Current Asset Management
(Chapter 7)
(Chapter 6 – pages 143 – 145)
 Working Capital Management
 Current Asset Investment Policy
 Temporary and Permanent





Current Assets
Zero Working Capital
Cash Management
Marketable Securities
Accounts Receivable Management
Inventory Management
Working Capital Management:
An Overview
 Gross Working Capital -(Current Assets)
 New Working Capital - (Current Assets - Current
Liabilities)
 Working Capital Management
 Involves investing in current assets and financing
of current assets:
Current Asset
Investment
Current
Liabilities
Long-Term
Financing
Current Asset Investment Policy
 Everything else remaining the same, higher levels
of current assets mean lower risk and lower
expected return
 Lower Risk
 Greater ability to meet short-run obligations.
 Lower Return
 Cash and marketable securities typically yield
low returns. Furthermore, when current assets
are increased, additional financing costs will be
incurred thereby lowering returns.
 Lower levels of current assets result in opposite
effects.
Alternative Current Asset Investment
Policies
Current Asset (millions of $)
14
Conservative - low risk
12
Moderate
10
8
Aggressive - high risk
6
4
2
0
0
10
20
30
40
Sales (millions of dollars)
Temporary vs. Permanent Investment
in Current Assets
 Temporary Investment - Commonly, firms experience
short-run fluctuations in current assets. For example,
retail department stores will have high levels of
inventory around Thanksgiving. In January, the
inventory should be low.
 Permanent Investment - Firms always have some
minimum level of investment in current assets (i.e., a
permanent investment). As a firm grows over time,
the level of permanent current assets also grows
(e.g., a supermarket chain with 70 stores will have
more permanent inventory than a chain with 4
stores).
Temporary and Permanent Current
Assets
Millions of dollars
14
12
Temporary Fluctuations in
Current Assets
10
8
6
4
Permanent Current Assets
2
Time Period
21
18
15
12
9
6
3
0
0
Cash Management: An Overview

Beginning Cash Balance
+ Cash Inflows - - - Speed Up
- Cash Outflows - - - Slow Down
= Ending Cash Balance
- Desired Cash Balance
= Surplus or Shortage
 If Surplus: Pay off short-term debt or buy marketable
securities
 If Shortage: Short-term borrowing or sell marketable
securities
Desired Cash Balance:
 Precautionary Demand - Satisfy possible, but




as yet indefinite cash needs.
Speculative Demand - Build up current cash
balances in anticipation of future business
costs being lower.
Risk Preferences
Compensating Balances
Transactions Demand - Cash needs arising in
the ordinary course of doing business.
Float
 Much of cash management is oriented
towards managing the float.
 Mail Float
 Time lapse from the moment a customer
mails a remittance check until the firm
begins to process it.
 Processing Float
 Time required for the firm to process
remittance checks before they can be
deposited in the bank.
Float (Continued)
 Transit Float
 Time
necessary for a deposited check to
clear through the commercial banking
system and become usable funds to the
company.
 Disbursing Float
 Funds available in the firm’s bank account
until its payment check has cleared
through the system.
Electronic Funds Transfer
 Substantially reduces float
 Some Examples:
 Automated
teller machines
 Direct deposit of payroll checks
 Paying the supermarket and others with
bank cards.
Lock-Box System
 Customers mail remittance checks to
P.O. Box.
 Local bank processes and deposits
checks directly into the company’s
account.
 Reduces mail and processing float.
 Also reduces transit float if lock-box is
located near Federal Reserve Bank or
branches.
Marketable Securities
 The marketable securities portfolio is typically used
for temporary investments of excess cash, or as a
substitute for cash (i.e., near cash). Therefore,
securities in the portfolio are generally safe, shortterm, and highly liquid.
 Treasury Bills
 Short-term obligations of the federal government
with maturities of 91 days to a year. They are
traded on a discount basis in bearer form. Not
taxable at state and local levels, but taxable at the
federal level.
 Commercial Paper
 Unsecured promissory notes issued by large
corporations in amounts of $25,000 or more (No
active secondary market).
Marketable Securities Continued
 Negotiable Certificates of Deposit (CDs)

Offered by financial institutions (e.g., banks,
S&Ls). Those big business is interested in have
$100,000 minimums.
 Banker’s Acceptance: Generally arise out of foreign
trade.
 Importer (buyer) issues a promise to pay a certain
amount to the exporter (seller).
 A bank accepts the promise, and commits itself to
pay the amount when due.
 Exporter (seller) can now sell this acceptance in
the marketplace at a discount (a price that is less
than the promised amount).
Accounts Receivable Management
 Major Decisions

Credit Standards
 Credit Terms
 Collection Policy
 Credit Standards: Will they pay as agreed?
 Credit Scoring
 Credit Reports
 Past Experience
 Financial Analysis
 Debt Ratios, Liquidity Ratios, Profit Ratios
Accounts Receivable Management
(Continued)
 Credit Terms

Example: 2/10, net 30
 Collection Policy
 Standard Operating Procedures
 Be professional, firm, and do not bluff.
 Vary procedures with slow payers.
 Evaluating Collection Efforts
 Average Collection Period, Bad Debt to Sales
Ratio, Aging Accounts Receivable, Receivables
to Assets Ratio, Credit Sales to Receivables
Ratio.
Inventory Management
(Covered in Detail in Production
Management)
 Basic Costs Associated With Inventory

Carrying Costs
 storage, insurance, cost of capital used
 Ordering Costs
 placing orders, shipping and handling
 Costs of Running Short
 lost sales, reduced customer goodwill
 Objective
 Minimize total costs associated with managing
inventory.