Chapter15
Managing Short-Term Assets
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Learning Outcomes
Chapter 15
Discuss the goal of effective cash management and how (a) the
cash budget, (b) techniques that exist to accelerate cash
receipts, and (c) cash disbursement controls should be
employed to develop an optimal cash management policy.
Explain the rationale for holding marketable securities, and
describe the general characteristics of investments that should
be included in portfolios of marketable securities.
Discuss accounts receivable (credit) management, and describe
how a proposed credit policy change should be evaluated.
Explain the rationale for holding various forms of inventory, and
describe how a firm can determine its optimal level of inventory.
Describe how management of current assets differs for
multinational firms and for purely domestic firms.
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Cash Management
The goal is to minimize the amount of cash
the firm must hold for use in conducting its
normal business activities, but sufficient to:
 Pay creditors
 Maintain its credit rating
 Meet unexpected cash needs
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Firms Hold Cash For:
Transaction Balance
 Cash balance necessary for day-to-day operations
 The balance associated with routine payments and
collections
Compensating Balance
 Deposit to meet bank loan requirements
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Firms Hold Cash For:
Precautionary Balance
 Cash balance held in reserve for unforeseen
fluctuations in cash flows
 Access to line of credit can reduce need for
precautionary balances
Speculative Balance
 Cash balance held to enable the firm to take
advantage of any bargain purchases that might
arise
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The Cash Budget
A schedule showing cash receipts, cash
disbursements, and cash balances for a firm
over a specified period of time
Target Cash Balance
 The minimum cash balance a firm desires to
maintain in order to conduct business
Disbursements and Receipts Method
 The net cash flow is determined by estimating the
cash disbursements and the cash receipts
expected to be generated each period.
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Unilate Textiles 2011 Cash Budget
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Unilate Textiles 2011 Cash Budget
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Cash Management Techniques
Synchronized Cash Flows
 Cash inflows coincide with cash outflows,
permitting a firm to hold low transaction balances.
Check Clearing
 The process of converting into cash a check that
has been written and mailed, into the payee’s
(receiver’s) account
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Cash Management Techniques
Float
 The difference between the balance shown in a
checkbook and the balance on the bank’s records
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Cash Management Techniques
Disbursement Float
 The value of checks that have been written and
disbursed but have not fully cleared though the
banking system and thus have not been deducted
from the account upon which they have been
written
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Cash Management Techniques
Collection Float
 The total amount of money from checks that have
been received and deposited but that have not yet
been credited to the account into which they were
deposited
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Cash Management Techniques
Net Float
 = disbursement float - collection float
 = checkbook balance - bank balance
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Acceleration of Receipts
Lockbox Arrangement
 Reduces float by having payments sent to post
office boxes located near customers
• Faster mail delivery
• Faster check clearing within the same Federal
Reserve district
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Acceleration of Receipts
Preauthorized Debit System
 Allows a customer’s bank to periodically transfer
funds from that customer’s account to a selling
firm’s bank account for the payment of bills
Concentration Banking
 A technique used to move funds from many bank
accounts to a more central cash pool to more
effectively manage cash
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Disbursement Control
Payables Concentration
 More control, but can delay payments
Zero-Balance Account (ZBA)
 A disbursement account that has a balance of zero
when there is no activity
Controlled Disbursement Accounts (CDA)
 Checking accounts in which funds are not
deposited until checks are presented for payment,
usually on a daily basis
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Marketable Securities
Securities that can be sold on short notice
without much loss of principal or original
investment
 Substitute for cash balances
 Temporary investments
• Finance seasonal or cyclical operations
• Amass funds to meet financial requirements in
the near future
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Characteristics of Marketable Securities
Maturity
 Short-term
Risk
 Low
Liquidity
 High
Return (Yield)
 Relatively low
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Credit Management
Credit Policy
 A set of decisions that include a firm’s credit
standards, credit terms, methods used to collect
credit accounts, and credit monitoring procedures
Credit Standards
 Standards that indicate the minimum financial
strength a customer must have to be credit
worthy
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Credit Management
Terms of Credit
 The payment conditions offered to credit
customers
 Length of credit period and any cash discounts
offered
Credit Period
 The length of time for which credit is granted
 After that time, the credit account is considered
delinquent
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Credit Management
Cash Discount
 A reduction in the invoice price of goods offered
by the seller to encourage early payment
Collection Policy
 The procedures followed by a firm to collect its
accounts receivables
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Credit Management
Receivables Monitoring
The process of evaluating the credit policy
and payment patterns to determine whether
a shift in the customers’ payment pattern
occurs or whether the credit policy needs
modifications
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Credit Management
Receivables Monitoring
Days Sales Outstanding (DSO)
• The average length of time required to collect
accounts receivable
• Also called the average collection period
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Credit Management
Receivables Monitoring
Aging Schedule
 Report showing how long accounts receivable
have been outstanding
 The report divides receivables into specified
periods, which provides information about the
proportion of receivables that are current and
proportion that are past due for given lengths of
time
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Unilate Textiles Aging Schedule, 2010
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Analyzing Proposed Changes
in Credit Policy
Marginal Costs and Benefits
•
•
•
•
Change
Change
Change
Change
in
in
in
in
sales
variable operating costs
average collection period
carrying cost of receivables
Proposed changes should be evaluated the
same way as capital budgeting projects would
be; changes should be made only if NPV
Proposal > 0.
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Inventory Management
Raw Materials
 Inventories purchased from suppliers that will
ultimately be transformed into finished goods
Work In-Process
 Inventory in various stages of completion
Finished Goods
 Inventories that have completed the production
process and are ready for sale
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Optimal Inventory Level
Sustain operations at lowest possible cost
Inventory Costs
 Carrying Costs
• Storage, insurance, use of funds, depreciation,
etc…
 Ordering Costs
• Costs of placing an order
• The cost of each order is generally fixed
regardless of the average size of inventory.
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Optimal Inventory Level
C = carrying cost as a percent
PP = purchase price of inventory
Q = quantity
O = cost per order
T = total demand in units
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Optimal Inventory Level
Economic Order Quantity (EOQ)
 The optimal quantity that should be ordered
 It is the quantity that will minimize the total
inventory costs.
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Optimal Inventory Level
EOQ Model
 Formula for determining the order quantity that
will minimize total inventory costs
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EOQ Model Extensions
Reorder Point
 The level of inventory at which an order should
be placed
Safety Stocks
 Additional inventory carried to guard against
changes in sales rates or production/shipping
delays
Quantity Discount
 A discount from the purchase price offered for
inventory ordered in large quantities
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Inventory Control Systems
Red-Line Method
 An inventory control procedure in which a red line
is drawn around the inside of an inventory-stocked
bin to indicate the reorder point level
Computerized Inventory Control System
 A system of inventory control in which a computer
is used to determine reorder points and to adjust
inventory balances
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Inventory Control Systems
Just-in-Time System
 A system of inventory control in which a
manufacturer coordinates production with
suppliers so that raw materials or components
arrive just as they are needed in the production
process
Outsourcing
 The practice of purchasing components rather
than making them in-house
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Multinational
Working Capital Management
Cash Management
 Speed up collections and slow down
disbursements
 Shift cash as rapidly as possible to those areas
where it is needed
 Put temporary cash balances to work earning
positive returns
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Multinational
Working Capital Management
Credit Management
 Credit policy is more important because:
• Risk of default
• Political and legal collection constraints
• Exchange rate changes between sale and time
receivable is collected
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Multinational
Working Capital Management
Inventory Management
 Concentrate inventory or distribute?
• Costs versus distribution schedules
 Exchange rates affect inventory
 Threat of expropriation
 Tax effects
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