Podcast
Questions and Answers
What is the primary reason a company might choose to hold large amounts of cash?
What is the primary reason a company might choose to hold large amounts of cash?
Which type of inventory includes products that are completed but not yet sold?
Which type of inventory includes products that are completed but not yet sold?
What is the effect of reducing the average amount of inventory on carrying costs?
What is the effect of reducing the average amount of inventory on carrying costs?
Which of the following is NOT considered a type of inventory cost?
Which of the following is NOT considered a type of inventory cost?
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What is the primary purpose of a cash budget in cash management?
What is the primary purpose of a cash budget in cash management?
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What is the purpose of the Economic Order Quantity (EOQ) model?
What is the purpose of the Economic Order Quantity (EOQ) model?
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Which of the following methods specifically helps to reduce the need for excess cash holdings?
Which of the following methods specifically helps to reduce the need for excess cash holdings?
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What does the term 'float' refer to in cash management?
What does the term 'float' refer to in cash management?
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Which of the following actions would NOT contribute to minimizing cash holdings?
Which of the following actions would NOT contribute to minimizing cash holdings?
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What is the impact of a firm having 4 days of net float and processing $1 million of checks daily?
What is the impact of a firm having 4 days of net float and processing $1 million of checks daily?
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What is the primary focus of working capital management?
What is the primary focus of working capital management?
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Which of the following is NOT a determinant of a firm’s investment in accounts receivable?
Which of the following is NOT a determinant of a firm’s investment in accounts receivable?
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What is the total payment amount for January according to SKI's cash budget?
What is the total payment amount for January according to SKI's cash budget?
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What does the cash conversion cycle measure?
What does the cash conversion cycle measure?
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Which component is least likely to impact inventory management decisions?
Which component is least likely to impact inventory management decisions?
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What should be taken into consideration when calculating cash collections?
What should be taken into consideration when calculating cash collections?
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How is the average collection period typically determined?
How is the average collection period typically determined?
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According to the cash budget, what is the surplus amount for February?
According to the cash budget, what is the surplus amount for February?
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Why would a firm decide to carry inventory?
Why would a firm decide to carry inventory?
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Why should depreciation not be included in the cash budget?
Why should depreciation not be included in the cash budget?
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What primarily indicates a firm's credit policy?
What primarily indicates a firm's credit policy?
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What could SKI do to enhance its Economic Value Added (EVA)?
What could SKI do to enhance its Economic Value Added (EVA)?
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Which financial metric helps in measuring how quickly a company collects cash from its receivables?
Which financial metric helps in measuring how quickly a company collects cash from its receivables?
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What potential cash inflow options should SKI consider apart from collections?
What potential cash inflow options should SKI consider apart from collections?
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What is the operating cycle in days if the inventory period is 73 days and the average collection period is 33 days?
What is the operating cycle in days if the inventory period is 73 days and the average collection period is 33 days?
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If the cash cycle is calculated as 77 days, what is the duration of the payables period based on the operating cycle?
If the cash cycle is calculated as 77 days, what is the duration of the payables period based on the operating cycle?
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What might indicate that SKI is holding too much cash according to the cash budget analysis?
What might indicate that SKI is holding too much cash according to the cash budget analysis?
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Which formula correctly represents the inventory period based on average inventory and cost of goods sold (COGS)?
Which formula correctly represents the inventory period based on average inventory and cost of goods sold (COGS)?
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What is the purpose of maintaining a relatively high amount of cash for SKI?
What is the purpose of maintaining a relatively high amount of cash for SKI?
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How does a financial manager determine the optimal cash balance to hold?
How does a financial manager determine the optimal cash balance to hold?
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What does net working capital represent?
What does net working capital represent?
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What primary reason justifies holding a cash reserve?
What primary reason justifies holding a cash reserve?
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Which strategy would a financial manager likely employ to reduce the cost of holding cash?
Which strategy would a financial manager likely employ to reduce the cost of holding cash?
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How would an effective working capital management approach generally impact a business?
How would an effective working capital management approach generally impact a business?
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What is the main purpose of the Economic Order Quantity (EOQ)?
What is the main purpose of the Economic Order Quantity (EOQ)?
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Which of the following is an assumption of the EOQ model?
Which of the following is an assumption of the EOQ model?
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How is the Economic Order Quantity (EOQ) calculated?
How is the Economic Order Quantity (EOQ) calculated?
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What is meant by carrying cost in the context of EOQ?
What is meant by carrying cost in the context of EOQ?
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What effect does a tighter credit policy have on sales?
What effect does a tighter credit policy have on sales?
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Which component of a credit policy focuses on the timeframe allowed for customers to pay their debts?
Which component of a credit policy focuses on the timeframe allowed for customers to pay their debts?
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What is the implication of offering cash discounts in a credit policy?
What is the implication of offering cash discounts in a credit policy?
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Which of the following factors can be negatively impacted by a strict collection policy?
Which of the following factors can be negatively impacted by a strict collection policy?
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Study Notes
Introduction to Working Capital Management
- Working capital management involves managing current assets (cash, accounts receivable, inventory) and current liabilities (accounts payable, short-term debt).
- Students should be able to describe basic working capital management, the determinants of a firm's investment into accounts receivable, and how credit policy changes are determined.
- Students should also understand the reasons for carrying inventory and how inventory management decisions are made.
Topic and Structure of the Lesson
- The lesson covers the key components of working capital management:
- Cash conversion cycle
- Cash management
- Inventory management
- Receivables management
Key Terms
- Key terms used in working capital management include:
- Cash conversion cycle
- Inventory conversion
- Cash budget
- Credit policy
- Days sales outstanding
Introduction to Working Capital Management
- Definition of working capital as current assets minus current liabilities.
Figure 2.1: Working Capital
- Illustrates the concept of working capital as a component of a firm's total assets and the relationship with total liabilities and shareholders' equity.
- Shows the subcategories of fixed and current assets, and the different kinds of liabilities.
- Current assets are categorized as fixed and intangible.
- Liabilities include current and long-term categories.
Short-Term Financing Questions
- Focused on determining appropriate cash levels, short-term borrowing amounts, and appropriate credit extensions to customers.
Figure 30.2: Simple Cycle of Operations
- A diagram showing the sequential flow of goods and cash from raw materials purchase to cash collection on sales,
- This illustration shows how cash is tied up by raw materials, work-in-progress, and finished goods inventory.
Figure 30.3: Cash Conversion Cycle
- Breakdown of how long it takes from purchasing raw materials to converting those materials into cash through sales.
- Components of the cash conversion cycle include; Inventory period, Accounts payable period, and Accounts receivable period.
- Operating cycle is the sum of inventory and receivables period.
- Cash conversion cycle is the operating cycle minus accounts payable period.
Cash Conversion Cycle, US Manufacturing, 2011
- Data is presented to illustrate the relationships between sales, cost of goods sold, inventory, accounts receivable, and accounts payable of USD in billions (2011).
30-1 Working Capital and the Cash Conversion Cycle
- Calculates average inventory period, average receivables period, and average payables period.
- Shows how the different periods are added together to determine the cash conversion cycle
- Uses figures from the previous section to calculate lengths in days
Quick Quiz 1
- Presents a case study to assess students' ability to calculate the operating cycle and cash conversion cycle, given average inventory, average receivables, average payables, net sales, and cost of goods sold.
Quick Quiz 1 Solution
- Provides the calculations to find the inventory turnover, inventory period, receivables turnover, average collection period, payables turnover, payables period, operating cycle, and the cash cycle for the case in the Quick Quiz 1
Alternative Formulae
- Provides the calculations to find the length in days for the inventory period, average collection period, and payables period given average inventory values, cost of goods sold, sales amounts.
Working Capital Terminology
- Definitions of net working capital, working capital policy, and working capital management.
Cash
- Cash Does Not Pay Interest
- Move money from cash accounts into short-term securities
- Concentration banking
- Lock-box system
- Financial managers balance liquidity and opportunity costs.
- Trade-off between cost of keeping an inventory of cash and benefits of potentially saving from transaction costs.
Cash Doesn't Earn a Profit
- Importance of holding cash for transactions, precautionary, compensating balances and speculation.
What is the Goal of Cash Management?
- To meet the short-term cash needs of day-to-day operations.
- To minimize transaction balances
- To meet other needs and objectives.
Ways to Minimize Cash Holdings
- Use a lockbox
- Insist on wire transfers from customers
- Synchronize inflows and outflows
- Increase forecast accuracy
- Hold marketable securities
- Negotiate a line of credit
What is "Float"?
- The difference between the cash shown on a firm's books and the cash balance shown on the bank's records.
Cash Budget: The Primary Cash Management Tool
- Purpose: Forecast cash inflows, outflows, and ending cash balances.
- Used to plan loans needed or funds available to invest daily, weekly or monthly.
SKI's Cash Budget
- Illustrative example of a cash budget with details for January and February, including collections (sales), purchases, wages, rent, and other payments.
###Should Depreciation Be Explicitly Included in the Cash Budget?
- No, Depreciation is a noncash charge, in a cash budget only cash payments and receipts are included.
- Depreciation does impact taxes; taxes which are included in a cash budget.
What are Some Other Potential Cash Inflows Besides Collections?
- Proceeds from sale of fixed assets, Stock and bond sales, Interest earned, and Court settlements.
How Could Bad Debts be Worked Into the Cash Budget?
- Collections would reduced by the amount of the bad debt losses.
- For instance, if the firm had a 3% bad debt loss, total collections would be 97% of sales.
- Lower collections result in higher borrowing needs.
Analyze SKI's Forecasted Cash Budget
- SKI's cash holdings would exceed the target level for each month.
- SKI would improve Economic Value Added (EVA) through investments or returns to shareholders.
Why Might SKI Want to Maintain a Relatively High Amount of Cash?
- To prevent cash shortfall if sales are less than forecasted
- For conservative planning, or if confidence in sales forecast is low.
- To fund future investments.
Inventory Management Components
- Raw materials
- Work-in-process
- Finished goods
Types of Inventory Costs
- Carrying costs: Storage, insurance, property taxes, dep and obsolescence
- Ordering costs: Placing orders, Shipping and handling
- Costs of running short: Lost sales, customer goodwill, disruption to schedules.
Determining Optimal Order Size (EOQ Model)
- Graph illustrating the relationship between order size, carrying costs, order costs and total costs..
- Minimum total costs indicate the economically optimal order quantity.
Inventory Model
- The EOQ (economic order quantity) model determines the ideal order size that minimizes total inventory costs.
- Assumptions for EOQ calculations include perfect sales forecasting, evenly distributed sales throughout the year and no unexpected delays in order receiving.
Inventories (Example)
- Calculation of EOQ given annual sales, ordering cost and carrying cost.
EOQ Example
- Illustrative example of a calculation of the Economic Order Quantity(EOQ) given specified values for annual sales, cost per order, and cost of carrying 1 unit in inventory.
Elements of Credit Policy
- Credit Period, Cash Discounts, Credit standards, and Collection Policies
Does a Firm Face Any Risk if it Tightens its Credit Policy?
- Tightening credit policy may discourage sales, and some customers might choose to do business elsewhere.
If SKI Succeeds in Reducing DSO
- Reduces cash holdings in the short run if customers pay sooner, but over time could be reinvested in more productive assets or distributed as dividends to shareholders.
Reading Assignment
- Ross Chapter 14 and 15
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Description
This quiz covers the fundamentals of working capital management, including the management of current assets and liabilities. Students will learn about the cash conversion cycle, inventory management, and credit policies. Understanding these concepts is essential for effective financial management in any organization.
