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CHAPTER 16
Current Asset Management
and Financing
Investment and financing policies
Cash and marketable securities
management
Receivables and inventory
management
Short-term financing
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Short-Term Financial Management
Short-term financial management
involves all current asset accounts
and most current liability accounts.
The primary goal of short-term
financial management is to support
operations at the lowest possible cost:
Must have sufficient current assets.
Must ensure liquidity
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Current Asset Investment Policies
CA ($)
High
Moderate
Low
Utilization
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Current Asset Investment Policies
Factors affecting current asset levels
Level of business risk
• High business risk - greater level of current
assets required (safety stocks)
• Low business risk - lower level of current assets
required
Opportunity costs of capital
• Interest rates
• Market returns on investment capital
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Current Asset Financing Policies
Moderate. Matches the maturity of the
assets with the maturity of the financing.
Uses permanent capital to finance
permanent assets.
Uses temporary financing to finance
temporary assets.
Aggressive. Uses short-term financing
to finance permanent assets.
Conservative. Uses permanent capital
to finance temporary assets.
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$
Temporary CA
ST Financing:
Loans
Permanent CA
LT Financing:
Stock and
Bonds
Fixed Assets
Years
Lower dashed line, more aggressive.
Higher dotted line, more conservative.
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Cash Management
The goal of cash management is to
hold the minimum amount necessary
to meet liquidity requirements.
The primary cash management
techniques are:
Cash flow synchronization
Float management
• Acceleration of receipts
• Disbursement control
Costs of cash management initiatives
must have corresponding benefits.
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Cash Flow Synchronization
The greater the timing match between
a business’ cash inflows and outflows,
the lower the required cash balance.
Some businesses are able to bill
customers on a cycle that promotes
cash flow synchronization.
The cash budget is the best method
for monitoring cash management.
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Float
Net float is the difference between the
cash amount on the firm’s books and the
amount on the bank’s books.
Suppose Family Healthcare writes $2,000 in
checks daily. It takes 6 days for these to be
received and clear the banking system, so
its disbursement float is $12,000.
Family Healthcare receives $3,000 in checks
daily which are cleared in 3 days. Thus, its
collections float is $9,000.
Its net float is $12,000 - $9,000 = $3,000.
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Acceleration of Receipts
Net float is maximized by accelerating
receipts and slowing disbursements.
Some techniques used for receipt
acceleration are:
Lockboxes
Concentration banking
Automated clearinghouses
Federal Reserve wire system
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Disbursement Control
Disbursement control is the “flip side”
of receipt acceleration.
Some techniques used for disbursement control are:
Payables centralization
Master and zero-balance accounts
Controlled (remote) disbursement
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Marketable Securities Management
Businesses hold marketable securities
for two primary reasons:
As an interest earning substitute for cash.
As a temporary repository for cash being
accumulated to meet a specific need.
In reality, cash management and
marketable securities management are
accomplished simultaneously.
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Marketable Securities (Cont.)
Characteristics of marketable securities
In general, marketable securities are
chosen on the basis of safety:
Protection of principal is primary.
Amount of return is secondary.
Specific securities used depend on the:
Expected holding period.
Size of the business.
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Receivables Management
Importance of receivables management
to HSO’s (third party predominance)
Financing of A/R with short-term debt
vs. equity (cost of capital issues)
Goal of A/R mgmt. is to minimize the
carrying costs
Acceleration of A/R receipts
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Receivables Management
Monitoring A/R position
Factors affecting A/R balance -- credit
sales volume and avg. collection period
(ACP)
ACP = Avg. A/R balance divided by average
daily credit sales
Comparison of ACP to historical/industry
Limitations of using ACP to monitor A/R
position (influence of sales volume)
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Receivables Management
Monitoring A/R position
Aging schedules of A/R accounts
Influence of sales volume changes on
average age of A/R accounts
Uncollected A/R balance schedule -factors out influence of fluctuations in
sales volume on A/R balance and ACP
Interpretation of uncollected A/R balance
schedule
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Receivables Management
Management interventions to improve
A/R position
Reasonably aggressive collections policy
“Early payment” discounts
Electronic billing/payment methods
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Inventory Management
Relationship to receivables management
Consequences of poor inventory mgmt.
Too little inventory (stockouts)
Too much inventory (tied up cash)
Inventory management methods
Computerized inventory control systems
Just in time inventory methods
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Inventory Management
Inventory Management Methods
Economic Ordering Quantity (EOQ) model
• Minimize the costs of holding inventory
• Total inventory costs as a function of inventory
carrying costs and inventory ordering costs
• Does not consider the cost of the inventory
• Allow for identification of optimal “ordering
quantity” per order to minimize costs (ICC, IOC)
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Inventory Management
Inventory Management Methods
Economic Ordering Quantity (EOQ) model
• Examples of ICC (storage, insurance, financing)
• Estimation of ICC as a percentage of total
inventory purchase (10-20%)
• Relationship of ICC to total inventory purchases
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Inventory Management
Inventory Management Methods
Economic Ordering Quantity (EOQ) model
• Fixed nature of IOC assumed
• Examples of IOC (costs of ordering)
• Estimation of IOC as a function of average
inventory purchases
• Relationship of IOC to total inventory purchases
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Inventory Management
Inventory Management Methods
Economic Ordering Quantity (EOQ) model
• Total inventory holding costs (TIC) = ICC + IOC
• Estimation of EOQ using formula
• Interpretation of EOQ
• Equivalence of ICC and IOC at EOQ
• Minimization of TIC at EOQ
• Application of EOQ model -- reorder points,
safety stock estimation, quantity discounts
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Current Liability Management
Current liabilities as source of WC
Short-term financing has three
primary advantages over long-term:
Lower issuance costs
Fewer restrictive covenants
Generally lower interest rate
Major sources for providers:
Accruals
Accounts payable (trade credit)
Bank loans
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Accruals
 Accruals consist primarily of wages owed
to employees and taxes owed to
governments.
 Accruals are free in the sense that no
explicit interest is charged.
 However, managers have little control over
the level of accruals, which is influenced
more by industry custom and tax laws.
 Management of accrual accounts (source
of short-term financing)
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Accounts Payable (Trade Credit)
Trade credit is credit furnished by a
firm’s suppliers.
Trade credit is often the largest source
of short-term credit for most firms.
Categories of trade credit
Free trade credit
Costly trade credit
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Northwest Healthcare buys $3,000,000
(at net) of medical supplies from one of
its vendors on terms of 2/10, net 30.
How much free and costly trade credit
is available from this vendor?
Calculate net daily purchases
Net daily purchases = $3,000,000/360
= $8,333.
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Gross/Net Breakdown
Northwest buys supplies worth
$3,000,000 because that is the net, or
cash, price.
If Northwest does not take the discount,
it must pay $3M / 0.98 = $3,061,224 for
the supplies. This is the gross, or
invoice, price.
The difference, $61,224, is a financing
cost similar to the interest on a loan.
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Gross/Net Breakdown
Payables level with discount
Payables = $8,333 x 10 = $83,333.
Payables level without discount
Payables = $8,333 x 30 = $249,990.
Credit breakdown
Total trade credit = $249,990
Free trade credit = 83,333
Costly trade credit = $166,657
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Approximate Cost of
Costly Trade Credit
Northwest loses $61,224 to obtain
$166,657 in extra trade credit, so
$61,224
Cost =
= 0.367 = 36.7%.
$166,657
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Approximate Cost Formula
360
Cost = Discount % x
Discount
1 - Discount % Days
taken
period
= 2 x 360 = 0.0204 x 18
98
30 - 10
= 0.367 = 36.7%.
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What Should Northwest Do?
Northwest should take the $83,333 in
free trade credit--it should take all the
free trade credit that it can get.
However, it should take the costly
trade credit only if the implied cost is
less than the cost of alternative
financing sources.
Because Northwest can obtain bank
loans at a 10% rate, it should not take
the $166,657 in costly trade credit.
Copyright © 1999 by the Foundation of the American College of Healthcare Executives