Chapter 6: Introduction to Working
Capital Management
Outline:
 The Working Capital Cash Conversion
Cycle (CCC)
 How Changes in Current Accounts Impact
External Financing
 Working Capital Investment and
Financing Strategies
 Management of Credit and A/R
 Management of Inventory
 Management of A/P
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Session 4: Module 3, Chapter 6 - 1
The Cash Conversion of a Business
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Session 4: Module 3, Chapter 6 - 2
Discussion Question
What is a company’s CCC and cash
turnover given the following?
 Days’ inventory = 45 days
 Days’ receivables = 35 days
 Days’ payables = 30 days
Answer:
CCC = Days' Inventory + Days' Receiveables
 Days' Payables
CCC = 45 + 35  30 = 50 days
365
365
Cash Turnover =
=
= 7.3 Times
CCC
50
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Session 4: Module 3, Chapter 6 - 3
Discussion Question
Why should caution be exercised when
reducing the receivables and inventory
conversion periods or extending the payables
deferral period?
Answer:
 Lost sales from overly strict credit and collection
 Production stoppages from inadequate materials or parts
 Payables stretched beyond the due date
 Foregone cost-saving trade discounts
 Higher prices assessed by vendors due to smaller
orders or slower payment
 Refusal to sell to customers that are good credit
risks but occasionally slow in paying
 Excessive reliance on A/P in lieu of a stable base of
short-term bank credit
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Session 4: Module 3, Chapter 6 - 4
Discussion Question
Which two accounts vary spontaneously as
sales levels change, and how do they change?
Answer:
 Current assets—As sales increase, credit sales
also increase, resulting in larger dollar amounts
invested in A/R.
 Current liabilities—Decrease in A/P results
in a decrease in cash or an increase
in debt because decreases in current
liabilities must be offset by decreases
in an asset account or increases in other
liability accounts.
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Session 4: Module 3, Chapter 6 - 5
Discussion Question
What are some of the characteristics of a
restrictive current asset investment strategy?
Answer:
 Company maintains low levels of current
assets relative to sales.
 Raw materials investment is tightly
managed using JIT.
 A/R balances are kept low.
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Session 4: Module 3, Chapter 6 - 6
Discussion Question
What are some of the characteristics of a
relaxed current asset investment strategy?
Answer:
 A company maintains high levels of current
assets relative to sales:



High levels of cash
High levels of A/R
A large investment in current assets is
likely to lower investment returns, but
the firm operates with less risk because
of its larger liquid asset balances.
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Session 4: Module 3, Chapter 6 - 7
Alternative Current Asset
Financing Policies
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Session 4: Module 3, Chapter 6 - 8
Relationship Between Treasury
and Credit Management

Credit management
Treasury and credit management are typically
separated (must maintain good relations).
 Credit is a sales tool, so credit manager works
with sales manager.
 Establish credit standards, define credit
extension terms, approve customers for credit
sales and set individual/aggregate credit
limits.


A/R management


Typically a credit manager responsibility.
Bill and process payments, monitor payment
patterns and collect delinquent accounts.
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Session 4: Module 3, Chapter 6 - 9
Trade Credit Policies
Policies and
procedures should
clearly define:
 Credit standards
 Credit terms
 Discount terms
 Collection
policies
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Session 4: Module 3, Chapter 6 - 10
Discussion Question
What are the ramifications of overly strict or
overly lenient credit standards?
Answer:
 Too strict: A company may decline trade
credit to customers who represent an
acceptable credit risk and limit their sales
opportunities.
 Too lenient: A company may grant
trade credit to customers who represent
an unacceptable credit risk and increase
the risk of late payments and bad debt
expenses.
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Session 4: Module 3, Chapter 6 - 11
The Five C’s of Credit
Character
An intent or willingness to pay, as
evidenced by payment history
Capacity
Current and future financial resources
that can be committed to pay obligations
Capital
Short- and long-term financial resources
to supplement insufficient cash flow for
payments
Collateral
Assets or guarantees used to secure an
obligation if payment terms are not met
Conditions
General, existing economic environment
impacting a customer’s ability to pay or
willingness of a company to grant credit
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Session 4: Module 3, Chapter 6 - 12
Credit Terms and Customer Discounts
Credit
limits
The aggregate amount of credit granted
each customer; new customers generally
receive the lowest limit; companies
continuously review customer payment
history and adjust limits as needed.
Penalty
fees
Assessed for payments received after the
due date; usually a percentage of the
amount past due; must be stated clearly at
the time of sale and disclosed on the
invoice.
Eligibility
for
discount
A benchmark eligibility date established for
discounts; may be the postmark date of
remittance or the date funds are received.
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Session 4: Module 3, Chapter 6 - 13
Forms of Credit Extension
Open account
Installment credit
Revolving credit
Letter of
credit (L/C)
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Session 4: Module 3, Chapter 6 - 14
Common Terms of Sale









Cash before delivery (CBD)
Cash on delivery (COD)
Cash terms
Net terms
Discount terms
Monthly billing
Draft/bill of lading
Seasonal dating
Consignment
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Session 4: Module 3, Chapter 6 - 15
Sales Discounting
Gross method
Method
Gross


Records gross
revenues on the
income statement
and in receivables
Records discounts
as an expense
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Net method


Records net
revenues on the
income statement
and in receivables
Shows any
discounts not
taken as income
Session 4: Module 3, Chapter 6 - 16
Financing Accounts Receivable








Unsecured borrowing
Secured borrowing
Securitization
Captive finance
subsidiary
Third-party financing
B2B credit cards
Factoring
Private-label financing
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Session 4: Module 3, Chapter 6 - 17
Cross-Border Trade Management
Other methods:
 Banker’s acceptance (BA)
 Trade acceptance
 Barter, countertrade, trading
companies
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Session 4: Module 3, Chapter 6 - 18
Discussion Question
In a documentary collection, what roles do the
banks involved in the transaction play?
Answer:
Act only as collecting and paying agents and assume
no direct obligation for ensuring that payment is
made:
 Remitting bank, the bank of the seller/exporter,
receives collection documents from the seller
and remits (forwards) them to the buyer’s
bank with instructions for payment.
 Collecting bank is the bank that presents the
documents to the buyer. In exchange for these
documents, the bank collects cash or a promise
to pay.
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Session 4: Module 3, Chapter 6 - 19
Documentary Collection
Foreign
Collecting
Bank
(5)
(4)
(7)
(6)
Buyer
(Importer)
Remitting
Bank
(3) (8)
(2)
(1)
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Seller
(Exporter)
Session 4: Module 3, Chapter 6 - 20
Letter of Credit (L/C)
Commercial L/C



Issued by a bank as
the intended
mechanism of
payment
Involves the domestic
or international
shipment of
merchandise
Typically requires
presentment of a
draft, commercial
invoice and related
shipping documents
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Standby L/C



Issued primarily by
U.S. banks
Serves as a vehicle to
ensure the financial
performance of a
bank’s customer to a
third-party
beneficiary
Typically requires the
presentation of a
sight draft and
documentation
Session 4: Module 3, Chapter 6 - 21
Banker’s Acceptance (BA)



Created when one
person signs an
unconditional written
order directing a bank
to pay a certain sum of
money on demand or at
a definite time to
another person.
By accepting, the bank
agrees to pay the face
value if the buyer fails
to make payment.
Bank may hold to
maturity or sell at
discount as short-term
negotiable instrument.
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
Acceptance financing
cost:
 Discount rate (rate
earned by investor)
 Commission
Accepted
Session 4: Module 3, Chapter 6 - 22
Consumer Credit Legislation






Truth in Lending Act (1968)
Fair Credit Reporting Act (1971)
Fair Credit Billing Act (1975)
Equal Credit Opportunity Act (1975)
Fair Debt Collection Practices Act
(1978)
Credit Card Accountability
Responsibility and Disclosure Act
(2009)
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Session 4: Module 3, Chapter 6 - 23
Elements of Basic Inventory Policy

Why companies hold inventory
Provide goods for expected sales
 Precautionary, speculative or to meet supplier
requirements


Types of inventory




Raw materials, WIP, finished goods, scrap or
obsolete items, and stores and supplies
Levels of inventory
Benefits and costs of inventory
Inventory financing
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Session 4: Module 3, Chapter 6 - 24
Just-In-Time (JIT) Inventory
Management




Minimizes inventory by
reducing costs or
uncertainties underlying
motives for holding
inventory.
Often paired with MPS.
Retailers link to POS
equipment.
Goals:



Eliminate waste.
Standardize the
production process.
Continuously improve
quality.
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
Benefits: Improved
supplier relationships,
lower transaction costs,
better planning.



Supplier-managed
replenishment programs
Paid-on-production
processes
Accounting methods
and purchase timing
may need changes.
Session 4: Module 3, Chapter 6 - 25
Discussion Question
What is the primary responsibility of accounts
payable (A/P), and what are the elements of
this process?
Answer:
Vouchering
 Verify incoming invoices and authorize
payments.
 Traditional three-way match: Invoice
matched to both an approved purchase
order and receiving (possibly shipping)
information.
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Session 4: Module 3, Chapter 6 - 26
Disbursement System
Considerations
Centralized vs. decentralized A/P and
disbursements?
 Information access
 Fraud prevention





Written policies and internal controls
Prompt bank reconciliation
Quality check stock
Banking services (e.g., positive pay)
Relationship maintenance with payees
$ $ $ $ $ $ $ $
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Session 4: Module 3, Chapter 6 - 27
Discussion Question
What are some disadvantages of centralized
disbursement systems?
Answer:
 Potential negative impact on payee
relations
 Delayed payments to vendors and/or
lost discount opportunities
 Must coordinate between central A/P
and field offices to resolve payment
disputes
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Session 4: Module 3, Chapter 6 - 28
Chapter 7: Working Capital Tools
Outline:






Treasury Management
Timelines
Cash Discount
Calculations
Cash Conversion
Cycle (CCC)
A/R Monitoring and
Control
Considerations for
Global Management of
Working Capital
E-Commerce
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Session 4: Module 3, Chapter 7 - 29
Operating Cash Flows
Cash inflows
(various sources)
$
Concentration/
funding flows
$
Cash outflows
(disbursements)
$
Surplus
 Suitable
investments
 Pay down debt
Liquidity
management
flows
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Shortage
 Sell investments
 Draw on debt
Session 4: Module 3, Chapter 7 - 30
Cash Flow Timeline and Float
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Session 4: Module 3, Chapter 7 - 31
Discussion Question
Discuss the differences between collection
and disbursement float from the perspective
of the seller/payee and buyer/payor.
Answer:
 From seller/payee’s perspective, collection float
(i.e., mail, processing and availability float)
represents delay between time check is
mailed and time seller/payee’s account is
credited with available funds.
 From buyer/payor’s perspective,
disbursement float (i.e., mail, processing
and clearing float) represents delay between
time check is mailed and time buyer/payor’s
account is debited.
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Session 4: Module 3, Chapter 7 - 32
Benefits of Float Reduction:
Negotiating Shared Benefits
Payment timing
changes
The seller adjusts the timing
(i.e., value date) of the
payment.
Price changes
(discount offer)
The seller offers the buyer a
cash discount to compensate
for earlier payment.
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Session 4: Module 3, Chapter 7 - 33
Float Neutral Calculation


Discount approach depends on cost of funds (i.e.,
opportunity cost) for buyer and timing difference in
days.
Example: r = 12% and TD = 3 days.
Discount = 1 
Where:
TD = Total days
difference between
check and electronic
payments
r = Opportunity cost
as an annual rate
1

 r 
1
+
TD
 365  




1
= 1

 12%  
1 + 3  365  



1
= 1  0.99901467
1.0009863
= 0.00098533 = 0.001 (Rounded) or 0.10%
=1 
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Session 4: Module 3, Chapter 7 - 34
Discussion Question
What is the primary cost associated with
collection float, and why? What are some
methods used to reduce or eliminate
collection float, and what considerations do
these decisions require?
Answer:
 Opportunity cost, because uncollected
funds cannot be invested or used to pay
down debt.
 Methods used to reduce or eliminate
collection float should be weighed against
the cost of achieving those improvements:


Remote deposit capture (RDC)
Lockbox services
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Session 4: Module 3, Chapter 7 - 35
Collection and Disbursement Float
For Check-Based Payments
Sending Party
Disbursement Float
Processing Float
Mail Float
Check
drawn and
mailed out
Lockbox
receives
check
Field office
receives
check
Receiving Party
Mail Float
Check encoded
and processed
through clearing
system
Clearing Float
Depositor
receives
collected
funds
Check clears
back to
drawee bank
account
Check
processed
and deposited
Collection Float
Processing Float
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Availability Float
Session 4: Module 3, Chapter 7 - 36
Cost for a Buyer of Not Taking the
Cash Discount

Should a discount be taken if the cost
of short-term funds is 8%?
Discount Cost =
D
365

100  D N  T
=
2
365

100  2 30  10
=
2 365

= 0.0204  18.25 = .3723 or 37.23%
98 20
Where:
D = Discount percentage—2%
N = Net period—30 days
T = Discount period—10 days
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Session 4: Module 3, Chapter 7 - 37
Discussion Question
Describe three situations when a buyer should
forgo an offered cash discount.
Answer:
 If the firm can earn a rate of return exceeding the
discount rate by investing the funds in the short
term instead of paying early and earning the
discount
 If the firm does not have cash available to take
the discount but has a short-term credit
facility that carries an interest rate higher
than the approximate cost of not taking the
discount
 If the firm has the ability to effectively change
the discount terms by stretching out its A/P
terms
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Session 4: Module 3, Chapter 7 - 38
Benefit for a Seller of Offering a
Cash Discount

Sellers induce early payment or offer discount to be
competitive. Calculate seller’s net benefit due to reduction
in revenue per $1 of sales. Terms below are 2/10, net 30.
TAFP  1  D $100,000  1  .02 
PVReceive on Day 10 = 
=
= $97,598.91
 
 
CC 
.15 
1 +  T  365 
1 +  10  365 
PVReceive on Day 30 =
TAFP
=
 
CC 
1 +  N  365 
$100,000
= $98,782.13
 
.15 
1 +  30  365 
NPV = PVDay 10  PVDay 30 = $97,598.91  $98,782.13 =  $1,183.22
Where TAFP = total amount of full payment; CC = annual opportunity cost of capital (in this
example, 15%); D = discount rate; T = days in discount period; N = days in net period
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Session 4: Module 3, Chapter 7 - 39
Cash Conversion Cycle (CCC)
Elements in the CCC:
Days’ inventory
Inventory
 365
Cost of Goods Sold
Days’ receivables
Accounts Receivable
 365
Revenues
Days’ payables
Accounts Payable
 365
Cost of Goods Sold
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Session 4: Module 3, Chapter 7 - 40
Calculation of the Cash Conversion
Cycle (CCC)

Calculates the time required to
convert a cash outflow (a payment to
a supplier) into a cash inflow (a
collection from the customer for the
goods sold)
Cash Conversion Cycle = Days' Inventory + Days' Receivables  Days' Payables
= 103.15 Days + 41.36 Days  63.48 Days = 81.03 Days
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Session 4: Module 3, Chapter 7 - 41
Discussion Question
If a company has a cash conversion cycle of
81.03 days, how many cash conversion cycles
does the company go through in a year (cash
turnover ratio)?
Answer:
Cash Turnover =
365 Days
Cash Conversion Cycle
365
=
81.03
= 4.5 Times
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Session 4: Module 3, Chapter 7 - 42
Discussion Question
What can a treasury professional discover by
monitoring individual accounts receivable?
Answer:
 Errors or delays in the invoicing or payment
process that are slowing collections
 Customers who may delay payment
intentionally until follow-up is initiated
 A change in financial condition that
may alter a customer’s ability to make
timely payments and require the
curtailment of future credit sales
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Session 4: Module 3, Chapter 7 - 43
Days’ Sales Outstanding (DSO)

Assume that a company has outstanding receivables
of $285,000 at the end of the first quarter and credit
sales of $310,000 for the quarter. Using a 90-day
averaging period, the DSO for this company can be
computed as follows:
Avg. Daily Credit Sales =
DSO =
Sales During Period
$310,000
=
= $3,444.44
Number of Days in Period
90
Outstanding A/R
$285,000.00
=
= 82.74 Days
Avg. Daily Credit Sales
$3,444.44
If the company’s credit terms are net 60, the average
past due is computed as follows:
Average Past Due = DSO  Avg. Days of Credit Terms
= 82.74 Days  60 Days = 22.74 Days
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Session 4: Module 3, Chapter 7 - 44
Aging Schedule CTP

Separates A/R into current and past-due
receivables in 30-day increments (on a
customer or aggregate basis) and can
determine the percent past due
Age of A/R
Current
Amount of A/R
% of Total A/R
$1,750,000
70%
1-30 days past due
375,000
15%
31-60 days past due
250,000
10%
Over 60 days past due
125,000
5%
Total
$2,500,000
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100%
Session 4: Module 3, Chapter 7 - 45
A/R Balance Pattern for March
=+$ 25,000
=+$160,000
=+$105,000
=+$ 50,000
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Session 4: Module 3, Chapter 7 - 46
Discussion Question
All of the following are true of the stipulations generally
specified in a multicurrency account EXCEPT
a) the base currency in which the account is
denominated.
b) the currencies not accepted (all others are accepted).
c) the spread or margin over the spot rate to use in
exchanging each currency back to the base
currency.
d) the value date to apply to debits and
credits for each transaction type and
currency.
Answer: b. The correct stipulation is “The
portfolio of currencies accepted.”
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Session 4: Module 3, Chapter 7 - 47
Types of Netting
Bilateral


Purchases between
two subsidiaries are
periodically netted
against each other.
Payments netted in
different currencies
are converted to a
common currency.
Only the net difference is
transferred.
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Multilateral




Similar to a bilateral
system, but multiple
subsidiaries participate.
Payments are converted
to a common currency.
Payments are combined.
Central treasury
management center
makes the necessary FX
conversions.
Subsidiaries either pay or
receive the net amount in
their own currency.
Session 4: Module 3, Chapter 7 - 48
Before Netting
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Session 4: Module 3, Chapter 7 - 49
With Multilateral Netting
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Session 4: Module 3, Chapter 7 - 50
Discussion Question
Describe lead and lag payments used in
netting systems.
Leading
 Executing cross-border payments between
subsidiaries before the scheduled payment date
 Used when a subsidiary country’s currency is
expected to depreciate relative to the parent
company’s currency
Lagging
 Executing cross-border payments between
subsidiaries after the scheduled payment date
 Used when a subsidiary country’s currency is
expected to appreciate relative to the parent
company’s currency
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Session 4: Module 3, Chapter 7 - 51
Re-Invoicing
Companyowned
subsidiary
Title and funds in subsidiary’s currency
Buys goods from
exporting
subsidiary
Sells goods to
importing
subsidiary
Actual shipment
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Session 4: Module 3, Chapter 7 - 52
Before Re-Invoicing
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Session 4: Module 3, Chapter 7 - 53
With Re-Invoicing
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Session 4: Module 3, Chapter 7 - 54
Export Financing: Long-Term Export
Financing through an ECA
Advantages


Interest rate generally
fixed at a lower rate and
for a longer term than
otherwise available.
Indirect government
involvement can provide
some protection from
government appropriation
or interference.
Disadvantages


Time required to
obtain the necessary
approvals
Currency exposure if
loan’s currency differs
from the
project/subsidiary’s
cash flows
Ex-Im Bank is the official export credit agency (ECA) of
the U.S.
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Session 4: Module 3, Chapter 7 - 55
Electronic Commerce (E-Commerce)




Different types of
e-commerce
Electronic data
interchange (EDI)
Use of the
Internet for ecommerce and EDI
Key issues in the
development of ecommerce
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Session 4: Module 3, Chapter 7 - 56
Discussion Question
Identify the different types of e-commerce.
Answers:
B2B
B2C
B2B
C2C
1. Applications include logistics and supply chain
management as well as billing and payment.
2. It allowed businesses easier access to customers
and vice versa.
3. Early applications were sales to customers and
purchasing from suppliers via EDI/EFT.
4. It involves alternative payment
approaches to facilitate the many,
small-value payments occurring between
consumers.
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Session 4: Module 3, Chapter 7 - 57
Electronic Data Interchange (EDI)
Structured electronic transactions




Buy side
Sell side
Purchasing
Order placement
Receiving
A/P




Sales
Order processing
Shipping
A/R
Secure messages, no data reentry
Proprietary EDI


Exclusive use of trading partners
Retail, transportation, automotive
v3.0 © 2011 Association for Financial Professionals. All rights reserved.
Cross-industry EDI


ASC X12
UN/EDIFACT
Session 4: Module 3, Chapter 7 - 58
Use of the Internet for E-Commerce
and EDI
Internet-based e-commerce


Uses the Internet and
Internet technology to
link business
applications between
trading partners
Data transfer is often in
a non-EDI format:


Proprietary between
two users
Industry standard or a
general standard
v3.0 © 2011 Association for Financial Professionals. All rights reserved.
Internet-enabled EDI


Often used to
encourage smaller
trading partners
to begin using EDI
Useful for low
transaction
volumes within
limited trading
communities
Session 4: Module 3, Chapter 7 - 59
Discussion Question
How have UNCITRAL, the UCC and the E-SIGN
Act affected the development of e-commerce?
Answer:
 UNCITRAL formulated a framework stating that
information should not be denied legal effect
based solely on format.
 For signatures, UNCITRAL trusts public key
cryptography (public/private keys).
 U.S. still uses UCC (paper-based transactions),
but in 2000 E-SIGN Act gave digital signatures
same authority as ink signatures (used as
model elsewhere).
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Session 4: Module 3, Chapter 7 - 60
B2B E-Commerce Implementation
Evaluated receipts settlement (ERS)


Eliminates need for supplier to send invoice to a customer
(customer pays by preestablished date)
Quantity received  agreed-upon price
Traditional Approach





Send purchase order (PO) for
shipment.
Receive delivery at some later
date.
Receive invoice for shipment
from supplier.
Match the PO, receiving dock
and invoice.
Pay for the goods if everything
matched properly.
ERS Approach



Supplier and manufacturer enter longterm supply chain agreement:
 Prices
 Quantities
 Delivery schedules
 Product specifications
Supplier has access to manufacturer’s
production schedules.
Barcode scanning transmitted to A/P,
no invoicing.
v3.0 © 2011 Association for Financial Professionals. All rights reserved.
Session 4: Module 3, Chapter 7 - 61
B2B E-Commerce Implementation

Paid-on-production

In retail, title transfers at shipping dock;
in manufacturing, paid-on-production can
be used due to multiple legal concerns:





Liability
Bankruptcy
Use of inventory assets for supporting loans
Title transfers when item is used.
Electronic presentment of invoices
and bills
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Session 4: Module 3, Chapter 7 - 62
Discussion Question
A manufacturer has a long CCC and a strategic
partnership with a single supplier, cannot adjust
raw materials turnover due to the nature of the
process, and must use JIT. Which of the following
e-commerce processes fits best?
a) Evaluated receipts settlement (ERS)
b) Paid-on-production
c) Electronic bill presentment and payment
(EBPP)
d) Electronic invoice presentment and
payment (EIPP)
Answer: b
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Session 4: Module 3, Chapter 7 - 63