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Chapter 14

Working Capital

and Current

AssetManagement

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Current Assets:

CashMarketable Securities

PrepaymentsAccounts ReceivableInventory

Current Liabilities:

Accounts PayableAccruals

Short-Term DebtTaxes Payable

Fixed Assets:

Investments

Plant & Machineryan! an! "uil!in#s

Long-Term Financing:

Debt

$%uity

Long & Short er! Assets & Lia"ilities

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he Cash Conversion Cycle

& Short-term financial management'mana#in# current

assets an! current liabilities'is on o( the (inancial

mana#er)s most important an! time-consumin# activities*

& The #oal o( short-term (inancial mana#ement is to

mana#e each o( the (irms) current assets an! liabilities to

achieve a balance bet+een profitability and riskthat

contributes positively to overall (irm value*

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Acco#nts $eceiva"le %anage!ent

the average collection period, the avera#e len#th o(time (rom a sale on cre!it until the payment becomesusable (un!s to the (irm*

&The collection perio! consists o( t+o parts, the time perio! (rom the sale until the customer mails

payment. an!

, the time (rom +hen the payment is maile! until the (irmcollects (un!s in its bank account*

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Acco#nts $eceiva"le %anage!ent

he 'ive Cs o( Credit

& Character:The applicant)s recor! o( meetin# pastobli#ations*

& Capacity:The applicant)s ability to repay the re%ueste!cre!it*

& Capital:The applicant)s !ebt relative to e%uity*

& Collateral:The amount o( assets the applicant has

available (or use in securin# the cre!it*& Conditions:Current #eneral an! in!ustry-speci(ic

economic con!itions*

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Acco#nts $eceiva"le %anage!ent

Credit Scoring

& Credit scoringis a proce!ure resultin# in ascore that measures an applicant)s overall cre!it

stren#th. !erive! as a +ei#hte!-avera#e o(scores o( various cre!it characteristics*

& The proce!ure results in a score that measuresthe applicant)s overall cre!it stren#th. an! thescore is use! to make the accept/re0ect !ecision(or #rantin# the applicant cre!it*

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Acco#nts $eceiva"le %anage!ent

Credit Scoring )cont.*

& The purpose o( cre!it scorin# is to make a

relatively in(orme! cre!it !ecision %uickly an!

inexpensively*

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Acco#nts $eceiva"le %anage!ent

Changing Credit Standards

& The (irm sometimes +ill contemplate chan#in# its cre!itstan!ar!s to improve its returns an! #enerate #reatervalue (or its o+ners*

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Acco#nts $eceiva"le %anage!ent

Changing Credit Standards

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Changing Credit er!s

& A (irm)s credit termsspeci(y the repayment termsre%uire! o( all o( its cre!it customers*

&Cre!it terms are compose! o( three parts, The cash discount, The cash discount period

, The credit period

& 1or example. +ith cre!it terms o( 2/34 net 54. the !iscountis 26. the !iscount perio! is 34 !ays. an! the cre!it perio!is 54 !ays*

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%A+ Co!pany has an average collection period o( 40

days )t#rnover , -/40 , 9.1*. n accordance ith the

(ir!3s credit ter!s o( net -0 this period is divided into -2

days #ntil the c#sto!ers place their pay!ents in the !ail)not everyone pays ithin -0 days* and 5 days to receive

process and collect pay!ents once they are !ailed.

%A+ is considering initiating a cash disco#nt "y changing

its credit ter!s (ro! net -0 to 210 net -0. he (ir!e6pects this change to red#ce the a!o#nt o( ti!e #ntil the

pay!ents are placed in the !ail res#lting in an average

collection period o( 2/ days )t#rnover , -/2/ , 14.*.

Changing Credit er!s 76a!ple

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Credit %onitoring

& Cre!it monitorin# is the on#oin# revie+ o( a (irm)saccounts receivable to !etermine +hether customers are

payin# accor!in# to the state! cre!it terms*

& Slo+ payments are costly to a (irm because theylen#then the avera#e collection perio! an! increase the(irm)s investment in accounts receivable*

& T+o (re%uently use! techni%ues (or cre!it monitorin#are the avera#e collection perio! an! a#in# o( accountsreceivable*

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Credit %onitoring

Average Collection Period

& The avera#e collection perio! is the avera#e number o(

!ays that cre!it sales are outstan!in# an! has t+o parts

, The time (rom sale until the customer places the payment inthe mail. an!

, The time to receive. process. an! collect payment*

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Credit %onitoring

Aging o( Acco#nts $eceiva"le

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Credit %onitoring

Collection Policy

& The (irm)s collection policyis its proce!ures (or

collectin# a (irm)s accounts receivable +hen they are

!ue*

& The e((ectiveness o( this policy can be partly evaluate!

by evaluatin# at the level o( ba! expenses*

& As seen in the previous examples. this level !epen!s

not only on collection policy but also on the (irm)scre!it policy*