New Venture Development
Exam 2 content
Revised March 13
Spring 2013
Working Capital
• Working capital consists of the current assets
and the current liabilities of a business.
• Current assets are gross working capital.
– Cash, marketable securities, accounts receivable,
and inventory
• Net working capital is the difference between
a business’s total current assets and its total
current liabilities.
• Compare to the current ratio of current assets
divided by current liabilities
Working Capital Management
• Working capital management is our ability to
effectively and efficiently control current
assets and current liabilities in a manner that
will provide our firm with maximum return on
its assets and will minimize payments for its
liabilities.
Current Asset Management
•
•
•
•
Cash management
Marketable securities management
Accounts receivable management
Inventory management
Marketable Securities Management
• Marketable securities normally are those
investment vehicles that include U.S. treasury
bills, government and corporate bonds, and
stocks.
• Excess cash should be placed in the above
vehicles because they increase in value more
than cash itself.
Accounts Receivable Management
• The goal of accounts receivable management
is to increase sales by offering credit to
customers.
– Options to offering credit include:
• The business issuing its own credit card or line of credit.
• Factoring—selling accounts receivable to another firm
at a discount off of the original sales price.
Accounts Receivable Management
(continued)
• Credit terms are the requirements that our
business establishes for payment of a loan
(the use of credit by a customer).
– To speed up collections, cash discounts are
often offered to a business customer. An
example would be 2/10 net 30. If the customer
pays the bill within 10 days of the invoice a 2
percent discount is given. Otherwise the entire
net is due 20 days later or at the 30th day.
Analyzing accounts receivable
• Accounts receivable turnover:
Credit Sales
Accounts receivable turnover 
Avg accounts receivable
• Example:
$300,000
Accounts receivable turnover 
6
$50,000
• Collection days is 365 days in a year divided by
accounts receivable turnover:
365
Collection days 
 60.833days  61days
6
Analyzing inventory turnover
• Inventory turns:
COGS
#of inventory turns 
Avg inventory
• Example:
$150,000
# of inventory turns 
 7 .5
$20,000
• Inventory turnover days is 365 days in a year
divided by the # of inventory turns in a year:
365
Inventory turnover days 
 48.67 days  49days
7.5
Inventory Management
• The overall goal of inventory management
is to minimize total inventory costs while
maximizing customer satisfaction.
• Two primary decisions must be made:
– Establish the reorder quantity (the number of
items to order)
– Establish the reorder point (that level of
inventory at which a new order will be placed).
Inventory Management (continued)
• Economic Order Quantity Formula:
– Attempts to balance ordering costs against
storage costs and provide us with the most
economic quantity to order to minimize overall
inventory costs.
EOQ 
– Where
2 DS
IP
Inventory Management (continued)
• Reorder Point Calculations
– The reorder point (ROP) has three factors that
are used in determining the quantity of an item
that exists when we actually place an order:
• Lead-time (L) is the time that lapses from order
placement to order receipt.
• Daily demand (d) is the quantity of a product that is
used per day.
• Safety Stock (ss) the quantity of stock you keep for
variations in demand.
ROP  Ld  ss
Current Liabilities Management
• Current liabilities management consists of
minimizing our obligations and payments
for short-term debt, accrued liabilities, and
accounts payable. It consists of:
– Short-term debt management
– Accrued liabilities management (servicing longterm debt)
– Accounts payable management
Current Liabilities Management
(continued)
• Short-term debt management
– Short-term debt consists of business
obligations that will be paid within the current
accounting period. They consist of the
following:
•
•
•
•
•
Current payments on long-term debt
Bank lines of credit
Notes payable
Accounts payable
Short-term loan for one year or less
Accrued Liabilities Management
(continued)
• Accrued liabilities are those obligations of the
firm that are accumulated during the normal
course of business and are primarily payroll
taxes and benefits, property taxes, and sales
taxes.
Accounts Payable Management
• Accounts payable are the debts of a business
which are owed to vendors. Vendors offer
several types of discounts. They are:
– Trade discounts
– Cash discounts
– Quantity discounts
Accounts Payable Management
(continued)
• Trade discount examples
– 2/10 net 30 - buyer must pay within 30 days of the invoice date, but will
receive a 2% discount if they pay within 10 days of the invoice date.
– 3/7 EOM - buyer will receive a cash discount of 3% if the bill is paid within 7
days after the end of the month indicated on the invoice date.
– 3/7 EOM net 30 - buyer must pay within 30 days of the invoice date, but will
receive a 3% discount if they pay within 7 days after the end of the month
indicated on the invoice date
– 2/15 net 40 ROG - buyer must pay within 40 days of receipt of goods, but will
receive a 2% discount if paid in 15 days of the invoice date.
– Trade discounts may be expressed as a single amount, such as 30 percent, or in
a series, such as 30/20/10.
Accounts Payable Management
(continued)
• Cash discounts are offered to credit customers to
entice them to pay promptly.
– The seller views a cash discount as a sales discount.
– The customer views it as a purchase discount.
– The terms of a cash discount play an important role in
determining how the invoice will be paid.
• “Preferred payment” method discount
– Some retailers (particularly small retailers with low
margins) offer discounts to customers paying with
cash, to avoid paying fees on credit card transactions.
Accounts Payable Management
(continued)
• Cash discounts will normally appear on an invoice
in terms such as 2/10 n30.
– This means that the customer may deduct 2 percent
off of the invoice price if he or she pays within 10
days.
– If the customer does not pay within 10 days, he has
the use of 98% of the money owed for the next 20
days.
– If the customer pays within 30 days, the net, or total
amount, of the invoice is due.
– If he or she pays after 30 days, the credit agreement
with the seller normally stipulates that a monthly
interest charge be added to the unpaid balance.
Accounts Payable Management
(continued)
• Calculations used in cash discounts:
– A $10,000 invoice with terms of 2/10 n30
– Option 1: Pay off the $10,000 with a payment
of $9,800 within 10 days of the invoice date.
• This is computed by multiplying the invoice price by
1 minus the discount (1 - 0.02 = 0.98, and $10,000 x
0.98 = $9,800).
• Or by taking the invoice price times the discount
and subtracting it from the invoice price ($10,000 x
0.02 = $200, and $10,000 - $200 = $9,800).
Accounts Payable Management
(continued)
• Calculations used in cash discounts
(continued):
– A $10,000 invoice with terms of 2/10 n30
– Option 2: Pay the invoice price of $10,000 on
the 30th day after the invoice date. If this
option is chosen, he will pay the equivalent of
36.7 percent annual interest because of his
delaying payment. The logic is shown on the
following page.
Accounts Payable Management
(continued)
• Calculations used in cash discounts
(continued):
– $200 is the cost paid on $9,800 for 20 days, or
an interest rate of 2.04 percent ([$200 
$9,800] x 100).
– This will result in an effective annual interest
rate of 36.7 percent (2.04 x [360  20days]).
– The effective annual interest rate is obtained
by multiplying the time period interest rate by
the number of time periods in an accounting
year (360  20).
The working capital cycle
A negative working capital cycle is a good thing; Owen must borrow $ to maintain WC
Trade discounts
The offer
• Your supplier offers you a
trade discount of 2/10n30
• What does this mean?
• You get a 2% discount if you
pay within 10 days
• Otherwise, pay full amount
within 30
Implications
• But you are essentially
borrowing $200 at an
effective annual interest
rate of 37%
Letter Logic valuation
𝑉𝑎𝑙𝑢𝑒 𝑜𝑓 𝑓𝑖𝑟𝑚 =
𝑃𝑟𝑖𝑐𝑒
𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠
𝑋
𝑋𝑅𝑒𝑣𝑒𝑛𝑢𝑒𝑠
𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝑅𝑒𝑣𝑒𝑛𝑢𝑒𝑠