20-2 Working Capital Management CashInventory Accounts Receivable This chapter presents multiple strategies for managing the working capital of the firm.
20-3 Account Receivables and Credit Policy Credit Management Steps 1. Establish terms of sale 2. What form of IOU will be required? 3. Perform a credit analysis 4. Create a credit policy 5. Develop a collection policy
20-4 A/R and Credit Policy Terminology Trade Credit Bills awaiting payment from one company to another Consumer Credit Bills awaiting payment from final customer to a company Terms of Sale Credit, discount, and payment terms offered on a sale
20-5 Terms of Sale: Example 5/10 net percent discount for early payment 10 - number of days that the discount is available net 60 - number of days before payment is due
20-6 Implicit Cost: Example On a $100 sale, with terms 5/10 net 60, what is the implied interest rate on the credit given?
20-7 Credit Agreements Terminology Open account – Agreement whereby sales are made with no formal debt contract Commercial draft – An order to pay Sight draft Time draft Trade acceptance Bankers acceptance – A time draft accepted (and therefore guaranteed) by the bank.
20-8 Credit Analysis Credit Analysis: Procedure to determine the likelihood a customer will pay his or her bills. Credit agencies like Dun & Bradstreet provide reports on the credit-worthiness of a potential customer. Financial ratios can be calculated to help determine a customers ability to pay his or her bills.
20-9 The Five Cs of Credit Numerical Credit Scoring categories The customers character The customers capacity to pay The customers capital The collateral provided by the customer The condition of the customers business
20-10 Credit Analysis: Two Approaches 2. Multiple Discriminant Analysis - 1. Beaver, McNichols and Rhie – Calculate the chance of failing during the next year relative to the odds of not failing based on the following equation:
20-11 Credit Analysis: Example If the Altman Z-score cutoff for a credit-worthy business is 2.7 or higher, would we accept the following client? Yes, a score above 2.7 indicates good credit.
20-12 Credit Analysis: Discussion Credit analysis is only worthwhile if the expected savings exceed the cost. When is this true?
20-13 The Credit Decision Credit Policy: Standards set to determine the amount and nature of credit to extend to customers. Extending credit gives you the probability of making a profit, not the guarantee. There is still a chance of default. Denying credit guarantees neither profit nor loss.
20-14 The Credit Decision and Probable Payoffs Refuse credit Offer credit Payoff = Revenue - Cost Payoff = - Cost Customer pays = p Customer defaults = 1-p Payoff = 0 Decision
20-15 The Credit Decision Based on the probability of payoffs, the expected profit can be expressed as: Solving for p (probability), the break-even probability of collection is:
20-16 The Credit Decision: Some Final Thoughts 1. Maximize profit 2. Concentrate on the dangerous accounts 3. Look beyond the immediate order
20-17 Collection Policy Collection Policy: Procedures to collect and monitor receivables. Aging Schedule: Classification of accounts receivable by time outstanding.
20-18 Aging Schedule: Example * The totals in the last row are based on the assumption that there are more than four customers. The others were omitted for brevity. What is the goal of a good collection policy?
20-19 Inventory Management Primary Goal = Minimize amount of cash tied up in inventory Recall the Components of Inventory: Raw materials Work in process Finished goods Carrying Costs: The cost of storing goods plus the cost of capital tied up in inventory
20-20 Optimal Order Size: Minimize Costs
20-21 Optimal Inventory: Economic Order Quantity
20-22 Cash Management Cash vs. Short-Term Securities Why not all cash? Why not all short-term securities? A sweep program is a program which helps firms invest idle cash. The firms bank automatically sweeps surplus funds into a higher-interest account.
20-23 Float Float – The time between the moment a check is written and the moment the funds are deposited in the recipients account. Payment Float – Checks written by a company that have not yet cleared. Availability Float – Checks already deposited that have not yet cleared.
20-24 Managing Float Check mailed Cash available to recipient Check charged to payers account Check clears Check clears Check received Mail float Check deposited Processing float Availability float Payment float
20-25 Float and Check Handling Concentration Banking System whereby customers make payments to a regional collection center, which then transfers funds to a principal bank. Lock-box System System whereby customers send payments to a post office box, and a local bank collects and processes the checks.
20-26 Lock-Box System: Example A lock box receives 180 payments per day, with an average amount of $1,000. The daily interest rate is.02% and the lock box saves 1.75 days in mailing time and 1.25 days in processing time. If the bank charges $0.35 per check, should the company use this system? Yes, the firm is ahead $45 per day, plus any internal processing costs.
20-27 Electronic Funds Transfer (EFT), Three Methods 1) Direct Payment Automated Clearinghouse (ACH) 2) Direct Deposit 3) Wire Transfer Fedwire CHIPS (Clearing House Interbank Payments System) Other Payment Systems
20-28 Investing Idle Cash: The Money Market Money Market – the market for short-term financial assets. Treasury bills Commercial paper Certificates of deposit Repurchase agreements
20-29 Appendix A: How Purchases are Paid
20-30 Appendix B: Methods Used to Make and Receive Electronic Payments
20-31 Appendix C: Use of Payment Systems in the United States, 2009 Source: and