ĐẠI HỌC HOA SEN
Khoa Kinh tế Thương mại
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KHOA KINH TẾ THƯƠNG MẠI
FINANCIAL
MANAGEMENT
ThS. Nguyễn Tường Minh
Email: minh.nguyentuong@yahoo.com.vn
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References
• Foundation of Financial Management, Block & Hirt,
McGraw Hill, 13th edition,USA, 2009.
• Fundamentals of Corporate Finance, Brealey et al.,
McGraw Hill, 5th edition, USA, 2007.
• Other relevant materials.
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Chapter 7: Current Asset
Management
•
Main Contents:
1.
2.
3.
4.
5.
Cash Management
Collections and Disbursement
Marketable Securities
Management of Accounts Receivable
Inventory Management
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WHAT IS CURRENT ASSET
MANAGEMENT ?
• Involves the management of cash, marketable securities, accounts receivable,
and inventory
• Ensures a competitive advantage and often creates an increase in shareholder
value
• Primarily concerned with liquidity and safety, and then on maximizing profits
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I. 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 firm
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I. Cash Management (cont’d)
1. Reason for holding Cash Balance
• Transactions balances
– Payment towards planned expenses
• Compensative balances for banks
– Compensate a bank for services provided rather than paying directly for them
• Precautionary needs
– Emergency purposes
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I. Cash Management (cont’d)
2. Cash flow cycle
• Ensure that cash inflows and outflows are synchronized for transaction purposes
– Cash budget 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
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I. Cash Management (cont’d)
3. Expanded Cash Flow Cycle
• Financial Managers must pay
attention to the percentage of sales
generated:
– By cash
– By outside credit cards (*)
– By the company’s own credit terms
(**)
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II. Collections and
Disbursements
• Primary concern to the Financial managers is the management of:
– Cash Inflows – still affected by collection mechanisms
– Payment outflow
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II. Collections and
Disbursements (cont’d)
1. Float
• Difference between firm’s recorded amount and amount credited to the firm
by a bank
– Arises due to time delays in mailing, processing and clearing checks through
the banking system
– Can be managed to some extent by combining disbursements and collection
strategies
– Main challenge: the physical presentation of the check to the issuing bank
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II. Collections and
Disbursements (cont’d)
1. Float (cont’d)
• Factors that help in reducing Float: (*)
– Ease of credit and debit cards payments and online banking for customer
– Wire transfers for corporation
– Rise of Internet commerce
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II. Collections and
Disbursements (cont’d)
1. Float (cont’d)
• Example of Float – Day one:
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II. Collections and
Disbursements (cont’d)
1. Float (cont’d)
• Example of Float – Day two:
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II. Collections and
Disbursements (cont’d)
2. Improving Collections
• Setting up multiple collections centers at different locations
• Adopt Lockbox System (*) for expeditious check clearance at lower costs
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II. Collections and
Disbursements (cont’d)
3. Extending Disbursements (*)
• Speed up processing of incoming checks
• Slow down payment procedures
– Extended disbursement float – allows companies to hold onto their cash balances
for as long as possible
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II. Collections and
Disbursements (cont’d)
• Cash Management Network:
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II. Collections and
Disbursements (cont’d)
4. 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
• Carried out through Society for Worldwide Interbank Financial
Telecommunications (SWIFT)
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II. Collections and
Disbursements (cont’d)
5. International Cash Management
• Factors differentiating international cash management from domestic based
systems:
– Differing payment methods, and 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
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II. Collections and
Disbursements (cont’d)
5. International Cash Management (cont’d)
• Financial managers try to keep as much cash as possible in a country with
a strong currency
• Sweep account
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III. Marketable Securities
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III. Marketable Securities (cont’d)
• Types of Short-Term Investments:
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IV. Management of Account
Receivable
• Account 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
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IV. Management of Account
Receivable (cont’d)
• Credit policy administration:
1. Credit standard
– Determine the nature of credit risk based on:
• Prior records of payments and financial stability
• Current net worth and other related factors
– 5 characters of credit:
• Character
• Capital
• Capacity
• Conditions
• Collateral
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IV. Management of Account
Receivable (cont’d)
2. 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 discounts
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IV. Management of Account
Receivable (cont’d)
3. Collection policy
– A number if quantitative measures applied to assess credit Policy
• Average collection period:
• Ratio of bad debts to credit sales
• Aging of Accounts Receivable – way of finding out if customer are paying their bills
within the time prescribed in the credit terms
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IV. Management of Account
Receivable (cont’d)
3. Collection policy
• If the normal credit term are 30 days, 40% of account are overdue
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IV. Management of Account
Receivable (cont’d)
• An actual credit decision
– Bring together various elements of Accounts Receivable management
– Assuming that the ratio between sales and account receivable is six to one
Accounts receivable =
Sales = $10,000 = $1,667
Turnover
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– Only invest $1,667 in receivables; the company gets an after tax return of $480 28
V. 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
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V. Inventory Management (cont’d)
1. Level vs Seasonal Production
• Level production
– Maximum efficiency in manpower and machinery usage
– May result in high inventory buildup
• Seasonal production
– Eliminate inventory buildup problems
– May result in unused capacity during slack periods
– May result in overtime labor charges and overused equipment repair charges
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V. Inventory Management (cont’d)
2. Inventory policy in Inflation and Deflation
• Inventory position can be protected in an environment of price instability by:
– Taking moderate inventory positions (by not committing at a single price)
– Hedging with a futures contract to sell at a stipulated price some months from now
• Rapid price movement in inventory may also have a major impact on the
reported income of the firm
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V. Inventory Management (cont’d)
3. 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
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V. Inventory Management (cont’d)
4. Determining the Optimum Inventory Level
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V. Inventory Management (cont’d)
5. Determining Economic Ordering Quantity (EOQ):
EOQ = 2SO
C
• S: Total sales in units
• O: Ordering cost for each order
• C: Carrying cost per unit in dollars
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V. Inventory Management (cont’d)
5. Determining Economic Ordering Quantity (cont’d):
Assuming that we anticipate selling 2,000 units, it will cost us $8 to place each order
The price per unit is 1$, the carrying charge per unit is $0.20.
Determine (1) Economic Ordering Quantity, (2) Available Average Inventory, and
(3) Total cost of Inventory.
EOQ = 2SO
C
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V. Inventory Management (cont’d)
6. Inventory Usage Pattern:
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V. Inventory Management (cont’d)
7. 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:
• Eliminate loss due to stock outs
• Increased profits from unexpected orders
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V. Inventory Management (cont’d)
7. Safety stocks and Stock outs (cont’d):
Average inventory = EOQ + Safety stock
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Carrying costs = Average inventory in units x Carrying cost per unit
If a safe stock of 50 units were maintained.
Determine (1) the Average Inventory figure, assuming that the Economic Order
Quantity is 400 units; (2) Carrying Costs, assuming that the carrying cost of each
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unit is $0.20
V. Inventory Management (cont’d)
8. Just-in-Time Inventory Management:
• Basic requirements (*) for JIT:
– Quality production that continually satisfies customer requirements
– Close ties between suppliers, manufacturers, 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 decade
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V. Inventory Management (cont’d)
8. Just-in-Time Inventory Management (cont’d):
• Advantages of JIT
– Reduction in space due to reduced warehouse space requirement
– Reduced construction and overhead expenses for utilities and manpower
– Reduction in costs from quality control
– Elimination of waste
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V. Inventory Management (cont’d)
8. Just-in-Time Inventory Management (cont’d):
• Areas of concern for JIT
– Integration cost (*)
– Parts shortages could lead to lost sales, and slow grwoth
• 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
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Appendix
Part 1 - Cash management
Part 2 - Float
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Part 1
CASH MANAGEMENT
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I. Tracing Cash and Net Working
Capital
Cash = Long-term debt + Equity + Current Liabilities
– Current Assets other than Cash – Fixed Assets
• Activities increase Cash (source of Cash):
• Activities decrease Cash (Uses of Cash):
– Increase long-term debt
– Decrease long-term debt
– Increase equity
– Decrease equity
– Increase current liabilities
– Decrease current liabilities
– Decrease current assets other than cash
– Increase current assets other than cas
– Decrease fixed assets
– Increase fixed assets
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I. Tracing Cash and Net Working
Capital
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II. The Operating Cycle and the
Cash Cycle
1. Defining the Operating and Cash cycle:
• Operating Cycle
– The entire cycle from the time we acquire inventory to the time we collect the cash
– Operating cycle describes how a product moves through the current asset accounts
Operating Cycle = Inventory period + Accounts Receivable period
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II. The Operating Cycle and the
Cash Cycle (cont’d)
1. Defining the Operating and Cash cycle (cont’d):
• What is Operating Cycle ?
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II. The Operating Cycle and the
Cash Cycle (cont’d)
1. Defining the Operating and Cash cycle (cont’d):
• Cash Cycle
– The time between cash disbursement and cash collection
Cash Cycle = Operating Cycle - Accounts Payable period (*)
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II. The Operating Cycle and the
Cash Cycle (cont’d)
1. Defining the Operating and Cash cycle (cont’d):
• What is Cash Cycle ?
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II. The Operating Cycle and the
Cash Cycle (cont’d)
1. Defining the Operating and Cash cycle (cont’d):
– The gap between Cash inflow and Cash outflow creates the need for short-term
financial management
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II. The Operating Cycle and the
Cash Cycle (cont’d)
1. Defining the Operating and Cash cycle (cont’d):
• Solution to solve the gap:
– Borrow or hold a liquidity reserve (*)
– Changing the inventory, receivable, and payable periods
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II. The Operating Cycle and the
Cash Cycle (cont’d)
• Under here is the financial information of Slowpay Company:
– Credit sales for the year just ended $50,000, and the cost of goods sold was $30,000
Determine (*):
1.
How long does it take Slowpay to collect on its receivables ?
2.
How long does merchandise stay around before it sold ?
3.
How long does Slowpay stay to pay its bills ?
4.
What are the Operating Cycle and Cash Cycle ?
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Part 2
FLOAT
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I. Understanding Float
Float = Available balance – Ledger balance (book balance)
• Available balance – the balance show on the bank account
• Ledger balance – the cash balance that a firm shows on its books
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I. Understanding Float (cont’d)
1. Disbursement Float:
8 June: Write a check of $100,000
Supplier
- Book balance
immediately reduced by
$100,000
Company
•Before 8 June: float = 0
•From 8 June to the check
is presented: float = $100,000
Until the check is presented,
the available balance is
greater than its book balance
by $100,000
Has an account of $100,000
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I. Understanding Float (cont’d)
1. Disbursement Float (cont’d)
– Checks written by a firm generate Disbursement float
– Disbursement float causes a decrease in the firm’s book balance, but no change in its
available balance
– Company writing the check can obtain the benefit of this cash during the period of
check clearing
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I. Understanding Float (cont’d)
2. Collection Float and Net Float:
8 October: Receive a check of $100,000
•Before 8 Oct: float = 0
•From 8 Oct to the check
is presented: float = - $100,000
- Book balance
immediately increases
by $100,000
Company
Deposit the check to
company’s bank.
Present the check
Customer’s bank
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Had an account of $100,000
I. Understanding Float (cont’d)
2. Collection Float and Net Float (cont’d)
– Checks received by the firm create Collection float
Net Float = sum of the total collection + sum of the total disbursement
– The net flow at a point in time is the overall difference between the firm’s available
balance and its book balance
– Net float is positive, the firm’s disbursement float exceeds its collection float or the
available balance exceeds its book balance
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I. Understanding Float (cont’d)
2. Collection Float and Net Float (cont’d)
Net Float = sum of the total collection + sum of the total disbursement
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I. Understanding Float (cont’d)
2. Collection Float and Net Float (cont’d)
– The average daily sales of Exxon Mobil are about $1 billion. If the company’s collection
could be speed up by a single day…
…it could free up $1 billion for investing and with its interest earned
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I. Understanding Float (cont’d)
3. Float Management
– Should speed up collections
– reduce the lag between the time customers pay their bills and the time the cash becomes
available
– control payments and minimize the firm’s costs associated with making payments
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I. Understanding Float (cont’d)
3. Float Management (cont’d)
 Measure Float
Each month, mail a check of $500
•The total delay: 9 days
Company
– What is your average daily collection float ?
(9 x 500) / 30 = $150
– What is the meaning of average daily disbursement ?
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Book balance is $150 less than the available balance
I. Understanding Float (cont’d)
3. Float Management (cont’d)
 Measure Float (cont’d)
Each month, receive two items:
•1st receipt: $5 million (total delay: 9 days)
•2nd receipt : $3 million (total delay: 5 days)
Company
– What is your average daily collection float ?
Average
Daily Float
=
Average daily
receipts
x
Weighted
average delay
• Average daily receipts: 8/30 = $266,666.67
• Weighted average delay: (5/8)*9 + (3/8)*5 = 7.5 days
• Average Daily Float: $266,666.67 * 7.5 = $2 million
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Ex 1, 4, 6, p 717
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I. Understanding Float (cont’d)
3. Float Management (cont’d)
 Cost of the Float
– The basic cost of collection float to the firm is simply the opportunity cost of not
being able to use the cash
•Company has average daily receipts of $1,000
•Weighted average delay: 3 days
•Interest rate: 7.5% (yearly)
Company
– There is $3,000 that is not earning interest
– Cost of the Float = $0.62 per day
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I. Understanding Float (cont’d)
3. Float Management (cont’d)
 Cost of the Float
(cont’d)
•Company has average daily receipts of $1,000
•Weighted average delay: 3 days
Company
– Suppose the company could eliminate the float entirely, what would be the benefit ?
– If it costs $2,000 to eliminate the float, what is the NPV of doing so ?
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I. Understanding Float (cont’d)
3. Float Management (cont’d)
 Cost of the Float
(cont’d)
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I. Understanding Float (cont’d)
3. Float Management (cont’d)
 Cost of the Float
(cont’d)
– Suppose the company could eliminate the float entirely, what would be the benefit ?
• It will be richer $3,000
– If it costs $2,000 to eliminate the float, what is the NPV of doing so ?
• NPV = -$2,000 + $3,000 = $1,000
• The company should do it
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Part 3
CREDIT AND RECEIVABLES
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I. Credit and Receivables
1. The investment in Receivables
•Firm’s average collection period (ACP): 30 days
Company
– If credit sales run $1,000 per day, the firm’s average account receivable will be ……
30 days x $1,000 per day = $30,000
– A firm’s investment in account receivable depend on factors that influence credit sales
and collections
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I. Credit and Receivables
1. The investment in Receivables
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II. Terms of Sale
1. Cash discounts
– Cash discounts (sales discounts) – a discount given to induce prompt payment
– Cash discounts are given to speed up the collection of receivables
– Cash discounts are given to charge higher prices to customers that have had credit
extended to them
– Buyer pay in 10 days to make the greatest possible use of free credit
2/10, net 30
– …or pay in 30 days to get the longest possible use of money in exchange
for giving up the discount (20 days’ credit)
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II. Terms of Sale (cont’d)
1. Cash discounts (cont’d)
 Cost of the Credit ( from buyer’s viewpoint)
– Suppose the order if for $1,000; and applied the term:
2/10, net 30
– Early payment gets the buyers a 2% discount
– Does this provide a significant incentive for early payment ?
0
$980
1,000
10
30
$20 = interest in 20 days
of borrowing $980
The buyer
pays
– The interest rate of $980 = 20/980 = 2.0408%
– Effective Annual Rate (EAR) = (1+ 2.0408%)365/20 -1 = 44.6%
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II. Terms of Sale (cont’d)
1. Cash discounts (cont’d)
 Cost of the Credit (cont’d)
– From the buyer’s viewpoint, 44.6% is an expensive source of financing
– Ignoring the possibility of default by the buyer, the decision of a customer to forgo
the discount works to the seller’s advantage
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II. Terms of Sale (cont’d)
1. Cash discounts (cont’d)
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II. Terms of Sale (cont’d)
2. Cash discount and the ACP
•Currently, annual sales are $15 million, has term of net 30,
and ACP is 30 days
•If it offers terms of 2/10 net 30, 50% of its customers will
pay in 10 days
Company
1. What will the new ACP be ?
50% x 10 days + 50% x 30 days = 20 days
2. What will happen to the investment in receivables after the term of sales is offered ?
The A/R will fall by: ($15 million/365) x (30 - 20) = $410,960
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Ex 3, 7, p 758
II. Terms of Sale (cont’d)
2. Cash discount and the ACP (cont’d)
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Thank you for your attention !
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