640910790875.0690934091

28.866.71762987268.633400213775.3510300863

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2967.29727782618.618476389275.9157542153

29.167.58747722398.611062639276.1985398631

29.267.87792604168.60368066776.4816067086

29.368.1686236388.596330228376.7649538663

29.468.45956937628.589011081477.0485804576

29.568.75076262298.581722987477.3324856103

29.669.04220274868.574465709877.6166684584

29.769.33388912738.567239015177.9011281424

29.869.62582113718.560042671978.185863809

29.969.91799815958.552876451678.4708746111

3070.21041957968.545740127978.7561597075

30.170.50308478628.538633477279.0417182634

30.270.79599317168.53155627879.3275494496

30.371.08914413158.524508311479.6136524429

30.471.38253706548.517489360879.9000264262

30.571.6761713768.510499211880.1866705878

30.671.97004646958.503537652480.4735841219

30.772.26416175558.496604472980.7607662284

30.872.5585166478.489699465681.0482161125

30.972.85311056028.482822425181.3359329853

3173.14794291498.475973148381.6239160632

31.173.44301313388.46915143481.9121645678

31.273.73832064328.462357083282.2006777264

31.374.03386487248.45558989982.4894547714

31.474.32964525398.448849686582.7784949404

31.574.62566122358.442136252783.0677974762

31.674.92191221998.435449406983.3573616268

31.775.21839768538.4287889683.6471866453

31.875.51511706458.422154725183.9372717896

31.975.81206980588.41554651784.2276163228

3276.10925536028.408964152584.5182195127

32.176.40667318188.402407450484.8090806322

32.276.70432272788.395876230985.1001989588

32.377.00220345838.389370316585.3915737748

32.477.30031483628.382889531285.6832043674

32.577.59865632738.376433700885.9750900282

32.677.89722740058.37000265386.2672300535

32.778.19602752748.363596216886.5596237443

32.878.49505618258.357214223586.8522704059

32.978.79431284288.350856505587.1451693483

3379.09379698868.344522897287.4383198859

33.179.39350810268.338213234687.7317213372

33.279.69344567038.331927355188.0253730254

33.379.993609188.325665097888.3192742778

33.480.29399812268.319426303688.6134244261

33.580.59461199168.313210814588.9078228061

33.680.89545028348.307018474489.2024687578

33.781.19651249688.300849128689.4973616253

33.881.49779813328.294702623789.7925007569

33.981.79930669688.288578808190.0878855048

3482.10103769418.282477531390.3835152254

34.182.40299063438.276398644690.6793892789

34.282.7051650298.270342000590.9755070295

34.383.00756039258.264307452991.2718678454

34.483.31017624148.258294857191.5684710986

34.583.61301209498.252304069891.8653161647

34.683.91606747448.24633494992.1624024234

34.784.21934190398.240387354292.459729258

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70.6204.64723267716.8996779557211.5469106328

70.7205.00963255926.8972368876211.9068694468

70.8205.37216061116.8948001316212.2669607426

70.9205.73481669696.8923676739212.6271843708

71206.09760068136.889939501212.9875401823

71.1206.4605124296.8875155993213.3480280283

71.2206.82355180536.8850959553213.7086477606

71.3207.18671867576.8826805556214.0693992312

71.4207.55001290616.8802693867214.4302822927

71.5207.91343436266.8778624353214.7912967979

71.6208.27698291186.8754596882215.1524426001

71.7208.64065842066.8730611323215.5137195529

71.8209.00446075616.8706667542215.8751275103

71.9209.36838978586.868276541216.2366663269

72209.73244537766.8658904797216.5983358573

72.1210.09662739956.8635085572216.9601359567

72.2210.460935726.8611307607217.3220664808

72.3210.8253702086.8587570774217.6841272854

72.4211.18993073256.8563874943218.0463182268

72.5211.55461716296.8540219989218.4086391618

72.6211.9194293696.8516605784218.7710899474

72.7212.28436722086.8493032202219.133670441

72.8212.64943058866.8469499117219.4963805004

72.9213.01461934326.8446006405219.8592199837

73213.37993335556.8422553941220.2221887496

73.1213.74537249686.8399141601220.5852866569

73.2214.11093663876.8375769262220.9485135648

73.3214.4766256536.83524368221.311869333

73.4214.84243941216.8329144094221.6753538215

73.5215.20837778846.8305891021222.0389668905

73.6215.57444065486.8282677461222.4027084008

73.7215.94062788436.8259503292222.7665782135

73.8216.30693935046.8236368395223.1305761899

73.9216.67337492686.8213272651223.4947021918

74217.03993448756.8190215939223.8589560813

74.1217.40661790686.8167198141224.2233377209

74.2217.77342505946.8144219139224.5878469734

74.3218.14035582026.8121278817224.9524837019

74.4218.50741006446.8098377056225.31724777

74.5218.87458766746.807551374225.6821390414

74.6219.24188850526.8052688753226.0471573804

74.7219.60931245366.8029901979226.4123026516

74.8219.97685938926.8007153305226.7775747197

74.9220.34452918866.7984442614227.14297345

75220.71232172876.7961769794227.5084987081

75.1221.08023688686.793913473227.8741503598

75.2221.44827454046.791653731228.2399282714

75.3221.81643456736.789397742228.6058323094

75.4222.18471684576.787145495228.9718623407

75.5222.55312125386.7848969787229.3380182325

75.6222.92164767036.7826521821229.7042998524

75.7223.29029597436.780411094230.0707070683

75.8223.65906604486.7781737034230.4372397483

75.9224.02795776156.7759399995230.803897761

76224.3969710046.7737099712231.1706809752

76.1224.76610565256.7714836077231.5375892602

76.2225.13536158726.7692608982231.9046224854

76.3225.50473868886.7670418319232.2717805207

76.4225.87423683826.764826398232.6390632362

76.5226.24385591646.7626145859233.0064705023

76.6226.61359580496.760406385233.3740021899

76.7226.98345638556.7582017845233.74165817

76.8227.353437546.756000774234.1094383141

76.9227.72353915086.753803343234.4773424938

77228.09376110026.751609481234.8453705812

77.1228.46410327126.7494191775235.2135224487

77.2228.83456554666.7472324223235.5817979689

77.3229.20514780986.7450492049235.9501970148

77.4229.57584994456.7428695151236.3187194596

77.5229.94667183436.7406933427236.687365177

77.6230.31761336346.7385206773237.0561340407

77.7230.68867441626.7363515089237.4250259251

77.8231.05985487726.7341858274237.7940407046

77.9231.43115463136.7320236227238.163178254

78231.80257356376.7298648847238.5324384483

78.1232.17411155976.7277096034238.9018211631

78.2232.5457685056.7255577689239.2713262739

78.3232.91754428556.7234093713239.6409536568

78.4233.28943878736.7212644008240.010703188

78.5233.66145189686.7191228474240.3805747442

78.6234.03358350086.7169847014240.7505682022

78.7234.40583348616.7148499531241.1206834392

78.8234.77820173996.7127185928241.4909203326

78.9235.15068814956.7105906107241.8612787603

79235.52329260286.7084659973242.2317586001

79.1235.89601498766.706344743242.6023597305

79.2236.2688551926.7042268382242.9730820301

79.3236.64181310446.7021122734243.3439253778

79.4237.01488861366.7000010391243.7148896527

79.5237.38808160846.697893126244.0859747344

79.6237.7613919786.6957885246244.4571805026

79.7238.13481961176.6936872256244.8285068373

79.8238.50836439926.6915892196245.1999536188

79.9238.88202623046.6894944974245.5715207278

80239.25580499546.6874030498245.9432080452

80.1239.62970058456.6853148674246.315015452

80.2240.00371288846.6832299413246.6869428297

80.3240.37784179786.6811482622247.05899006

80.4240.75208720396.6790698211247.431157025

80.5241.1264489986.6769946088247.8034436068

80.6241.50092707156.6749226164248.175849688

80.7241.87552131646.672853835248.5483751513

80.8242.25023162456.6707882554248.92101988

80.9242.62505788826.668725869249.2937837572

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81.1243.37505785256.6646106397250.0396684922

81.2243.75023133876.6625577793250.412789118

81.3244.12552035196.6605080766250.7860284284

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81.5244.87644453266.6564181096251.5328626422

81.6245.25207948786.6543778279251.9064573157

81.7245.62782954486.6523406693252.2801702141

81.8246.00369459816.6503066252252.6540012232

81.9246.37967454216.6482756869253.027950229

82246.75576927166.646247846253.4020171176

82.1247.13197868176.6442230939253.7762017756

82.2247.50830266766.6422014223254.1505040898

82.3247.88474112466.6401828226254.5249239472

82.4248.26129394856.6381672865254.899461235

82.5248.63796103526.6361548057255.2741158409

82.6249.01474228076.6341453718255.6488876524

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82.8249.76864683396.6301356115256.3987824453

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83250.52300678136.6261379397257.149144721

83.1250.90035727046.6241436165257.5245008869

83.2251.27782129976.622152291257.8999735907

83.3251.65539876676.620163955258.2755627217

83.4252.03308956936.6181786005258.6512681698

83.5252.41089360556.6161962194259.0270898249

83.6252.78881077376.6142168037259.4030275774

83.7253.16684097246.6122403454259.7790813178

83.8253.54498410016.6102668367260.1552509368

83.9253.9232400566.6082962695260.5315363255

Sheet2

Cost 1Cost 2Total cost

1112113

299101

48791

77683

116677

165773

224971

294271

373673

463177

562783

672491

7922101

9220112

10619125

12118139

Trish, there should still be a vertical dotted line going from the minimum point on the yellow (in this version it's yellow, in the book

it's green) line to the horizontal axis. In this graph, that dotted line will NOT go through the intersection point of the other two lines

and that is intentional. The horizontal axis can still have a label that says "Optimum Balance" where this dotted line comes down.

Sheet2

Cost 1

Cost 2

Total Cost

Account Balance

Cost

Trade-off of Short-Term Financial Costs

Sheet3

Inventory Management

Inventory ManagementMismanagement of inventory has the potential to ruin a companyInventory is not the direct responsibility of the finance departmentUsually managed by a functional area such as manufacturing or operationsHowever, finance department has an oversight responsibility for inventory managementMonitor level of lost of obsolete inventorySupervise periodic physical inventories

Benefits and Costs of Carrying Adequate InventoryBenefitsReduces stockouts and backordersMakes operations run more smoothly, improves customer relations and increases salesCostsInterest on funds used to acquire inventoryStorage and securityInsuranceTaxesShrinkage SpoilageBreakageObsolescence

Inventory Control and ManagementInventory management refers to the overall way a firm controls inventory and its costDefine an acceptable level of operating efficiency with regard to inventoryTry to achieve that level with the minimum inventory cost

Economic Order Quantity (EOQ) ModelEOQ model recognizes trade-offs between carrying costs and ordering costsCarrying costs increase with the amount of inventory heldOrdering costs increase with the number of orders placedEOQ minimizes the sum of ordering and carrying costs

EOQ (Q*)Total costs = Ordering costs + Carrying costsTotal costs = (number of orders per year Cost per order) + (Avg. INV Annual carrying cost per unit)Total costs = (D/Q S) + (Q/2 C)EOQ

Optimal length of one inventory cycle

Safety Stocks, Reorder Points and Lead TimesSafety stock provides a buffer against unexpectedly rapid use or delayed deliveryAn additional supply of inventory that is carried at all times to be used when normal working stocks run outRarely advisable to carry so much safety stock that stockouts never happenCarrying costs would be excessiveOrdering lead time is the advance notice needed so that an order placed will arrive at the needed timeUsually estimated by the items supplier

Tracking InventoriesThe ABC SystemSome inventory items warrant a great deal of attentionAre very expensiveAre critical to the firms processes or to those of customersSome inventory items do not warrant a great deal of attentionCommonplace, easy to obtainAn ABC system segregates items by value and places tighter control on higher cost (value) pieces

Just In Time (JIT) Inventory SystemsSuppliers deliver goods to manufacturers just in time (JIT)Theoretically eliminates the need for factory inventoryA late delivery can stop a factorys entire production lineJIT works best with large manufacturers who are powerful with respect to the supplierSupplier is willing to do almost anything to keep the manufacturers business

Management of Accounts Receivable

Accounts Receivable Management

Five Cs of CreditFramework for in-depth credit analysis that is typically used for high-value credit requests:

Credit ScoringUses statistically-derived weights for key credit characteristics to predict whether a credit applicant will pay the requested credit in a timely fashion.Used with high volume/small dollar credit requestsMost commonly used by large credit card operations, such as banks, oil companies, and department stores.

Credit Scoring of a Consumer Credit Application by ABC Co

Changing Credit Standards

Effects of Changes in Credit Standards for YMCoMarginal profit fromincreased sales Additional profit contribution from sales Cost of the marginal investment in accounts receivablesTo compute additional investment, use the following equations:

Cost of the marginal investment in accounts receivablesTotal variable cost of annual sales (TVC)

Cost of the marginal investment in accounts receivablesCost of marginal investment in A/RCompute additional investment and, assuming a required return of 12%, compute cost of marginal investment in A/R.

Cost of Marginal Bad Debt ExpenseSubtract the current level of bad debt expense (BDECURRENT) from the expected level of bad debt expense (BDEPROPOSED).Cost of marginal bad debt expense3. Cost of marginal bad debt expense4. Net profit for the credit decision

Credit MonitoringAgeing of accounts receivable: schedule that indicates the portions of total A/R balance outstanding

Credit Monitoring

Management of Cash

Cash ManagementCash management: the collection, concentration, and disbursement of fundsFloat: funds that have been sent by the payer but not yet usable funds to the company

Costs of Holding CashC*Costs of holding cashSize of cash balanceThe investment income foregone when holding cash.Trading costs increase when the firm must sell securities to meet cash needs.

The Baumol ModelC*Size of cash balanceThe optimal cash balance is found where the opportunity costs equals the trading costs

The Baumol ModelOpportunity Costs = Trading CostsThe optimal cash balance is found where the opportunity costs equals the trading costsMultiply both sides by C

Implications of the Miller-Orr ModelTo use the Miller-Orr model, the manager must do four things:Set the lower control limit for the cash balance.Estimate the standard deviation of daily cash flows.Determine the interest rate. Estimate the trading costs of buying and selling securities.

Implications of the Miller-Orr ModelThe model clarifies the issues of cash management: The best return point, Z, is positively related to trading costs, F, and negatively related to the interest rate K.Z and the average cash balance are positively related to the variability of cash flows.

Cash Position ManagementManagement of short-term investing if the company has a surplus of funds and borrowing arrangements if company has a temporary deficit of fundsCash position management: collection, concentration, and disbursement of funds on a daily basisSmaller companies set target cash balance for their current (Checking) accounts.

CollectionsPrimary objective: speeding up collectionsCollection systems: function of the nature of the business

CollectionsPerform cost-benefit analysis to determine if lockbox system worth using

Funds Transfer Mechanisms

BACS / Chaps/ Swift transfers

Electronic communication that, via bookkeeping entries, removes funds from the payers bank and deposits the funds in the payees bank.Bacs bankers automated clearing system (4 days)Chaps Clearing Houses Automated payment system (Same day transfers)Swift International Payments Mechanism

Managing Accounts Payable

Accounts Payable ManagementManagement of time from purchase of raw materials until payment is placed in the mailDecide between centralized or decentralized payables and payments systemsIf supplier offers cash discounts, analyze the best alternative between paying at the end of credit period and taking the discount.

Disbursements Products and MethodsZero-balance accounts (ZBAs): disbursements accounts that always have end-of-day balance of zeroAllows the firm to maximize the use of float on each cheque, without altering the float time of its suppliersKeeps all cash in interest-bearing accountsControlled disbursement: Bank provides early notification of cheque presented against a companys account every day.Positive pay: Company transmits to the bank a cheque-issued file to the bank when cheques are issued.Cheque-issued file includes cheque number and amount of each item.Used for fraud prevention

Developments in Accounts Payable and DisbursementsIntegrated (comprehensive) accounts payable: outsourcing of accounts payable or disbursements operationsPurchasing/procurement cards: increased use of credit cards for low-dollar indirect purchasesImaging services: Both sides of the cheque, as well as remittance information, is converted into digital images.Useful when incorporated with positive pay services

Financing Working Capital

Sources of Short-term FinancingSpontaneous financingAccounts payable and accrualsUnsecured bank loansCommercial paperSecured loans

Spontaneous FinancingAccrualsMoney you owe employees, for example, for work performed but for which they have not yet been paid Tend to be very short-termAccounts payable (AKA trade credit)Money you owe suppliers for goods you bought on creditCredit Terms: Terms of trade specify when you are to repay the debtExample of terms of trade: 2/10, net/30You must pay the entire amount by 30 daysIf you pay within 10 days, you will receive a 2% discount

Spontaneous FinancingThe prompt payment discountPassing up prompt payment discounts is generally a very expensive source of financing

Spontaneous FinancingAbuses of Trade Credit TermsTrade credit, while originally a service to a firms customers, has become so commonplace it is now expectedCompanies offer it because they have toStretching payables is a common abuse of trade creditPaying payables beyond the due date (AKA: leaning on the table)Slow paying companies receive poor credit ratings in credit reports issued by credit agencies

Unsecured Bank LoanRepresent the primary source of short-term loans for most companiesPromissory note (AKA Notes Payable)Note signed promising to repay the amount borrowed plus interestBank usually credits the amount to borrowers checking account

Unsecured Bank LoansLine of creditInformal, non-binding agreement between bank and firm that specifies the maximum amount firm can borrow over a specific time frame (usually a year)Borrower pays interest only on the amount borrowedRevolving credit agreementSimilar to a line of credit except bank guarantees the availability of funds up to a maximum amount (effectively a binding agreement)Borrower pays a commitment fee on the unborrowed funds (whether they are used or not)

Unsecured Bank LoansCompensating balancesA minimum amount by which the borrowers bank account cannot drop below (therefore it is unavailable for use)Increases the effective interest rate on a loanTypically between 10% and 20% of amounts loaned

Unsecured Bank LoansClean-Up RequirementsTheoretically a firm can constantly roll-over its short-term debtBorrow on a new note to pay off an old noteRisky for both the firm and the bankBanks require that borrowers clean up short-term loans once a yearRemain out of short-term debt for a certain time period

Commercial PaperNotes issued by large, financially-strong firms and sold to investorsBasically a short-term corporate bondUnsecured (usually)Buyers are usually other institutions (insurance companies, mutual funds, banks, pension funds)Maturity is less than 270 daysConsidered a very safe investment, therefore pays a relatively low interest rateRather than paying a coupon rate, interest is discountedCommercial paper market is rigid and formalno flexibility in repayment terms

Short-Term Credit Secured by Current AssetsDebt is secured by the current asset being financedMore popular in some industries than in othersCommon in seasonal businesses

Short-Term Credit Secured by Current AssetsReceivables Financing: Accounts receivable represent money that is to be collected in the near futureBanks recognize that this money will be collected soon are are willing to lend money based on this soon-to-be-collected moneyInvoice discounting: firm sells AR to lender but retains control of control of the accountsAR are now paid directly to lender to a specified accountFactoring AR: firm sells AR to lender (at a) and the lending firm (factor) takes control of the accountsAR are now paid directly to lenderLender assumes responsibility for credit control & collection

Short-Term Credit Secured by Current AssetsPledging Accounts Receivable (US Variant of Invoice Discounting)Firm promises to use the money paid from the collected accounts to pay off bank loan Accounts Receivable still belong to firm which still collects the accountsIf firm doesnt repay, lender has recourse to borrowerLender can provideGeneral line of credit tied to all receivablesLender likely to advance at most 75% of the balance of accountsSpecific line of credit tied to individual accounts receivableEvaluates based on creditworthiness of accountLender likely to advance as much as 90% of the balance of accepted accounts

Short-Term Credit Secured by Current AssetsFactoring Accounts ReceivableFirm sells Accounts Receivable to lender (at a severe discount) and the lending firm (factor) takes control of the accountsAccounts Receivable are now paid directly to lenderFactor usually reviews accounts and only accepts accounts it deems creditworthyFactors offer a wide range of servicesPerform credit checks on potential customersAdvance cash on accounts it accepts or remit cash after collectionCollect cash from customersAssume the bad-debt risk when customers dont pay

Short-Term Credit Secured by Current AssetsInventory Financing (Common in USA)Use a firms inventory as collateral for a short-term loanPopular but subject to a number of problemsLenders arent usually equipped to sell inventorySpecialized inventories and perishable goods are difficult to marketTypes of methods usedBlanket lienslender has a lien (claim) against all inventories of the borrower but borrower remains in physical control of inventoryChattel mortgage agreementcollateralized inventory is identified by serial number and cant be sold without lenders permission (but borrower remains in physical control of inventory)Warehousingcollateralized inventory is removed from borrowers premises and placed in a warehouse (borrowers access controlled by third party)

Short-Term Financial ManagementLength of cash conversion cycle determines the amount of resources the firm must invest in its operations.Cost trade-offs apply to managing cash and marketable securities, accounts receivable, inventory and accounts payable.Objective for account receivable: collect accounts as quickly as possible without losing sales.Objective for accounts payable: pay accounts as slowly as possible without damaging firms credit.Working Capital Finance Principle is to Match Length of Finance with Asset

Multiply both sides by 2C, divide by K.Take a square root.