Working Capital Management - Part 3 (class copy).pdf

8/10/2019 Working Capital Management - Part 3 (class copy).pdf

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Working Capital Management

A simplified lecture by Prof. Ken Yumang

De La Salle University Manila

References:

Fundamentals of Financial Management, Brigham and Houston

Financial Management: Principles and Application, Titman, Keown, and Martin


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Working Capital Management

Management of

Management of

Management of

Cash

Accounts Receivable

Inventory

Management of Accounts Payable


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Cash Management

Currency (paper money and coins) Demand Deposits (checking account)

Marketable Securities (treasury Bonds,

treasury bills, certificates of deposit,money market funds)

Cash and Cash Equivalents


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Cash Management

Create a cash budget

Whenever possible and practical, use credit cards,

debit cards, wire transfers, and direct deposits for

payments and/or collections.

Hold marketable securities rather than demand

deposits.

Establish a line of credit.

If you have a bargaining power as a buyer, stretch

the payments of accounts payable.

Use a lockbox (available in some countries only)

Synchronize inflows and outflows

Minimizing Cash Holdings:


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Cash Management

The Cash Budget

1. It is a useful tool for predicting theamount and timing of the firmsfuture financing requirements.

2. It is a useful tool to monitor andcontrol the firms operations.


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Accounts Receivable Management


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1. Credit Period length of time given to buyers

to pay for their purchases2. Discounts price reductions for early

payments

3. Credit Standards required financial strength

of acceptable credit customer4. Collection Policy procedures used to collect

due and past due accounts

Credit Policy Considerations


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Credit sales can actually be moreprofitable than cash sales!


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Aging of Accounts Receivable



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Lamar Lumber Company has sales of $10

million per year, all on 30 days credit terms; itsaccounts receivable are $2 million.

What is Lamars days sales outstanding

(days of receivable)? How much capital would be released or

freed up if Lamar could take action tocollect on time?

Problem Illustration:



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From relaxed to restricted to improvereturns.

From restricted to relaxed to attract sales

and to create value to the customers.

Changing Credit Standard



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Offering Cash Discount



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Inventory Management


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1. ABC Inventory System2. Two-Bin System3. Just-In-Time (JIT)

4. Economic Order Quantity (EOQ)

Common Inventory Management Strategies


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1. ABC Inventory System

The ABC inventory system is used in order to focus on the most

important items in inventory. Usually a relatively few items will account

for a very significant value. These relatively few items with greatimportance are categorized as the "A" items. It is also common for

many of the items in inventory to have a relatively small aggregate

value. These items are categorized as "C" items. The remaining items

are categorized as the "B" items. By closely monitoring the "A" items, a

company is able to manage the most important items with a relativelysmall effort.



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2. Just-In-Time (JIT)

Just-in-time (JIT) inventory refers to an inventory

management system with objectives of havinginventory readily available to meet demand, but not

to a point of excess where you must stockpile extra

products.



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3. Two-Bin System

An inventory control system used to monitor the quantity

of an item left behind. The two-bin inventory controlmethod is mainly used for small or low value items. For

example, when items in the first bin have finished, an

order is placed to refill or replace these items. The second

bin is supposed to have enough items to last until the

placed order arrives. The first bin has a minimum of stockand the second bin keeps reserve stock or remaining

material. Bin cards and store ledger cards are used to

record the inventory.



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A technique for determining the optimal order size with minimumcost.

Order Costs costs of placing the order Carrying Costs variable cost per unit of holding the

inventory for a specific period of time.

Relationships: Order costs decreases as size of the orderincreases; Carrying costs increases with the increase in ordersize.



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Assumptions: Demand is known, reasonably constant, independent Lead time is known

Receipt of inventory arrives on time Quantity discounts are not possible

Variables:Quantity (Q) number of units per orderDemand (D) demand in the units for the inventoryOrder Cost (O) set up cost for each orderCarrying Cost (C) cost of holding or stocking per unit of

inventory per year



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Order Cost = number of orders placed per year x order cost per order

annual demandunits per order

= (D / Q) x O

Carrying Cost = average inventory level x carrying cost per unit

units per order2

= (Q / 2) x C


= x order cost per order

= x carrying cost per unit


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Optimal or Economic Order Quantity is found when

ORDER COST = CARRYING COST

D QQ 2


x O = x C

EOQ = 2 x D x O

C

= 2 x Demand x Total Order Cost

Carrying Cost per Unit


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Inventory ManagementIllustration:


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MERALCO stocks certain switch connector at its centralwarehouse for supplying field services offices. The yearlydemand for these connectors is 15,000 units. MERALCOestimates its annual holding cost for this item to be $25per unit. The cost to place and process an order from thesupplier is $75. The company operates 300 days per year.The lead time to place and receive an order from thesupplier is 2 working days, therefore, it wants to keep atleast 100 units as safety stocks.

Determine the EOQ. How much is the annual order cost using established EOQ? How much is the carrying cost using the established EOQ? Determine the reorder point. Determine the reorder point with safety stocks.

Sanity Check:


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The number of days of LEAD TIME the firm needs to place andreceive an order, and the firms DAILY USAGE of the inventory item,assuming the inventory is used at a constant rate.

*Daily Usage = Units Demand / Total Days o f Operat ion

Reorder Point

Extra inventory that is held to prevent stockouts ofimportant items.

Safety Stock


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Accounts Payable Management


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Trade credit (accounts payable) may be free, orit may be costly. If the seller does not offerdiscounts, the credit is free in the sense that

there is no cost for using it.

Take the trade discount or not?

A t P bl M t


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A t P bl M t


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A t P bl M t


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Accounts Payable ManagementSanity Check:


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END

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Working Capital Management - Part 3 (class copy).pdf