F307 Chapter 8: Introduction to Working Capital Management

information access

obtaining access to timely & accurate info regarding status of disbursement accounts & disbursement clearings let company manage cash position more effectively

vouchering in B2B environment

once approved, forwarded to treasury manager or disbursements clear who generates a pmt.

r in float float-neutral calculation

opportunity cost as an annual rate

primary cost of collection float

opportunity cost b/c uncollected funds can't be reinvested or used to pay down debt

economic order quantity (EOQ)

optimal level of inventory, given specified ordering & holding costs

operational manager's view on CA management

prefer large inventory of raw materials or partially finished goods to meet production quotes

financial manager's view on CA management

prefer to minimize inventory & A/R to minimize cost of financing these assets

JIT Methodology

recognizes that excess inventory can be liability not asset -- a production/business philosophy that treats inventory as undesirable

how to shorten CCC

reduce receivables & inventory conversion periods and extend payables conversion period -- may improve profitability/value but caution warranted

effective A/R mgmt. includes

reducing invoicing float

primary benefit of holding sufficient inventory

reducing stock-out costs (lost sales due to lack of sufficient inventory)

primary benefit of in-house banking

reduction in overall costs

Cash Before Delivery (CBD)

referred to as prepayment terms & require buyer to make full & final pmt. before shipment or receipt of goods -- variation is to require substantial pre-pmt. of sale prior to delivery w/ balance collected at future date -- reduces potential for bad debt

capital

refers to individual or corporate customer's short- & long-term financial resources that could be accessed if immediate cash flow is insufficient to meet payment obligations

holding costs

related to carrying inventory -- such as: physical storage & handling costs, insurance, taxes, & opportunity cost of funds invested in inventory

largest portion of payment float

related to customer's payables policy & the trade (credit) terms negotiated between biller & customer

Days' Sales Outstanding (DSO)

relates to DR -- measures average amount of credit sales that are in A/R

focus of treasury in cash flow timeline

remains on the payment portion of the cycle

Raw Materials

represents basic input to manufacturing process & allows arrivals to be separated from production scheduling -- partially completed components fall into this category (NOT WIP)_

capacity

represents current & future financial resources a company or individual has available to pay obligations when they come due -- assessed using financial liquidity ratios & cash flow forecasts

Work in Progress (WIP)

represents items/materials in process of being manufactured

purchase-to-pay timeline

represents time from purchase of raw materials, retail goods, or services until payment is received & collected -- period of time between purchase & sale involves creation of inventory

current liabilities

required to be paid for within one year

Installment Account

requires customers to make equal periodic pmts. each containing principal & interest components

changes in CL: larger volume of sales activity ...

requires higher volume of materials purchased -- A/P increases b/c more materials purchased on credit, additional labor expenses increase accrued wages account, & tax increase accrued taxes account b/c of higher level of taxable income

changes in CL: decrease in A/P...

results in decrease in cash or increase in debt to pay off accounts -- decrease in CL must be offset by decreases in an asset account or increases in diff. liability accounts

as company generates additional profits

retained earnings amount increases

variation of securitization

sale of A/R to intermediary FI who packages accounts & securitizes them

Seasonal Dating

seller agrees to accept pmt. at end of buyer's selling season -- lets manufacturer provide ST financing for buyer's purchases & reduces manufacturer's inventory cost

primary benefit of factoring

seller can receive funds immediately upon completion of factoring arrangement

net cost of making payments in mgmt. of A/P

includes opportunity costs & administrative costs of managing A/P and disbursement process

restrictive CA investment strategy + aggressive financing policy

increased profitability but travels risky road

Basic forms of credit extension

(1) Open Account (2) Installment Account (3) Revolving Credit (4) Letter of Credit (L/C)

Types of Inventory

(1) Raw Materials (2) Work in Progress (WIP) (3) Finished Goods (5) Spoiled or Obsolete Items (5) Stores and Supplies -- inventory connected with some part of production process

elements of inventory policy

(1) Reasons for Holding Inventory (2) Types of Inventory (3) Levels of Inventory (4) Obsolescence and Spoilage (5) Benefits and Costs of Inventory

disadvantage of private-label financing

seller doesn't receive full face value of sale & may lose authority to decide which customers receive credit

has recourse

seller is liable for any bad debts that factor can't collect

Monthly Billing

seller issues monthly statement covering all invoices prior to cutoff date, typically toward end of month

Cash on Delivery (COD)

seller ships goods & buyer pays upon receipt

Net Terms

seller specifies net due date by which buyer must pay in full

first step in collecting amount

sending accurate & timely invoices w/ clearly stated pmt. terms & remittance instructions

Disbursement system considerations

set of procedures that determines who may authorize pmts. where & when pmts. originate, how potential fraud is controlled & how accounts are reconciled

principal costs of netting

setup, administration, & maintenance expenses

rationale behind using WACC for working capital decision evaluations

short-term rates may fluctuate rapidly in some economic situations -- prefer a more stable rate over time

changes in CA: if sales decrease ...

should cause corresponding decrease in CA accounts -- inventory may increase in the short-term while production schedules adjusted to reflect lower level of sales

decentralized A/P and disbursement systems

A/P & disbursement function managed at local/regional level -- field office managers approve invoices for pmts., issue pmts., reconcile accounts -- pmts. made through local/regional bank -- result of M&As where A/P & disbursement systems haven't been combined

primary current liability accounts

A/P, debt maturing in less than one year, notes payable, & accrued liabilities

working capital strategies

affect many financial ratios used to evaluate financial positions -- current & quick ratios

relaxed CA investment strategy can be offset by

aggressive financing strategy

management of multinational working capital

allows company to make & receive pmts. in variety of currencies w/o having to worry about FX implications of every transaction

Stores and Supplies

also called indirect purchases -- items aren't used directly, they support production process

Draft/Bill of Lading

also known as documentary collection -- sellers collect pmts. through banking channels

merchant discount

amount a credit card company (or acquiring bank) charges seller for service -- varies depending on method of transmission, size of sale, total vol., type of card used, & business/industry type

Asset-Based Lending

If company can't finance w/ unsecured borrowings & pledges A/R as collateral & borrows on secured basis

Just-in-Time (JIT)

attempts to minimize inventory levels by reducing costs or uncertainties that underlie motives for holding inventory

primary difference between disbursement & collection float

availability vs. clearing float

DI for a Retail Business

average length of time that finished goods inventory is held before sale

DP for all types of companies

average number of days between purchase & receipt of materials or supplies & issuance of payment for them

DR for Manufacturing, Retail & Service Companies

average number of days required to convert a sale into a collection

When are cash terms used

in sale of perishable items or in cases where buyer hasn't established credit history w/ seller

common practice in many B2B transactions

mailed invoice to the buyer w/ remittance advice being mailed back to the seller

Net Method

net revenues recorded on income statement & in receivables and discounts not taken are shown as income

Spoilage Inventory

no longer salable due to damage or other defects that occur over time -- must be disposed of through write-offs or form of discounted sale -- distinct from scrap which is a normal byproduct of manufacturing process

Obsolescence Inventory

no longer salable through normal channels b/c out of date or has been replaced w/ newer products -- must be tracked & written off or sold at a discount (potentially loss) to get it off books

types of current asset investment strategies

(1) restrictive (2) relaxed

Formula for CCC

DI + DR - DP

three-way match

"auto-match" -- issues w/ customers using this process-- validates invoices against purchase orders & receiving statements to authorize pmt. of invoices

purchase-to-pay & order-to-cash

"opposite sides of the same coin"

centralized A/P and disbursement systems advantages

(1) A/P & disbursement functions located in single place (2) easier to maintain control, obtain info, concentrate cash, provide greater access to cash position info & improve forecasting accuracy

Stages of operating cycle of a business

(1) Acquisition (2) Conversion

why in the B2B world quantitative credit scoring models aren't as widespread as in consumer sector

(1) Available databases for building commercial credit smaller than consumer models -- more difficult to develop reliable models (2) Per-transaction exposure is larger in commercial sector than consumer sector -- default by 1 commercial could have impact on small seller (3) Difficult to obtain financial info for some customers, especially smaller, private companies

characteristics of factoring

(1) Buyer of receivables has no recourse to seller -- some stipulate that they have recourse (2) Performed on notification basis -- seller notifies customers that account has been sold

Common Terms of Sale

(1) Cash Before Delivery (2) Cash on Delivery (3) Cash Terms (4) Net Terms (5) Discount Terms (6) Monthly Billing (7) Draft/Bill of Lading (8) Seasonal Dating (9) Consignment

Costs associated with offering trade credit

(1) Costs of A/R = Carrying Costs -- determined by using marginal cost of ST borrowing or WACC (2) Operating & Maintaining Credit Department -- can be very expensive

Financing Implications

(1) Credit terms, sales & collection patterns determine level of A/R -- must be financed & ability to extend credit relates directly to ability to borrow (2) Mis-mgmt. of receivables cause liquidity problems b/c delayed customer pmts. (3) Receivables source of liquidity when used as collateral, to securitize debt instrument, or sold for cash to factors

Reasons for Holding Inventory

(1) Enable company to plan activities to be schedules as efficiently as possible (2) Provide goods required for expected sales level during normal operating & production cycles (3) As a precautionary measure, for speculative purposes & to meet supplier requirements

Potential sources of income related to granting credit

(1) Extension of credit increases sales (2) Interest earned from pmt. arrangements -- can be significant, especially for retail companies that provide direct financing through private-label cards (3) Penalty fees for pmts. received after due-date -- % of amount past-due & stated clearly at time of sale & disclosed on invoice

characteristics of 3rd party financing

(1) Frees up capital -- but company relinquishes control over credit-granting decision & foregoes direct marketing opportunities (2) may have to discount price of goods sold to compensate 3rd party -- foregoing potential income

Determining aggregate amount of credit (credit limit) for each customer

(1) Grant new customer credit at lowest limit (2) After period of satisfactory pmt. performance, increase limit (3) Continuously review customer's pmt. history to justify limits

methods for discounted sales

(1) Gross Method (2) Net Method

types of float/delays that paper-based payment instruments are subject to

(1) Mail float (2) processing float (3) availability float

Characteristics of draft/bill of lading

(1) More common in international trade (2) Seller ships goods to buyer & sends shipping/title documents to a bank which transmits documents to buyer's bank (3) Buyer gains possession of documents/ownership of goods upon paying bank or upon signing draft agreeing to pay at future date (4) Upon collection, buyer's bank remits pmt. to seller's bank (5) Not guaranteed by bank

once all collection methods exhausted, company may pursue more serious actions, such as:

(1) Reporting customer's delinquent status to credit bureaus (2) Repossessing collateral (3) Negotiating additional corporate/personal guarantees (4) Obtaining lien on specific assets (5) Initiating direct legal action (6) Turning delinquent accounts over to collection agency

Advantages of accepting credit cards rather than maintaining A/R in B2B Setting

(1) Seller bears no direct costs of running credit department (2) Seller doesn't finance A/R (3) If proper authorization procedures followed then issuer absorbs bad debt loss (4) Sales increase by making it easier for customers to charge purchases (5) Seller is paid quicker -- typically 1-2 days following transaction

characteristics of an open account

(1) Seller issues invoice as formal evidence of obligation & records sale as A/R (2) Buyer billed for each transaction by invoice/monthly statement (3) Full pmt. of invoiced amount is expected within credit terms unless discounts/deductions available (4) Buyer's creditworthiness reviewed periodically but doesn't need to apply for credit each time places an order

Disadvantages of accepting credit cards for customer financing include:

(1) Seller relinquishes control over credit decision -- sale could be lost if not granted (2) Seller loses promotional opportunities by not having access to list of credit customers (3) Seller incurs discount costs & transaction fees (4) Expense of maintaining compliance w/ credit card data security standards

what pmt. not received by due date, company can:

(1) Send duplicate invoice or mail formal letter/series of letters -- dunning letters (2) Call customer or pay personal visit (3) Suspend further shipping of goods or terminate services until past-due items paid (4) Negotiate with customer for pmt. of overdue amounts

Characteristics of Consignment

(1) Supplier retains title to goods until sold, at which time title is transferred to ultimate buyer (2) Consignee deducts commission or fees & forwards remainder to buyer

What should monitoring of financial distress include

(1) Tracking payments & level of credit outstanding (2) monitoring news/press releases issued by customer

characteristics of an installment account

(1) Used frequently for purchase of high-value consumer durables -- automobiles (2) Seller requires buyer to sign a contract -- specifies credit terms of obligation, discloses interest rate, & lists all other costs

disadvantages of long-term export financing through ECAs

(1) additional time may be required to obtain necessary approvals (2) exporter may face currency exposure if currency of loan is diff. from cash flow of project being financed or home currency

credit manager is responsible for

(1) administers policies that establish credit standards (2) defines terms of trade credit extension (3) approves customers for credit sales (4) sets individual & aggregate credit limits within policy guidelines

characteristics of WIP

(1) allow different phases of production process to be separated (2) use & amount of inventory = functions of production process (3) serves as a buffer between production stages with different processing speeds

Multicurrency agreement specifies 4 stipulations

(1) base currency the account is denominated in (2) portfolio of currencies accepted (3) spread/margin over spot rate to use in exchanging currency back to base (4) value date to apply to debits/credits for each transaction type & currency

types of cash flows that treasury professionals must consider

(1) cash outflows (2) cash inflows (3) concentration/funding flows (4) liquidity management flows

types of A/P and disbursement systems

(1) centralized A/P & disbursement systems (2) decentralized A/P & disbursement systems (3) decentralized A/P & disbursement systems with centralized clearing

5 Cs of credit

(1) character (2) capacity (3) capital (4) collateral (5) conditions

working capital can be obtained (increased) by?

(1) collecting cash flow from operations (2) increasing debt (3) selling assets & investments (4) selling equity

characteristics of seasonal dating

(1) common in industries w/ distinct seasonality of toys -- toys, greeting cards, garden supplies, sporting goods, textbooks (2) Time between goods shipped to buyer & when pmt. received can be lengthy -- so seller may offer discounts to encourage buyer to pay early

critical areas of coordination between treasury and A/P management

(1) communication from A/P to treasury regarding invoices vouchered for payment 92) communication from treasury back to A/P regarding reconciliation of cleared items

proper management of A/R includes

(1) creating, preserving, & collecting A/R (2) maintaining up-to-date customer records (3) initiating collection procedures on past-due accounts

most important sources of internally generated credit information

(1) credit application/agreement completed by applicant (2) company's records regarding applicant's payment history

credit policies & procedures should clearly define

(1) credit standards (2) credit terms (3) discount terms (4) collection policies

credit scoring process

(1) differentiating standard & high risk accounts based on applicant's monthly income, outstanding obligations & employment history (2) wighting characteristics of applicants fitting into categories to establish creditworthiness (3) setting cutoff scores for clear approval/denial of credit (4) applying further analysis to applicants whose scores fall between cutoff points

decentralized A/P and disbursement systems with centralized clearing

(1) enterprise-wide software packages w/ distributed access & data entry -- allowed ability for hybrid system (2) invoices received & processes locally and at common A/P processing location (3) disbursements made by a central A/P system -- can generate pmts. from central bank account or from subsidiary

Major components of invoicing float

(1) entry & billing system delays (2) mail float -- when paper invoice is mailed to customer

establishing credit standards process

(1) establish credit acceptance criteria that represents max amount of payment risk willing to assume (2) must decide whether to approve credit applicant under criteria & if approved, set a credit limit for applicant

decentralized A/P and disbursement systems advantages

(1) greater autonomy to field office managers (2) easier to take advantage of discount terms that require pmts. made in shorter time frame

characteristics of revolving credit

(1) if account not paid in full by due date, interest charge is based on avg. amount outstanding over entire period (2) not automatically liquidating -- new purchases are added to balance as pmts. for older purchases are received & processed

key considerations when determine credit extension policies

(1) if credit standards = too strict -- may decline trade credit to customers that represent acceptable risk (limiting sales opportunities) (2) if credit standards = too lenient -- may grant credit to customers that represent unacceptable risk (increasing risk of late pmts. & bad debt expense)

internal factoring allows company to

(1) implement leading/lagging arrangements (2) centralize/improve export trade financing & collections (3) minimize FX risks (4) reduce bank costs (5) reduce pmt. costs

Unique demand of JIT manufacturing environment

(1) implementation requires changes to account methods used for inventory & impacts timing of purchases (2) companies purchase more frequently & buyer smaller amounts -- increases transactions to monitor/record (3) process of evaluating cost of inventory is more difficult

secondary benefits of in-house banking

(1) improved visibility & control over subsidiary cash assets (2) minimized borrowing (3) improved ability to manage internal/external FX risks (4) potential tax benefits

other benefits of re-invoicing centers

(1) improves worldwide ST liquidity mgmt. -- provides flexibility in inter-subsidiary pmts. (2) eases implementation of leading/lagging arrangements (3) improves export trade financing & collections (4) reduces bank costs (5) minimizes FX risks & obtains advantaged FX rates by enabling larger trades (6) reduces pmt. costs

goals kept in mind during designing of disbursement system

(1) information access (2) fraud prevention (3) relationship maintenance w/ payees (4) timing of payments

advantages of long-term export financing through ECAs

(1) interest rate fixed at lower rate & for longer term than would otherwise be available (2) indirect govt. involvement can provide protection against govt. appropriation of interference

international treasury management solutions include

(1) investments/debts especially intra-company or subsidiary-to-subsidiary basis (2) netting (3) pooling (4) re-invoicing (5) FX transactions & FX risk mgmt.

measures most often used in ratio analysis

(1) liquidity & working capital ratios -- current, quick & cash flow to total debt ratios (2) debt mgmt. & coverage ratios -- times interest earned, long-term debt to capital, debt to total assets, & total liabilities to total assets ratios (3) profitability measures -- return on sales, return on total assets & return on equity

characteristics of floor planning

(1) loans made against each individual item, recorded by serial number & aren't fully repaid until item is sold (2) lenders perform periodic inventory audits

decentralized A/P and disbursement systems disadvantages

(1) loss of control over info (2) loss opportunity to concentrate funds, reduce borrowing expenses, & increase investment returns (3) increased likelihood of unauthorized disbursements (4) cost & complexity of redundant systems (5) increased possibility of excess/idle balances at local banks (6) increased difficulty in obtaining info about company's day-to-day cash position & outflows (7) increased transfer, reconciliation & administrative costs

improvement in financial performance will be short lived if some or all of the following occur

(1) lost sales due to overly strict credit & collection standards (2) production stoppages due to inadequate raw materials or parts inventories (3) payables stretched beyond due date (4) foregone cost-saving trade discounts (4) higher prices assessed by vendors b/c individual orders = smaller or pmt. slower (5) refusal to sell to customers that are good credit risks, occasionally slow in paying (6) excessive reliance on A/P in lieu of a stable base of short-term bank credit

examples of stores and supplies

(1) lubricating oils or maintenance materials for production machinery in manufacturing business (2) paper & other office supplies in service business

CA investment & financing strategy involves trade-offs that need to be weighed in light of --

(1) mgmt's tolerance for risk (2) sales stability & predictability (3) lender concerns (4) interest rate environment (5) availability of funds (6) supplier reliability & other factors

credit reports include info such as:

(1) payment history -- provided on voluntary basis (2) financial info (3) max outstanding credit amounts (4) length of time credit has been available (5) any outstanding collection actions

centralized A/P and disbursement systems disadvantages

(1) potentially negative impact on payee relationships -- result in delayed pmts. to vendors or suppliers and/or lost discount opportunities (2) coordination between central A/P department & field offices to resolve pmt. disputes

major costs of re-invoicing

(1) re-invoicing center expenses -- incurred when establishing physical location (2) administrative costs

principal benefits of using a netting system

(1) reduction in # of FX transactions & cross-border wire transfers & benefits from natural hedging (2) more favorable FX rates due to potentially larger FX trades from consolidation (3) improved cash/currency exposure forecasting for subsidiary & parent company b/c of ability to preplan cross-border pmts.

costs involved in maintaining levels of inventory

(1) set-up or order costs (2) holding costs

two decision that treasury professionals making about working capital

1) How much working capital to have and 2) How to finance that working capital -- decisions made concurrently b/c they impact one another

Credit Policy Constraints

(1) terms/policies based on industry standard practices -- difficult for company to vary from competitors (2) Consider how offering credit impacts existing loan covenants -- change in A/R balances can affect working capital ratios (3) Legal constraints vary from country-country or within a country

characteristics of re-invoicing

(1) title to goods passes through re-invoicing center but actual goods shipped directly from export to import units (2) establishing re-invoicing center requires govt. & tax approval & negotiations with tax authorities in all involved countries

characteristics of asset based lending

(1) to enforce claim on inventory, lender takes possession if company defaults or files for bankruptcy (2) lender store inventory at public warehouse or in field warehouse (3) warehouses secure storage facilities where raw materials or finished goods held until warehouse receipt presented to claim them (4) lender release materials after portion of loan supported by inventory is paid

Delaying a payment near end of credit terms enables company to:

(1) use cash to reduce debt (2) invest cash on a short-term basis (3) purchase other assets

working capital can be used (reduced) by?

(1) using cash flow in operations (2) repaying debt (3) purchasing assets & investments (4) paying dividends & buying back stock/equity

basic services provided by ECAs

(1) working capital guarantees --- pre-export financing (2) export credit insurance (3) loan guarantees (4) direct loans -- buyer financing

if there is a more-than-corresponding decline in non-interest-bearing CL

(A/P, wages, & taxes payable) -- additional short and/or long-term debt must support CA

different types of float

(a) collection float (b) disbursement float (c) invoicing float (d) payment float

inventory timeline for a business that supplies customers with info

(from economic advice & real estate listings) -- the process of filling an order may be immediate, resulting in very little actual inventory

formula for float-neutral calculation

1 + TD (r/365)

Cash Turnover Formula

365 / CCC

private-label financing

3rd party operates credit function in seller's name rather than seller administering credit program in-house

current ratio

= (CA / CL)

spontaneous accounts

CA & CL accounts b/c there is no specific working capital mgmt. decisions involved in increasing these accounts & they vary whenever sales activity occurs -- magnitude impacts amount of external financing necessary

working capital

CA - CL: cash & liquid assets that can quickly be converted to cash

methods used to reduce/eliminate collection float

RDC or lockbox services -- should be weighed against cost of achieving improvements

most common opportunity cost used

WACC

Cash Management

another name for working capital management

fluctuating current assets

anything over base (permanent) CA

primary external source of credit information

applicant's financial statements (audited & unaudited) -- provide info about corporate credit applicants b/c statements & related ratios can be compared to industry averages

how customers use discrepancies

as a reason to delay pmt. -- effectively increasing their credit period

monitoring financial distress

as financial distress for customer increases, so does probability of slower pmts. or default on account

consumer credit bureaus

assess creditworthiness based on proprietary models

conditions

assesses general, existing economic environment that impacts customer's ability to pay or willingness of a company to grant credit

DI for a Manufacturing Company

average number of days that elapse from purchase of raw materials until sale of finished goods -- also called Days' Sales in Inventory (DSI) --- period of time = raw materials in inventory + WIP inventory + finished goods in inventory

Cash Conversion Cycle

average number of days the cash outflow for acquisition of materials & supplies and cash inflow from sale of products or services -- calculates average length of time company must finance a cash outflow before receiving cash inflow

asset based lending

based on value of inventory rather than borrower's general financial strength

Legitimacy of shortfalls & deductions must

be ascertained

Pmt. Discrepancies must

be investigated

Related Bookkeeping, invoicing, & pmt. adjustments must

be recorded

quantitative credit analysis

begins w/ examination of applicant's financial statements -- use ratio analysis to assess financial condition

benefits from float reduction

benefit from shortening all types of float associated w/ collection & lengthening types of float associated w/ disbursements

renegotiating appropriate trade terms

better alternative than delaying pmt. to suppliers

JIT Systems + Material Planning Systems (MPS)

bring together long range production planning w/ current flow of materials through production process - allows for time-phased methods of planning that facilitate adjustments for changing costs

Cash Terms

buyer generally has 7-10 days to make pmt.

If seller extends proximo payment terms

buyer must pay by specified date during following month

float-neutral calculation

buyer will agree to electronic payment rather than paper-based if seller agrees to this

Payment Discrepancies in B2B environment

can arise from customers paying multiple invoices each w/ possible adjustments, w/ single pmt.

liberal credit policy

can increase sales but increases account servicing costs, collection costs, & bad debt expense

characteristics of finished goods

can manage highly variable or unpredictable demand levels more easily -- valuable in retail environment b/c allows retailer to maintain wide variety of goods for customers

costs of collecting delinquent accounts

can reduce impact of bad debts by purchasing various types of insurance to cover receivables losses -- insurance premiums included in cost/benefit analysis when assessing potential profitability of credit sales

major current asset accounts

cash, marketable securities, A/R, inventory, & prepaid expenses

primary benefit of re-invoicing center

centralization of FX exposures -- can be managed more effectively

approaches to financing decision

classified as maturity matching, conservative, & aggressive

rules in cash management about float

collect quickly & disburse slowly

local and national credit rating agencies

collect, evaluate, & report info about companies' credit histories

cash flow timeline

combine purchase-to-pay, inventory, & order-to-cash timelines -- difference between timelines creates working capital (a reserve of cash)

banks or other financial creditors

commercial finance or leasing companies -- provide credit info about applicant's payment history & available credit

card payments

common in consumer/retail transactions & increasingly accepted in B2B environment -- Company receives pmt. (less merchant discount) 1-2 business days following transaction

Open Item System

commonly used in B2B Sales -- (1) Invoices sent to customer recorded in A/R file (2) When pmt. received its matched w/ specific invoices being paid (3) Pmt. discrepancies noted -- discounts, allowances, adjustments, returns (4) Remittance info indicates invoices being paid & adjustments to pmt. (5) Process may be manual, automated, or combo (6) Most open accounts clearing through this system

3rd party financing

company collects info necessary to complete credit application from customer & forwards it to an FI who decides whether to grant credit

Revolving Credit

company grants credit w/o requiring specific transaction approval as long as account remains current

operating cycle or cash conversion cycle

company's daily operating activities create flow of cash through various working capital accounts

re-invoicing center

company-owned subsidiary that purchases goods from exporting subsidiary & sells goods to import subsidiary

restrictive CA investment strategy can can be mitigated by

conservative financing strategy

Finished Goods

consists of completed items/materials available for sale & lets company fill orders when received rather than depend upon product completion to satisfy customer demands

trade credit

contractual arrangement allowing customer to take possession of good, product, or service now and pay for it later

WACC

cost of long-term capital & for many it may be more appropriate to use short-term measure for opportunity cost

opportunity cost of delaying trade payment.

cost of lost cash discounts, lost goodwill with suppliers, & lost sales due to delayed shipments

collection policy

costs related to delinquent account monitoring & bad debt collection impact company's income

major objective of collection policy

covert A/R into cash quickly, while minimizing collection expense & bad debt expense -- type of credit offered impacts which method used

private label financing from customer's perspective

credit appears to be arranged through seller

Account considered current if:

credit outstanding is < established credit limit & minimum pmts. are made on time

changes in CA: as volume of sales activity increases ...

credit sales increase -- resulting in larger dollar amounts invested in A/R

working capital financing strategy

decisions about how to finance permanent & fluctuating CA

affect of e-commerce on float created by paper processes

declining recently

invoicing float

delay between the day a customer places an order & day the customer actually receives an invoice for that order that can be processed for payment -- much larger than collection or disbursement float -- e-commerce & other tech. can reduce it

selection of CA investment strategy

depends on risk/return trade-off characteristics -- opinion of company's creditors (bank & other lenders) -- may be influenced by industry practices

general approach in evaluating diff. cash flow alternatives

determine PV of alternatives at some interest rate & choose best alternative for organization -- lowest PV cost or highest PV benefit

if discounts are offered, company must

determine benchmark eligibility date -- can be postmark date of pmt. remittance or date funds received

idea behind opportunity cost

determine most attractive unused alternative is for any funds/balances that are generated as a result of decision

DI for a Service Company

determined by average length of time that materials are held in inventory until used to provide services

Electronic Bill Presentment and Payment (EBPP) & Electronic Invoice Presentment and Payment (EIPP)

e-commerce tools -- used to reduce invoice & payment float and to improve overall collections

long-term debt

e.g intermediate-term loan of 4-5 years -- guarantees financing during years -- firm has excess financing & pays interest unnecessarily during year if amount borrowed is at or approaches estimated need when fluctuating CAs peak -- assets may be used as collateral to facilitate this

leading

employed when subsidiary country's currency is expected to depreciate relative to parent company's current

what does operating a captive financing company do

enhances parent's liquidity & provides access to capital at lower cost

relationship maintenance with payees

ensuring timely payments to employees, vendors, suppliers, lenders, tax agencies, bondholders, & shareholders; & filing any necessary tax or legal forms

framework for assessing risk/return trade-offs in working capital mgmt.

established by treasury professionals -- must include investment & financing strategies that reflect firm's needs & attitudes toward risk taking, with consideration given to industry practices

win-win approach

establishing strategic partners w/ suppliers & customers -- focus shifted away from end of operating cycle & toward beginning of operating cycle

when offering cash discounts, seller must ...

evaluate costs vs. benefits gained from receiving early pmts.

relaxed CA investment strategy + conservative financing strategy

excessively liquid & less profitable than needs to be -- large cash balances/excessively liquid perceived as takeover targets

current assets

expected to be converted into cash within on year

current asset investment strategies

extent of company's uncertainty & risk tolerance determines investment levels in CA accounts -- must choose strategy that suits business needs, risk tolerance & mgmt. style

no recourse or without recourse

factor must absorb loss if a customer fails to pay

sales manager's view on CA management

favor large inventory of finished goods to meet consumer demands & a liberal credit policy to stimulate sales

aggressive financing strategy

finances all fixed assets with long-term debt/equity, but finances only portion of permanent assets w/ long-term financing -- short term financing supports remainder of CA & all temporary CA -- utilizes more ongoing short term financing that other strategies -- most profitable b/c least costly -- lower current ratio & greater liquidity risk

Securitization

financing method that frees up company's capital & enhances creditworthiness by using consumers' installment pmts. to pay off securitized instrument's principal & interest

collateralized loans

form of inventory lending -- (1) loans arranged using inventory as collateral w/ lender providing financing for predetermined % of inventory (2) cash flows viewed as primary repayment source & inventory as second (3) claim against inventory perfect in form of a lien (4) stated interest rate may be lower than unsecured credit, total cost higher b/c of additional expense w/ perfecting/monitoring claim

supply chain financing

form of inventory lending -- (1) seller received financing based on existence of sales contracts/purchase orders w/ large, financially stable trading partners (2) arranged by buyer & providers lower-cost loans based on credit rating & financial capabilities (3) seller benefits by receiving lower interest rate (4) buyer benefits by not having to directly finance seller & create on-balance sheet debt

examples of cash inflows

funds collected from customers, obtained from financial sources (loan or investment income) and/or received from other sources

examples of cash outflows

funds disbursed to employees, vendors & suppliers; lenders; local, state & federal tax agencies; bondholders; & shareholders

if CA decrease

funds have been released from investments in A/R and/or inventory -- overall need short short-term liabilities to support CA declines

credit information

gathered in stages from internal & external sources -- costs weighed against benefits at each stage

if buyer refuses to pay in COD

goods are returned & seller must pay shipping & handling costs

export financing

govt. supports export activities through export loans, credit guarantees, or combo

Gross Method

gross revenues recorded on income statement & in receivables and discounts recorded as expense

paid-on production process

has specific implications for financial managers -- (1) payment record is created for goods and/or services based on usage rather than shipment (2) employed in manufacturing environment & similar to consignment sales in retail (3) Title to product transferred during manufacturing process

collateral

identifies available assets or guarantees used to secure an obligation in even that payment terms aren't met

discriminant analysis

identify factors that effectively distinguish between paying & nonpaying customers -- sometimes used on region-by-region basis

external financing requirements

if need for working capital > increase in funds generated by additional profits, then difference must be financed

timing of payments

important to pay vendors in timely fashion & that payments aren't made before due

Discount Terms

in addition to specifying net due date, seller may offer a discount on pmts. made prior to that date q

where scrap or obsolete inventories occur

in environments where rapid changes in existing products or introductions of new products

Scrap or Obsolete Items

in industries such as steel & aluminum manufacturing, scrap from production can be reused in later batches or sold to recyclers

why is information float different from others

instead of referring to delays in actual collection of funds -- refers to lack of knowledge about funds themselves

integration of treasury * A/P mgmt. with Enterprise Resource Planning (ERP)

integrate coordination functions easily -- (1) separate systems for disbursement mgmt. or treasury into software provided by banks (2) software may not interface with A/P ledger (3) customized interfaces or middleware required to facilitate transfer of info between applications

Netting

internal company (intracompany) payables system designed to reduce number of cross-border pmts. among company units through elimination/consolidation of funds denominated in different currencies

re-invoicing

intra-company method of centralizing responsibility for monitoring & collecting international A/R to more effectively manage related FX exposures

importing unit

invoiced & pays funds to the re-invoicing subsidiary in own currency

exporting unit

invoices & receives funds from re-invoicing subsidiary in own currency

commercial credit analysis

involve credit scoring (evaluated by purchasing credit reports from 3rd party) or by generating credit scores based on internal/external databases

Leading & Lagging

involve executing cross-border payments between subsidiaries before schedule pmt. date (leading) or after scheduled pmt. date (lagging)

concentration/funding flows

involve internal transfers among operating unit of a company & between a firm's various bank accounts with the objective of pooling funds for other purposes or funding various disbursement accounts

liquidity management flows

involve using organizations liquidity reserves in most effective manner

Vouchering

involves 3-way match -- invoice is matched to approved purchase order and receiving & shipping info

Establishing Credit Terms

involves designing sales contracts (agreements) that clearly specify under what conditions terms are granted

Creating Collection Policies

involves determining steps involved to collect delinquent accounts or bad debts

multilateral netting system

involves more than 2 subsidiaries -- each subsidiary informs central treasury mgmt. center of planned cross-border pmts. through electronic system

Factoring

involves outright sale of receivables to a company that specializes in financing & mgmt. of receivables

consumer billing

involves sending statements listing goods/services purchased during preceding month

order-to-cash timeline

is a cash inflow & represents the final piece of operating cycle -- includes all tasks involved in soliciting customers & converting inventory into sales & cash

installment credit

is liquidating -- normal pmts. will eventually pay off balance of account over time

A/P or Trade Credit granted by suppliers

least expensive financing alternative & finances significant portion of industry -- spontaneous financing source increases & decreases w/ level of inventory on hand

Delaying Payment

lets company who purchased materials to delay outflow of cash -- lengthens DP & shortens CCC from buyer's point of view

advantage of private-label financing

lets seller retain many promotional aspects of conduction credit functions while incurring none of the costs of maintaining credit operation and/or financing A/R

A/R Management

linked closely to company's credit, billing, & collection policies -- requires careful control & monitoring at individual & aggregate levels -- sales, accounting & finance personnel involved in activities

conservative financing strategy

long-term financing supports fixed assets, permanent CA, & some portion of fluctuating CA -- try to finance average level of fluctuating CA -- lease use of short-term financing & has higher financing costs b/c long-term debt is carried when not needed -- lower reliance on short-term financing results in higher current ratio & lower profits b/c of higher total interest expense

relaxed CA investment strategy

maintain high levels of CA relative to sales -- CA consists of high levels of inventory (result from concerns over replenishing raw materials or reluctance to lose sales b/c of insufficient finished goods) & A/R (result of liberal credit policy) -- large investment in CA lowers returns -- LESS RISK b.c of larger liquid asset balances

restrictive CA investment strategy

maintain low levels of CA relative to sales -- investment in raw materials managed tightly using JIT inventory -- outstanding A/R & cash balances kept low -- higher risks associated w/ tighter mgmt. of credit & inventory & lack of cash available for A/P -- MOST PROFITABLE if no unexpected events that drive down liquidity to a point that causes problems

in-house bank responsible for

managing international treasury management solutions

if surplus of funds

may (1) invest in suitable investments or (2) pay down existing debt

if shortage of funds

may (1) sell off investments or (2) draw on available debt sources (credit lines or commercial paper issuance)

objective of inventory management

minimize total costs associated with inventory while meeting desired level of production and/or customer service

Letter of Credit (L/C)

most complex form of credit extension -- most commonly used in import/export transactions

information sources

must consider type, quantity & cost of info when establishing method for analyzing credit sources

as current asset accounts increase -->

need for working capital increases

Days' Inventory (DI)

or Inventory Conversion Period -- impacted by any decision that affects raw materials, WIP, or finished goods held in inventory

Days' Payables (DP)

or Payables Conversion Period -- represents actual trade credit period, often very diff. from stated trade terms

Days' Receivables (DR)

or Receivables Conversion Period-- impacted by (1) changes in A/R policies (i.e. credit standards, credit terms, or collection efforts), or (2) changes in competitive marketplace or general business conditions

trade references

other companies from whom applicant has purchased on credit -- provide secondary source of info about applicant's payment performance

opposing incentives

partners along supplier-producer-customer chain have them -- changed somewhat by introduction of electronic payment systems

character

perceived honesty/integrity of individual applicant or corporate applicant's officers -- indicates intent/willingness to pay, evidenced by personal or corporate payment history

payment float

period of time between the day a bill or invoice is sent/received & day a payment is actually credited to biller's bank account -- can be largest float component in commercial payment process

disbursement/collection float

period of time that occurs between creation of a payment & actual time when payment is credited in good funds to a payee's account -- small piece of float

inventory timeline for a manufacturing company

process of acquiring raw materials/parts, converting them into finished goods, storing goods as inventory & shipping goods sold -- may be lengthy

cash application

process of applying customer's pmt. against outstanding invoices or receivables -- occurs via open item or balance-forward system

cash outflows

process referred to as purchase-to-pay timeline

cash inflows

process referred to as the order-to-cash timeline

fraud prevention

protecting funds from unauthorized use, through written policies & internal controls, prompt bank reconciliation, & appropriate banking services (positive pay & debt blocks)

ratios

provide valuable insight when evaluated in relation to industry & country standards published by credit rating agencies & others

benefits of inventory

provided by (1) separating elements of purchasing, production, & shipment processes (2) may provide competitive advantage over other companies (3) may provide increased customer goodwill, higher sales levels & increased profits

Payables Management

provides effective source of liquidity for companies -- some use this form of "hidden" financing extensively

inventory management objective

prudent inventory reduction b/c excess inventory lowers profits

bilateral netting system

purchases between 2 subsidiaries of same company are netted against each other -- so periodically only net difference is transferred

what is asset-based lending based on

quality of receivables -- lender evaluates receivables to determine those acceptable as collateral for a loan that is repaid as company collects receivables

consumer sector credit analysis

quantitative credit scoring models used by major issuers of retail credit

inventory timeline

raw materials --> WIP --> finished goods

primary disadvantage of factoring

receivables will be sold at significant discount

Open Account

sometimes called open book credit & is most common type of commercial trade credit

Multicurrency accounts

special arrangement between bank & company -- bank lets customer receive/make pmts. in range of currencies from single account or multiple subsidiary accounts

The Multilateral Investment Guarantee Agency (MIGA)

subsidiary of the World Bank -- created to foster trade w/ developing countries & "South Side" trade (trade between developing countries)

Consignment

supplier (consignor) ships goods to another party (consignee) who has no obligation to pay until goods have been sold

rational for supplier-managed replenishment programs

supplier can truck trends in inventory usage & manage levels of inventory more efficiently -- reduces costs for supplier & customer

supplier-managed replenishment programs

supplier maintains & tracks inventory of materials provided to a customer -- (1) As inventory used, supplier bills customer & replenishes supply (2) Title to product is transferred at shipping dock

automated cash application programs

take pmt. & remittance info & apply pmts. by matching them to specific invoices -- algorithms determine priority of invoices credited in event of partial pmts. -- Reduces manual effort required to complete process

Dynamic Discounting

takes traditional discounts step further & includes ability to vary discount according to date of early pmt. -- earlier the pmt. the larger the discount

typical companies using 3rd party financing

tend to manufacture & market big-ticket items such as production machinery

Export Credit Agencies (ECAs)

term for entities established by govt.'s to provide services -- established to assist in financing goods/services from their country to international markets

If discount terms offered

the "cost" of discounted pmts. affects income -- customers take advantage of discount but discount doesn't produce a real increase in sales -- net revenue declines

collection-to-cash cycle

the actual receipt & processing of a payment

"permanent" current assets

the minimum amount or base of CA that company must have to do business

Working Capital Management

the responsibility of treasury professional to manage firm's financial assets to ensure sufficient liquidity to meet current & future obligations in timely & cost-effective manner

internal factoring concept

this unit buys A/R from exporting unit & collects funds from importing company -- done on recourse basis

information float

time between receiving good funds & time the organization knows it has funds available & can make use of those funds -- critical for global organizations

inventory timeline in a retail business

time from acquisition of retail inventory to its ultimate sale -- may be faster

availability float

time interval/delay between day when a payment is deposited into a bank account & day when payee's account is credited w/ collected funds -- ranges from 0-2 business days (domestically) & even longer for intl. payments

float

time interval/delay between start & completion of a specific phase or process occurring along cash flow timeline -- result of wait time & inefficiencies

clearing float

time interval/delay between the day a check is deposited by payee & day when payor's account is debited -- payee credited & payor debited at the same time

mail float

time interval/delay between the day a payment (& related remittance info) is mailed & the day it is received by payee or at payee's processing site -- ranges between 1-2 days to weeks in international payments

Disbursement float

time interval/delay between the day when payment is initiated & day when funds are debited from payor's account -- viewed from the payor's perspective -- applies principally to paper-based payment instruments

collection float

time interval/delay between time buyer/payor initiates payment & time the seller/payee receives good funds -- applies principally to paper-based payment instruments

processing float

time interval/delay between time the payee or payee's processing site receives payment & time the payment (check) is deposited into payee's account -- typically >1 day, may extend if processing system is inefficient or has delays

wait time

time lost while waiting for someone else to take action or time needed to transmit info between 2 parties

CCC metric

timing difference between actual payment for those materials & collection of cash from sale of finished goods

supplier's incentive

to engage in actions that minimize payment float

Information System or Software monitoring A/R purchase

to ensure compliance with credit terms & to detect changes in customer payment patterns at aggregate & individual customer levels

A/P manager's primary responsibility

to verify incoming invoices & authorize payments (process called vouchering)

TD in float-neutral calculation

total days' difference in timing between check & electronic payments

maturity-matching financing strategy

total permanent CA & fixed assets are financed w/ long-term financing (debt/equity) -- short term financing used to finance fluctuating CA -- amount of ST financing mirrors amount of fluctuating CA

set-up or order costs

transaction costs incurrent when obtaining a new batch of inventory -- such as supplies for setting up new production run

in-house bank

treasury becomes main provider of banking services for all company's operating entities -- individual transactions of subsidiaries can be aggregated, netted & processed in bulk

use what to manage in-house banking operations

treasury technology -- TMS & ERP systems

customer's incentive

try to maximize company's collection float

floor planning

type of asset-based lending used for high-value durable goods (automobiles, trucks or heavy equipment)

uncollectible A/R must be charged off as bad debt

use historical collection patterns to estimate level of losses & create reserve account through periodic charges to bad debt expense -- timing & volume of BD expense & charge-offs important to credit policy

financing alternatives

used by companies experiencing rapid growth or with seasonal operations or less financial security -- may be tied directly to amount of inventory when it can't be financed as part of working capital requirements

Balance-Forward System

used by companies selling goods/services to individual consumers -- Most common in revolving credit situations like retail credit cards -- (1) Credit limit established for individuals (2) A/R outstanding balances increase as purchases made/services provided

CBD in Business-to-Consumer

used frequently for catalog, telephone, or internet transaction

CBD in Business-to-Business

used when seller doesn't know buyer or when seller considers buyer a greater credit risk than willing to accept

lagging

used when subsidiary country's current is expected to appreciate relative to parent company's currency

current asset management

varying views by financial, operations & sales managers -- so cross-functional effort

short-term debt

w/ original maturity of > 1 year -- enables firm to adjust amount of financing to fluctuation in CA so never has excess financing & never pays interest unnecessarily

basic decision of CA financing strategies

whether to place greater reliance on short or long-term source of funding

Captive Finance Company

wholly owned subsidiary & may be established to perform credit operations & obtain A/R financing for sale of products

if management prefers to take risks in interest of generating higher profitability w/ regard to CA investment strategies

will operate w/ a low CA to sales ratio -- restricted (less liquid) strategy

if company's management is conservative w/ regard to CA investment strategies

will select high level of CA to sales -- leads to higher liquidity (safety) but lower profitability = relaxed (more liquid) strategy

credit manager

works closely w/ sales manager b/c credit used as tool to increase sales