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Chapter 7
Current Asset Management
Copyright 2006. Based on Foundations of Financial Manage-ment by Stanley B. Block and Geoffrey A. Hirt, 11th ed. (2005), on slides prepared by and copyright by McGraw-Hill/Irwin, and on work by John Kevin Doyle.
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Chapter 7 - Outline
Current Asset Management. Cash Management. Ways to Improve Collections. Marketable Securities. Three Primary Variables of Credit Policy. Inventory Management. Level vs. Seasonal Production. Economic Ordering Quantity.
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Current Asset Management is essentially an extension of working capital management.
It is concerned with the current assets of a firm (cash, A/R, marketable securities, and inventory).
A financial manager needs to remember that the less liquid an asset is, the higher the required return.
Current Asset Management
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Cash Management
The financial manager wants to keep cash balances to a minimum.
There are two reasons for holding cash:for everyday transactions (main reason).compensating balances.for precautionary needs (emergencies).
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Cash Management
Goals areto speed up the inflow of cash (or improve
collections) andslow down the outflow of cash (or extend
disbursements). Also will attempt to “play the float”.
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FIGURE 7-2Expandedcash flowcycle
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TABLE 7-1The use of float to provide funds
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TABLE 7-2Playing the float
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Ways to Improve Collections
Collection Center– speeds up collection of A/R and reduces mailing
time. Electronic Funds Transfer (or Wire Transfer of
Funds)– a system where payments are automatically
deducted from a bank account. Lockbox System
– when customers mail payment to a local post office box instead of to the firm.
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FIGURE 7-3Cashmanagementnetwork
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Marketable Securities
Treasury Bills (T-Bills) and Notes. Certificates of Deposit (CDs). Banker’s Acceptances. Eurodollar Certificates of Deposit. Passbook Savings Accounts. Money Market Funds.
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FIGURE 7-6An examination ofyield and maturitycharacteristics
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TABLE 7-3Types of short-term investments
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There are three things to consider in deciding whether to extend credit:
Credit Standards.Terms of Trade.Collection Policy. Measures of efficiency:
Average Collection Period.Ratio of Bad Debts to Credit Sales.Aging of Accounts Receivable.
Three Primary Variables of Credit Policy
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TABLE 7-4Dun & Bradstreetreport
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Inventory Management
Inventory is divided into three categories:
Raw Materials.Work in Progress (WIP) or Unfinished Goods.Finished Goods.
There are two basic costs associated with inventory:
Carrying Costs.Ordering Costs.
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Level vs. Seasonal Production
Level Production:producing the same (equal) amount each month. inventory costs are higher.operating costs are lower.
Seasonal Production:producing a different amount each month (based on
the season). inventory costs are lower.operating costs are higher.
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FIGURE 7-9Determining theoptimuminventory level
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Economic Ordering Quantity
Economic Ordering Quantity (EOQ):the optimal (best) amount for the firm to order each
time.occurs at the low point on the total cost curve.the order size where total carrying costs equal total
ordering costs (assuming no safety stock). Safety Stock:
“extra” inventory the firm keeps in stock in case of unforeseen problems.
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EOQ Formula
Assumes:Inventory usage at a constant rate.Order costs per order are constant.Delivery time of orders is consistent and order arrives as inventory reaches zero.
2SOEOQ=
C