reading 35 - Working Capital Management
HPR
(face value - purchase price) / purchase price
money market yield
= HPR * (360/days until maturity)
the number of days of payables, which provides a measure of how long it takes the company to pay its own suppliers:
Average accounts payable / Average days purchases (Purchases/365)
The number of days of inventory gives us an indication of how well the inventory acquisition, process, and distribution is managed
Average inventory / Average days ' cost of goods sold
external factors affecting working capital needs
Banking services ■ Interest rates ■ New technologies and new products ■ The economy ■ Competitors
The operating cycle is a measure of the time needed to convert raw materials into cash from a sale
Operating cycle = Number of days of inventory + Number of days of receivables
Market (or interest rate) risk
Price or rate changes may adversely affect return ■ There is no market to sell the maturity to, or there is only a small secondary market
Holding Period Return (HPR)
Rate of return over a given investment period. HPR = (Ending Price - Beginning Price) / Beginning Price
Credit or Default Risk
Risk that the borrower will default on an interest or principal payment. ■ Issuer may default ■ Issuer could be adversely affected by economy, market ■ Little secondary market
the number of days of receivables, also referred to as the day's sales outstanding and days in receivables
average accounts receivable / Average days sales on credit
inventory turnover
cost of goods sold/average inventory
accounts receivable turnover
credit sales/average receivables
current ratio
current assets divided by current liabilities
U.S. Treasury bills (T-bills)
short-term marketable IOUs issued by the U.S. federal government; ■ Obligations of US government (guaranteed), issued at a discount ■ Active secondary market ■ Lowest rates for traded securities; maturities: 13, 26, and 52 weeks
foreign exchange risk
■ Adverse general market movement against your currency
Banker's acceptances (BAs)
■ Bank obligations for trade transactions (usually foreign), issued at a discount ■ Investor protected by underlying company and trade flow itself ■ Small secondary market; 30-180 days; Credit and liquidity risk (depending on bank's credit)
Bank certificates of deposit (CDs)
■ Bank obligations, issued interest- bearing in $100,000 increments ■ "Yankee" CDs offer slightly higher yields; 14-365 days; Credit and liquidity risk (depending on bank's credit)
internal factors affecting working capital needs
■ Company size and growth rates ■ Organizational structure ■ Sophistication of working capital management ■ Borrowing and investing positions/ activities/capacities
safety measures for foreign exchange risk
■ Hedge regularly ■ Keep most in your currency and domestic market (avoid foreign exchange)
Safety measures for Market (or interest rate) risk
■ Keep maturities short ■ Keep portfolio diverse in terms of maturity, issuers
Safety measures to credit or default risk
■ Minimize amount ■ Keep maturities short ■ Watch for "questionable" names ■ Emphasize government securities
Mutual funds and money market mutual funds
■ Money market mutual funds commonly used by smaller businesses ■ Low yields but high liquidity for money market funds; mutual fund liquidity dependent on underlying securities in fund ■ Can be linked with bank sweep arrangement
Federal agency securities
■ Obligations of US federal agencies (e.g., Fannie Mae, Federal Home Loan Board) issued as interest- bearing ■ Slightly higher yields than T- bills; 5-30 days maturities; Slight liquidity risk; insignificant credit risk
Tax- advantaged securities
■ Preferred stock in many forms, including adjustable rate preferred stocks (ARPs), auction rate preferred stocks (AURPs), and convertible adjustable preferred stocks (CAPs) ■ Dutch auction often used to set rate ■ Offer higher yields; 7, 28, 35, 49, and 90 days
repurchase agreements (repos)
■ Sale of securities with the agreement of the dealer (seller) to buy them back at a future time ■ Typically over- collateralized at 102 percent ■ Often done for very short maturities (< 1 week); 1 day+
Liquidity risk
■ Security is difficult or impossible to (re)sell ■ Security must be held to maturity and cannot be liquidated until then
Bank sweep services
■ Service offered by banks that essentially provides interest on checking account balance (usually over a minimum level) ■ Large number of sweeps are for overnight; 1 day
Safety measures for liquidity risk
■ Stick with government securities ■ Look for good secondary market ■ Keep maturities short
Eurodollar time deposits
■ Time deposit with bank off- shore (outside United States, such as Bahamas) ■ Can be CD or straight time deposit (TD) ■ Interest- bearing investment ■ Small secondary market for CDs, but not TDs; 1-180 days; Credit risk (depending on bank) Very high liquidity risk for TDs
Commercial paper (CP)
■ Unsecured obligations of corporations and financial institutions, issued at discount ■ Secondary market for large issuers ■ CP issuers obtain short- term credit ratings; 1-270 days