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
