Finansal Yönetim Current Asset Management Chapter McGraw-Hill/Irwin Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved. Current Asset Management 77- 2 Chapter Outline What is current asset management • Cash management and its importance • Management of marketable securities • Accounts receivable and inventory • management Inventory management and policy decisions • required Liquidity vis- à -vis returns •7- 3 Cash Management Financial managers actively attempt to keep • cash (non-earning asset) to a minimum It is critical to have sufficient cash to assuage – emergencies Steps to improve overall profitability of a firm: – Minimize cash balances • Have accurate knowledge of when cash moves in and • out of the firm7- 4 Reasons for Holding Cash Balances Transactions balances • Payments towards planned expenses – Compensative balances for banks • Compensate a bank for services provided rather – than paying directly for them Precautionary needs • Emergency purposes –7- 5 Cash Flow Cycle Ensure that cash inflows and outflows are • synchronized for transaction purposes Cash budgets is a tool used to track cash flows – and ensuing balances Cash flow relies on: • Payment pattern of customers – Speed at which suppliers and creditors process – checks Efficiency of the banking system –7- 6 Cash Flow Cycle (cont ’ d) Cash inflows are driven by sales and influenced by: • Type of customers – Customers’ geographical location – Product being sold – Industry – When the cash balance increases, the extra cash • can be Used for various payments to lenders, stockholders, government, – etc Used to invest in marketable securities – When there is a need for cash a firm can : • Sell the marketable securities – Borrow funds from short-term lenders –7- 7 Expanded Cash Flow Cycle7- 8 E-commerce and Sales Benefits: faster cash flow • Credit card companies advance cash to the – retailer within 7 – 10 days against retailer’s with a 30 day payment terms Financial managers must pay close attention • to the percentage of sales generated: By cash – By outside credit cards – By the company’s own credit cards –7- 9 Float Difference between firm’s recorded amount and • amount credited to the firm by a bank Two types of float: • Mail float: Arises duet to the time it takes to deliver a check. – Clearing float: Arises due to the time it takes to clear a check once – the payment is made Both these floats do not exist anymore due to: • Electronic payments – Check Clearing for the 21 st Century Act – Check Clearing for the 21 st Century Act (Check 21) • Allows banks and others to electronically process a check –7- 10 Improving Collections and Extending Disbursements Improving collection: • Setting up multiple collection centers at different – locations Adopt lockbox system for expeditious check clearance at – lower costs Extending disbursement: • General trend: – Speedup processing of incoming checks • Slow down payment procedures • Extended disbursement float – allows companies to hold onto their – cash balances for as long as possible7- 11 Cost-Benefit Analysis Allows companies to analyze the benefits, • received by investing on an efficiently maintained cash management program7- 12 Cash Management Network7- 13 Electronic Funds Transfer Funds are moved between computer terminals • without the use of a ‘check’ Automated clearinghouses (ACH): Transfers information between – financial institutions and between accounts using computer tape International fund transfer is carried out through • SWIFT (Society for Worldwide Interbank Financial Telecommunications) Uses a proprietary secure messaging system – Each message is encrypted – Every money transaction is authenticated by a code, using smart – card technology Assumes financial liability for the accuracy, completeness, and – confidentiality of transaction7- 14 International Cash Management Factors differentiating international cash • management from domestic based systems: Differing payment methods and/or higher popularity – of electronic funds transfer Subject to international boundaries, time zone – differences, currency fluctuations, and interest rate changes Differing banking systems and check clearing – processes Differing account balance management and – information reporting systems Cultural, tax, and accounting differences –7- 15 International Cash Management (cont ’ d) Financial managers try to keep as much • cash as possible in a country with a strong currency and vice versa Sweep account: • Allows companies to maintain zero balances – Excess cash is swept into an interest-earning – account7- 16 An Examination of Yield and Maturity Characteristics Marketable • securities7- 17 Marketable Securities When a firm has excess funds, it should be • converted from cash into interest-earning securities Types of securities: • Treasury bills : Short-term obligations of the government – Treasury notes : Government obligations with a maturity of 1-10 – years Federal agency securities : Offerings of government organizations – Certificate of deposit : Offered by commercial banks, savings, and – other financial institutions Commercial paper : Represents unsecured promissory notes – issued by large business organizations Banker’s acceptances : Short-term securities that arise from foreign – trade7- 18 Management of Accounts Receivable Accounts receivable as an investment • Should be based on the level of return earned – equals or exceeds the potential gain from other investments Credit policy administration • Credit standards – Terms of trade – Collection policy –7- 19 Types of Short-Term Investments7- 20 Credit Standards Determine the nature of credit risk based on: • Prior records of payment and financial stability, – current net worth, and other related factors 5 Cs of credit: • Character – Capital – Capacity – Conditions – Collateral –7- 21 Credit Standards (cont ’ d) Dun & Bradstreet Information Services • (DBIS): Produces business information analysis tools – Publishes reference books – Provides computer access to information – The Data Universal Number System (D-U-N-S) – is a unique nine-digit code assigned by DBIS to each business in its information base7- 22 Dun & Bradstreet Report – An Example7- 23 Terms of Trade Stated term of credit extension: • Has a strong impact on the eventual size of – accounts receivable balance Creates a need for firms to consider the use of – cash discounts7- 24 Collection Policy A number if quantitative measures applied • to asses credit policy Average collection period – Ratio of bad debts to credit sales – Aging of accounts receivable –7- 25 An Actual Credit Decision Brings together various elements of • accounts receivable management Brings together various elements of • accounts receivable management7- 26 Inventory Management Inventory has three basic categories: • Raw materials – Work in progress – Finished goods – Amount of inventory is affected by sales, • production, and economic conditions Inventory is the least of liquid assets – • should provide the highest yield 7- 27 Level versus Seasonal Production Level production • Maximum efficiency in manpower and machinery – usage May result in high inventory buildup – Seasonal production • Eliminates inventory buildup problems – May result in unused capacity during slack – periods May result in overtime labor charges and – overused equipment repair charges7- 28 Inventory Policy in Inflation (and Deflation) Inventory position can be protected in an • environment of price instability by: Taking moderate inventory positions – Hedging with a futures contract to sell at a – stipulated price some months from now Rapid price movements in inventory may • also have a major impact on the reported income of the firm7- 29 The Inventory Decision Model Carrying costs • Interest on funds tied up in inventory – Cost of warehouse space, insurance premiums, – and material handling expenses Implicit cost associated with the risk of – obsolescence and perish-ability Ordering costs • Cost of ordering – Cost of processing inventory into stock –7- 30 Determining the Optimum Inventory Level7- 31 Economic Ordering Quantity EOQ = 2SO ; C Where, S = Total sales in units O = Ordering cost for each order C = Carrying cost per unit in dollars Assuming: EOQ = 2SO = 2 X 2,000 X $8U = $32,000 = 160,000 C $0.20 $0.20 = 400 units7- 32 Safety Stocks and Stock Outs Stock out occurs when a firm is: • Out of a specific inventory item – Unable to sell or deliver the product – Safety stock reduces such risks • Increases cost of inventory due to a rise in – carrying costs This cost should be offset by: – Eliminating lost profits due to stockouts • Increased profits from unexpected orders •7- 33 Safety Stocks and Stock Outs (cont ’ d) Assuming that; • Average inventory = EOQ + Safety stock 2 Average inventory = 400 + 50 2 The inventory carrying costs will now increase by $50 Carrying costs = Average inventory in units × Carrying cost per unit = 250 × $0.20 = $507- 34 Just-in-Time Inventory Management Basic requirements for JIT: • Quality production that continually satisfies – customer requirements Close ties between suppliers, manufactures, and – customers Minimization of the level of inventory – Cost Savings from lower inventory: • On average, JIT has reduced inventory to sales – ratio by 10% over the last decade7- 35 Advantages of JIT Reduction in space due to reduced • warehouse space requirement Reduced construction and overhead • expenses for utilities and manpower Better technology with the development of • electronic data interchange systems (EDI) EDI reduces re-keying errors and duplication of – forms Reduction in costs from quality control • Elimination of waste •7- 36 Areas of Concern for JIT Integration costs • Parts shortages could lead to lost sales and • slow growth Un-forecasted increase in sales: – Inability to keep up with demand • Un-forecasted decrease in sales: – Inventory can pile up • A revaluation may be needed in high-growth • industries fostering dynamic technologies