Intro to Working Capital Management

List of primary current liabilities

1. Accounts payable. 2. Debt maturing in less than 1 year. 3. Notes payable. 4. Accrued liabilities.

Multi-currency agreement stipulations

1. Base currency in which the account is denominated. 2. Portfolio of currencies accepted. 3. Spread or margin over the spot rate to use in exchanging each currency back to the base currency. 4. Value date to apply to debits & credits for each transaction type & currency.

Principal types of cash flows

1. Cash outflows. 2. Cash inflows. 3. Concentration or funding flows. 4. Liquidity management flows.

List of major current assets

1. Cash. 2. Marketable securities. 3. Accounts receivable. 4. Inventory. 5. Prepaid expenses.

Benefits of re-invoicing

1. Centralized FX exposure. 2. Improves short- term liquidity management -flexibility in inter-subsidiary payments. 3. Eases implementation of leading & lagging. 4. Improved export trade financing & collections. 5. Reduces bank costs. 6. Minimizes FX risk & better FX rates -larger trades. 7. Reduces payment costs.

Types of AP & disbursement systems

1. Centralized. 2. Decentralized. 3. Combination

5 Cs off Credit

1. Character: perceived honesty or integrity of applicant. 2. Capacity: financial resources to pay obligations. 3. Capital: short & long term resources. 4. Collateral: available assets or guarantees securing obligation. 5. Conditions: economic environment impacting customer's ability to pay.

Ways to obtain working capital

1. Collecting cash flow from operations. 2. Increasing debt. 3. Selling assets & investments. 4. Selling equity.

Critical areas of coordination between treasury & A/P

1. Communication from A/P to treasury regarding invoices vouchered for payment. 2. Communication from treasury to A/P regarding reconciliation of cleared items.

Proper management of accounts receivable includes

1. Creating, preserving, & collecting accounts receivable. 2. Maintaining up-to- date customer records. 3. Initiating collection procedures on past-due accounts

Considerations surrounding how much to invest in working capital and how much to finance

1. Current asset investment strategy.

Relaxed current asset investment strategy

1. High levels of current assets to sales. 2. High levels of inventory & AR. 3. Less risk because of larger liquid asset balances.

Treasury professional decisions in working capital management

1. How much working capital to have. 2. How to finance that working capital.

Types of float & typical timeline

1. Invoicing float - 40+days. 2. Payment float - 30+ days. 3. Disbursement or collection float - 1 to 5 days.

Levels of inventory approaches

1. JIT. 2. Supplier-managed replenishment: droplet maintains & tracks & title to product is transferred at shipping dock. 3. Paid-on production: pay record is created for goods and/ or services based on usuage rather than shipment & title to product is transferred during the manufacturing process.

Restrictive current asset investment strategy

1. Less liquid. 2. Investment in raw materials managed as tightly as possible using JIT inventory techniques. 3. Outstanding AR & cash balances are kept low, restrictive credit policy. 4. Most profitable as long as unexpected events do not drive down liquidity to the point it causes problems.

Approaches to financing decision

1. Maturity matching. 2. Conservative. 3. Agressive.

Forms of credit extension

1. Open account. 2. Installment credit. 3. Revolving credit. 4. Letter of credit.

Company's net cost of making payments

1. Opportunity costs 2. Administrative costs of managing AP & disbursement processes.

Elements of basic inventory policy

1. Reason for holding inventory. 2. Types of inventory. 3. Levels of inventory. 4. Obsolescence & spoilage. 5. Benefits & costs of inventory.

Inventory financing options

1. Supply chain. 2. Inventory financing. 3. Floor planning. 4. Collateralized loans

Working capital is reduced by.

1. Using cash flow in operations. 2. Repaying debt. 3. Purchasing assets & investments. 4. Paying dividends & buying back stock/equity.

Factors that may result in float

1. Wait time such as time lost waiting for someone else to take action or time needed to transmit info between 2 parties. 2. Inefficiencies within process. 3. Use of paper processes. 4. Delivery system such as mailing invoice.

Trade credit standards

2-stage process: 1. Company must establish credit acceptance criteria that represent a maximum amount of payment risk the company is willing to accept. 2. Must decide whether to approve a credit applicant under the criteria and if approved set a credit limit.

Decentralized AP & disbursement system

Advantage: greater autonomy to field office mangers. Improved relationship. Take advantage of discounts. Disadvantages: loss of control over info.

Centralized AP & disbursement system

Advantage: single location, making it easier to maintain control, obtain information, concentrate excess cash, provide greater access to cash position info, & improve cash forecasting. Disadvantages: potential negative impact on payee relationship. May result in delayed payments or lost discount.

Merchant discount

Amount credit card company or acquiring bank charges a seller for the service.

Current Assets

Assets expected to be converted into cash within 1 year.

Fluctuating current assets

Assets over the permanent current assets base.

Just-in-time inventory

Attempts to minimize inventory levels by reducing costs of uncertainties that underline motives for holding inventory. More of a philosophy that recognizes excess inventory can be liability instead of asset.

Days' inventory or Inventory conversion period - retail

Average length of time that finished goods inventory is held before sale.

Days' inventory or Inventory conversion period - service

Average length of time that materials are held in inventory until they are used to provide services.

Days' payable or payable conversion period.

Average number of days between the purchase or receipt of materials or supplies and issuance of payment for them. Actual trade period.

Days' receivables or receivables conversion period.

Average number of days required to convert a sale into a collection.

Days' inventory or Inventory conversion period - manufacturing

Average number of days that elapse from purchase of raw materials until sale of finished goods. Sum of average number of days that: 1. Raw materials remain in inventory. 2. Raw materials are converted into finish goods aka. Work in-progress inventory. 3. Finished goods remain in inventory.

Quantitative credit analysis

Begins with examination of a credit applicant's financial statements, usually using ratio analysis to assess a customer's financial condition.

Disbursement float

Buyer/payor - time interval between initiation & day when funds are debited from buyer's account.

Trade credit policies

Clearly define 1. Credit standards. 2. Credit terms. 3. Discount terms. 4. Collection policies.

Re-invoicing center

Company owned subsidiary that purchases goods from an exporting subsidiary & sells to importing subsidiary. Exporting unit: invoices & receives funds in own currency. Importing: invoiced & pays funds in its own currency. Requires local government & tax approval.

Trade credit

Contractual agreement allowing a customer to take possession of a good, product, or service now & pay for it later. Primary reason is to increase sales.

Spontaneous accounts

Current asset & current liability accounts that vary whenever sales activity occurs. No specific working capital management decisions are involved in increasing these accounts.

Current ratio

Current assets divided by current liabilities.

Working Capital

Current assets less current liabilities. Roughly corresponds to cash & liquid assets that can quickly be converted to cash.

Compare current liabilities to current assets in regards to working capital.

Current liabilities tends to carry interest rates charges that are higher than the rate of return on current assets.

Cash conversion cycle formula

Days' inventory plus days' receivables minus days' payables

Invoicing float

Delay between purchase of goods or services & receipt of an invoice by the buyer.

Carrying costs

Determined by using the marginal cost of short-term borrowing or the weighted average cost of capital.

Installment Credit

Equal periodic payments. Liquidating because will eventually be paid off.

Cash Inflows types

Funds collected from: 1. Customers. 2. Obtained from financial sources. 3. Received from other sources.

Cash outflows types

Funds disbursed to 1. employees, vendors, & suppliers. 2. Lenders. 3. Local, state, & federal tax agencies. 4. Bondholders. 5. Shareholders.

Export credit agencies

Government supports export activities through export loans, credit guarantees, or combination of both. Basic service: working cap guarantees or pre-export financing, export credit insurance, & loan guarantees & direct loans.

Order to cash

Includes all of the tasks involved in soliciting customers & converting inventory into sales & ultimately cash. Cash inflow.

Supply chain management

Integration of business processes with the entire chain of channel partners, which can include suppliers, intermediaries, 3rd party providers, & customers.

Netting

Internal company payables system designed to reduce the number of cross-border payments among company units through the elimination or consolidation of funds denominated in different currencies, thus enhancing natural hedging.

Concentrating/funding flows

Internal transfers among operating units & between firm's bank accounts, with objective of pooling funds or funding disbursement accounts.

Supply chain financing

Inventory lending where a seller receives financing based upon existence of sales contracts & purchase orders with large, financially stable, trading partners. Typically arranged by buyer. Benefits for seller: lower interest rate. Benefits for buyer: does not have to directly finance seller.

Maturity-Matching financing strategy

Long term i.e. debt & equity-Total of permanent current assets & fixed assets. Short term- fluctuating current assets. Intention when financed with line of credit. Fluctuating assets expand- drawing line supports expansion. Assets decline-funds are released & used to pay line of credit.

Conservative Financing strategy

Long-term - fixed & permanent assets, & portion of fluctuating current assets based on average level. Short term - portion of fluctuating current assets. Interest rate risk may be mitigated if: long term debt borrowed on fixed rate, short-term financing acquired on floating or variable rate.

Aggressive financing strategy

Long-term used for all fixed assets, portion of permanent current assets. Short-term- remainder permanent current assets, all fluctuating current assets. more Short-term financing. Lender may have cleanup period requiring completely payoff balance. Lessen risk: muti-year revolving credit agreements.

Permanent current assets

Lowest amount of current assets that company had in past several years.

Working capital management

Management of business & financial processes aimed at maximizing or creating shareholder value by optimizing the cash locked in short-term assets & liabilities.

Days' sales outstanding

Measure the average amount of credit sales that are in accounts receivable.

Objective of inventory management

Minimize total costs associated with inventory while meetings desired level of production and/ or customer service.

Open account

Most common type. Buyer billed for each transaction by invoice. Full payment expected. Buyer does not need to apply for credit each time places order.

Accounting method used for JIT

Most use rolling average of actual costs vs. Transaction by transaction cost accounting method.

Factoring

Outright sale of receivables. In most, buyer has no recourse to seller. Though some agreements may stipulate recourse.

Which float offers the greatest opportunity for improvement & effective management? Why?

Payment float is commonly caused by client deferring payment until specific due date. Payment float can often be the largest float component in any commercial pay process. Reduced by: e-commerce, but effective management of trade terms can typically provide even greater benefit.

Cash conversion cycle (CCC)

Period of time between disbursement for Accounts payable & collection of accounts receivable.

Bilateral netting

Purchases between 2 subsidiaries of the same company are netted against each other so that periodically, typically once or twice per month on preset dates, only net difference is transferred.

Inventory timeline

Raw materials to finished goods.

How are noncash current assets supported?

Reducing cash & by increasing debt and other liabilities.

Current liabilities

Required to be paid within 1 year.

Internal factoring

Same as re-invoicing except internal factoring unit does not take title. Factor can return past due receivables or bad-debt to subsidiary for collection.

Payment float from buyer & seller prospective

Seller or payee - delay between when invoice is sent & time seller's account is credited. Buyer or payor -invoice received & time buyer or payor's account is debited.

Collection float

Seller or payee - time interval between the buyer initiates payment & time the seller/payee receives good funds.

Disbursement system

Set of procedures that determine who may authorize payments, where & when the payments originate, how potential fraud is controlled, & how accounts are reconciled.

Re-invoicing

The centralizing responsibility for monitoring & collecting international AR. Takes title to goods, but goods are shipped to importing entity.

Information float

Time between receiving good funds & time organization knows that it had the funds available & can make use of funds resulting in inability to use or generate cash due to delay in receiving information.

Purchase to pay timeline

Time from the purchase of raw materials, retail goods, or services until payment is received & collected. Outflow of cash.

Float

Time interval or delay, between start & completion of specific phase or process occurring along the cash flow timeline.

Dynamic discounting

Trade discount that includes the ability to vary the discount according to date of early payment; earlier payment larger the discount.

In-house banking

Treasury becomes main provider of banking services for all company's operating entities. Primary benefit is reduction in overall banking costs. Secondary benfits include improved visibility & control over subsidiary cash assets, minimized borrowing, and an improved ability to manage internal & external FX risk.

Who is responsible for working capital management?

Treasury may lead and bear ultimate responsibility for results, but working cap management is cross-functional effort.

Stores & Supplies

Type of inventory that support production process. sometimes called indirect purchases.

Economic order quantity EOQ

Typically used to calculate optimal level of inventory, given specific ordering & holding costs. Can be difficult to apply because do not account for variables such as volume discounts & blanket purchase orders that cover schedule of deliveries.

Leading & lagging

Used in netting. Executing cross-border payments between subsidiaries before (lead) or after (lag) the scheduled payment date. Leading: subsidiary's currency expected to depreciate relative to parents. Lag: subsidiary's currency expected to appreciate relative to parents.

Liquidity management flows

Using the organization's liquidity reserve in the most effective manner. Surplus of funds: 1) invest in suitable investments or 2) pay down existing debt. Shortage of funds: 1)sell off investments or 2)draw on available debt sources such as credit lines or commercial paper issuance.

In-house bank responsibility

Usually responsible for managing international treasury including: 1. investments or debts, especially intracompany or subsidiary to subsidiary loans. 2. Netting. 3. Pooling. 4. Re-invoicing. 5. FX transactions & FX risk management.

Revolving Credit

company grants credit without requiring specific transaction approval, as long as the account remains current. Account is current if credit outstanding is below established credit limit & min payments made on time. Not paid by due date, interest charge is calculated based on average amount over entire period.

Open Item system

most commonly used in B2B sales. Invoice sent to customer is recorded in AR file. Payment is matched to specific invoices being paid & discrepancies are noted.

Line of Credit

most complex form of credit exposure and commonly used in import/export.