Chapter 13
Working Capital Management
Outline
Short-term Cash Flow Planning
Managing Accounts Receivable
Credit Terms, Float, and Cash
Management
Inventory Management
Effect of Working Capital on Capital
Budgeting
Short-term Cash Flow
Planning
Cash is an inventory item
 Need to know how much you will need to
complete daily transactions
 Anticipate daily cash inflow
 Plan for any short fall between outflow and inflow
For a business it’s the cash conversion cycle
(CCC)
CCC looks at the timing of cash flow or how
long it takes the business to generate cash
Short-term Cash Flow
Planning
CCC components
Production cycle – from when product is
started until customer “buys” the product
Collection cycle – from time customer
“buys” the product until customer makes
payment
Payment cycle – from the time company
receives materials for production until the
Short-term Cash Flow
Planning
Estimating production cycle
 Find average inventory
 Determine inventory turnover using COGS
 Calculate production cycle
 Example page 351…7.6 Days
Estimate collection cycle
 Find average accounts receivable
 Determine A/R turnover using credit sales
 Calculate collection cycle
Short-term Cash Flow
Planning
Estimate payment cycle
Find average accounts payable
Determine accounts payable turnover
Calculate payment cycle
Example page 353…7.0 days
CCC = 7.6 + 13.8 – 7.0 = 14.4 days
Must carry operations 15 days
Managing Accounts
Receivable
Objective in accounts receivable
management: speed up receivables
Want payment from customers as soon as
practical
Must be aware of standard business
practices
First step is to estimate cash flow from
sales
Managing Accounts
Receivable
Aging receivables
Identifies chronic late payers
Assigns late fees to proper accounts
Follow-up with late paying customers
Example 13.2
Follow-up invoice with late fees
Late fees billed by individual invoices
Credit Terms, Float
& Cash Management
Granting of credit to customers
 Policy on qualifying customers for credit
 Policy on payment plan
 Policy on follow-up for late payments
Qualifying for credit
 Credit screening
 Increasing cost as more information required
 Increasing cost usually match the increase in the size of
the credit
Credit Terms, Float
& Cash Management
Payment Policy
Methods to speed up receivables
Discount for speedy payment
Lock boxes for faster processing of payments
Wire transfers
Your Payment Policy (Accounts
Payable)
Methods to slow down payables
Inventory Management
Keeping track of inventory
ABC Method
A goods are critical goods, or high priced goods
B goods are moderately priced or essential
goods
C goods are low priced or non-essential goods
Most effort is spent on A goods
Little effort is spent on C goods
Economic Order Quantity – how much
Inventory Management
Cost components of inventory
 Carrying Costs
 The storage and handling costs while inventory is in
“store” or “manufacturing facililty”
 Costs include space and utilities
 Ordering Costs
 The cost paid to ship inventory items from supplier to
company
 Does not include the cost of the item
EOQ finds optimal trade-off between carrying
Inventory Management
 Carrying Costs (cc), per unit carrying costs times
average inventory
 Ordering Costs (oc) number of orders times cost per
order
 Total Inventory Costs = CC + OC
 EOQ is optimal order quantity that minimizes total
inventory costs with S being annual sales
Inventory Management
Additional Issues with EOQ
 Reorder Point
 Placement of order quantity before inventory hits zero
due to shipping time
 Does not alter the actual order quantity or average
inventory on hand
 Safety Stock
 Placement of order quantity before inventory hits zero
and with additional days in case order is delayed
 Does not alter quantity but does increase average
inventory on hand
JIT – Just in Time, system that sets safety
Effect of Working Capital on Capital
Budgeting
Working Capital usually a necessary
component of a project
 Build up current assets and current liabilities at
start of a project
 Necessary components for making products
 Expensed as products are sold
Maintained inventory levels during the project
but could build as production increases
Recover working capital at end of project
 Draw down of inventory items supporting
Problems – First Set
Problem
Problem
Problem
Problem
Problem
Problem
1 – Business Operating Cycle
3 – Production Cycle
5 – Collection Cycle
7 – Payable Cycle
9 – Accounts Receivable
11– Aging Accounts Receivable
Problems – Second Set
Problem 13 – Credit Screening
Problem 15 – Credit Terms
Problem 17 – Economic Order Quantity