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STF&WCM: Chapters 8/9
Work ing Capital Mgm t & Too ls
F307-B reeze Sess ion
Lectu re #5
Fall 2014
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Overview of Chapter 8 Topics Overview of Working Capital
Timelines and Float The Working Capital Cash
Conversion Cycle (CCC)
How Changes in Current Accounts
Impact External Financing Working Capital Investment and
Financing Strategies
Management of Credit and A/R
Management of Inventory Management of A/P
Global Management of WorkingCapital
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Cash Conversion Cycle
Build Inventory
Provide/SellServices &Products
CollectRevenues (A/R)
PurchaseSupplies,
Facilities, Etc.
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Borrow or
Liquidate
Investments
Invest or
Pay Down
Borrowings
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Operating Cash Flows
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CashInf lows
Cash
Inf lows
Cash
Inf lows
ConcentrationAccount
Concentrat ion
Flows
Concentrat ion
Flows
Cash
Outf lows
Cash
Outf lows
Cash
Outf lows
Funding
Flows
Funding
Flows
Short-Term Investments
Short-Term Borrowing
Liquid i ty
Mgmt Flows
Liquid i ty
Mgmt Flows
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Purchase-to-Pay Cycle
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1) Which type of float do you thinkwould be most important for a large
B2B manufacturing company?1. Collection Float
2.Disbursement Float
3. Invoicing Float
4. Payment Float
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Focus of Treasury on Cash FlowTimeline
Treasury focus is on the payment portionof the cycle
Calculation: Float Neutral Calculation
TD = total days difference in payment timing r = Opportunity cost as an annual rate
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1
Discount 1 r1 TD
365
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Float Neutral CalculationAssume r = 12% and TD = 3 days
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1Discount 1 12%
1 3365
11 1 0.99901467
1.0009863
0.00098533
0.001 (Rounded) or 0.10%
If the buyer is allowed to take a disc oun t of 0.10 %, they
wo uld b e indi f ferent (in present value terms) between paying
by c heck or b y electron ic transfer (a speedup of 3 days in
loss of value)
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2) Assuming an opportunity cost of8% and a 60-day change in payment
timing, what discount rate wouldmake the payment float neutral?
1. 0.5%2. 1.0%
3. 1.3%
4. 1.6%
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1Discount 1r
1 TD365
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Float Neutral CalculationAssume: r = 8% and TD = 60 days
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1Discount 1
8%1 60
365
11 1 0.987021.01315
0.01298 = 1.3% (Rounded)
If the buyer is al lowed to take a disc oun t of 1.3 %, they would
be ind i f ferent (in p resent v alue terms) between paying
electronical ly today o r on day 60 by check (a speedup of 60
days in los s of value)
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Collection/Disbursement Float
Components Mail Float Mail Time
Processing Float Deposit Preparation Time
Availability Float Check Availability Time
Clearing Float
Check Clearing Time Measurement of Float
Dollar-Days
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3) Which of the following is NOTpart of the Cash Conversion Cycle?
1. Days Inventory
2. Days Cash
3. Days Receivables
4. Days Payables
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The Working Capital CashConversion Cycle (CCC)
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Day 1 Day 30 Day 45 Day 80
PurchaseOf Materials
Payment ForMaterials
Sale ofProduct
Collect
Accounts
Receivable
Days Inventory
Days Receivables
Days Payables
Cash Conversion Cycle
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Problems in Managing CCC
Components Potential lost sales
Production stoppages
Stretched payables
Foregone cost-saving trade
discounts Higher prices assessed by
vendors on smaller orders orslow payments
Refusal to sell to weakcustomers
Excessive reliance on A/Prather than S/T bank credit
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4) What do you think is the mostimportant problem in managing the
CCC?1. Potential lost sales
2. Stretched payables
3. Production stoppages
4. Foregone trade
discounts
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Working Capital Investment andFinancing Strategies
18Copyright 2014 - The Treasury Academy - All Rights Reserved
Asset
Breakdown
Maturity
Matching
ConservativePolicy
Aggressive
Policy
Fixed AssetsPermanent
Current Assets
Fluctuating
Current Assets
Long-Term SourcesShort-Term
Sources
Long-Term SourcesS/T
Sources
Long-Term SourcesShort-Term
Sources
Selecting a Current Asset Investment Strategy Restrictive current asset investment
Relaxed current asset investment
Selecting a Current Asset Financing Strategy
5) C dit t d
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5) Credit management andaccounts receivable
management are essentiallythe same thing.
1. True
2. False
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Relationship Between Treasury andCredit Management
Separate func t ions
Credit manager administers policiesthat establish credit standards, defineterms of sale, approve credit sales, and
set individual and aggregate credit limits
A/R is created once a sale is made andtrade credit is extended
A/R management includes billingand processing payments,monitoring payment patterns, andcollecting delinquent accounts
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6) Short and long-term financialresources to supplement insufficient
cash flow for payments is known aswhat?
1. Character
2. Capacity
3. Capital
4. Collateral
5. Conditions
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The Five Cs of Credit
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Character An intent or willingness to pay as evidencedby payment history
CapacityCurrent and future financial resources that
can be committed to pay obligations
CapitalShort- and long-term financial resources to
supplement insufficient cash flow for
payments
CollateralAssets or guarantees available to secure an
obligation if payment is not made
ConditionsGeneral economic environment and
economic conditions for the customer and
the seller
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Quantitative Credit Analysis Most often used measures:
Liquidity and WC ratios Debt management and
coverage ratios Profitability measures
Consumer Credit Scoring Process1. Differentiating risks2. FICO Score3. Set cutoff score4. Applying further analysis
where necessary
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7) Which of the following is NOT areason why B2B quantitative credit
analysis is less effective than forconsumer analysis?
1. B2B has smaller per
transaction exposure
2. Smaller B2B database
3. Impact of one large default4. Difficulty in obtaining private
company data
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Why Quantitative Credit Analysis isNot as Effective for B2B
The available databases aremuch smaller for B2B
The per-transaction exposure
is usually much larger Impact of one large default
Difficult to obtain financial info
for some customers, especiallyfor smaller, private companies
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Key Inventory Factors
Types of Inventory Raw Materials Work in Progress (WIP) Finished Goods Scraps or Obsolete Items Stores and Supplies
Levels of Inventory Impact of excess inventory Just-In-Time (JIT) inventory Supplier-managed replenishment programs Paid-on-production inventory process
Benefits and Costs of Inventory
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I t Fi i
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Inventory Financing
If not financed as part of general working
capital requirements, alternatives may betied directly to the amount of inventory
Trade credit often finances a significantportion of inventory
Collateralized loans (asset-based lending)
Use of public or field warehouseto store inventory
Floor planning forhigh-value durablegoods
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Three-Way Match
PurchaseOrder
Receiving
AdviceInvoice
ApprovedVendorList ??
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Considerations for GlobalManagement of Working Capital
Global Working Capital ManagementTools and Techniques
Multicurrency Accounts
Netting Leading and Lagging Re-invoicing Center Internal Factoring Export Financing
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Before Netting
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Source: ETM3 - AFP
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With Multilateral Netting
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Source: ETM3 - AFP
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Re-invoicing Center Purpose
Buys goods from anexporting subsidiary
Resells the goods toan importingsubsidiary
Company OwnedSubsidiary
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Source: ETM3 - AFP
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Before Re-invoicing
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Source: ETM3 - AFP
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With Re-invoicing
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Source: ETM3 - AFP
O i f Ch t 9 T i
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Overview of Chapter 9 Topics
Introduction
Cash DiscountCalculations Buyers Perspective
Sellers PerspectiveAccounts Receivable (A/R)
Monitoring and Control DSO & Aging Schedule
Balance Pattern
Cash Conversion Cycle(CCC)
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Cost of a Buyer Not Taking a Cash
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Cost of a Buyer Not Taking a CashDiscount
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D 365Discount Cost =
100 D N T
2 365=
100 2 30 10
2 365= = .0204 18.25 =.3723 or 37.23%
98 20Where
D = Discount percentage is 2%
N = Net period is 30 days
T = Discount period is 10 days
The cost o f not taking the discoun t can be compared w i th
the organizations opportunity cost to borrow short- term
fund s. If we assume a rate of 8% for th is examp le, then
borrow ing cos t wou ld be less than the cost of not taking the
d iscount so the organization should borrow the funds and
TAKE the discoun t.
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8) A company is offered termsof 1/10, Net 50. What is the
cost of not taking this discount?
1. 9.2%
2. 7.4%
3. 7.9%
4. 12.3%
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D 365Discount Cost =
100 D N T
Cost of a Buyer Not Taking a Cash
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Cost of a Buyer Not Taking a CashDiscount
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D 365Discount Cost =
100 D N T
1 365=
100 1 50 10
1 365= = .0101 9.125 = .09216 or 9.2%
99 40Where
D = Discount percentage is 1%
N = Net period is 50 days
T = Discount period is 10 days
The cost o f not taking the discoun t can be compared w i th
the organizations opportunity cost to borrow short- term
fund s. If we assume a rate of 8% for th is examp le, then
borrow ing cos t wou ld be less than the cost of not taking the
d iscount so the organization should borrow the funds and
TAKE the discoun t.
Benefit to Seller of Offering a Cash Discount
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Benefit to Seller of Offering a Cash Discount
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Disc Pmt
Total Amount of Full Pmt 1 Disc RatePV
Annual Opp Cost1 Days in Disc Period
365
Disc Pmt
$100,000 1 .02 $98,000PV
1 .0041096.151 10
365
$98,000$97.598.91
1.0041096
Assume credit terms of 2/10, net 30 and opp . cost = 15
Present Value of Receiving Discoun ted Payment Am o
B fit t S ll f Off i C h Di t
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Benefit to Seller of Offering a Cash Discount
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Assume credit terms of 2/10, net 30 and opp . cost = 15
Present Value of Receiving Ful l Payment Amount
Full Pmt
Total Amount of Full PmtPV
Annual Opp Cost1 Days in Net Period
365
Full Pmt
$100,000 $100,000PV1 .0123288.15
1 30365
$100,000$98,782.13
1.0123288
NPV = PVDay 10PVDay 30= $97,598.91$98,782.13 =$1,183.22
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Cash Conversion Cycle (CCC)
Days Inventory
Days Receivables
Days Payables
Cash Conversion Cycle (CCC) Cash Turnover Ratio
41
Days Inventory Days Receivables
Days Payables Cash Conversion Cycle
Working Capital Gap
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A i S h d l
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Aging ScheduleSeparates A/R into current and past-due
receivables in 30-day increments (on a customeror aggregate basis) and can determine the
percent past due
Age of A/R Amount of A/R % of Total A/R
Current $1,750,000 70%
1-30 Days Past Due 375,000 15%
31-60 Days Past Due 250,000 10%
Over 60 Days PastDue 125,000 5%
Total $2,500,000 100%
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A/R Balance Pattern for March
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Cash Conversion Cycle (CCC)
Days Inventory
Days Receivables
Days Payables
Cash Conversion Cycle (CCC) Cash Turnover Ratio
44
Days Inventory Days Receivables
Days Payables Cash Conversion Cycle
Working Capital Gap
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Cash Conversion Cycle
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Cash Conversion Cycle
Elements in the cash
conversion cycle:
Days Inventory
Days
Receivables
Days Payables
Inventory
365Cost of Goods Sold
Accounts Receivable
365Sales
Accounts Payable 365Cost of Goods Sold
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C h C i C l
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Cash Conversion Cycle
Elements in the cash
conversion cycle:
Days
Inventory
Days
Receivables
DaysPayables
Days103.153659,200
2,600365
COGS
Inv
Days41.3636515,000
1,700365
Sales
A/R
Days63.483659,2001,600365
COGSA/P
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Cash Conversion Cycle (CCC)
Calculates the time required toconvert cash outflows
(necessary to produce
goods) into cash inflows
(through the collection ofaccounts receivable)
Days81.0363.48-41.36103.15
Pay.Days'-Rec.Days'Inv.Days'CCC
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Cash Turnover Ratio
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Cash Turnover RatioIf a company has a cash
conversion cycle of
81.03 days, how manycash conversion cycles
does the company go
through in a year (cash
turnover)? 365 DaysCash Turnover =
Cash Conversion Cycle
365=81.03 Days
= 4.5 Times
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Chapter 8 & 9: Wrap-up
Dont forget to work on theChap 8-9 team case Repo rt
due and disc ussio n in class
on 10/13 and 10/15
Excel #2 (Ac coun t Analysis )due o n Friday, 10/17/14
Exam #2 cov ering Chapters 6,
7, 8, & 9 wil l be given in class
on 10/20 and 10/22