1 Handout Manajemen Keuangan Working Capital Management

2 Working capital terminology Gross working capital – total current assets. Net working capital – current assets minus non- interest bearing current liabilities. Working capital policy – deciding the level of each type of current asset to hold, and how to finance current assets. Working capital management – controlling cash, inventories, and A/R, plus short-term liability management

3 Selected ratios for SKI Inc. SKI Ind. Avg. Current1.75x2.25x Debt/Assets58.76%50.00% Turnover of cash & securities16.67x22.22x DSO (days) Inv. turnover4.82x7.00x F. A. turnover11.35x12.00x T. A. turnover2.08x3.00x Profit margin2.07%3.50% ROE10.45%21.00%

4 How does SKI’s working capital policy compare with its industry? SKI appears to have large amounts of working capital given its level of sales. Working capital policy is reflected in current ratio, turnover of cash and securities, inventory turnover, and DSO. These ratios indicate SKI has large amounts of working capital relative to its level of sales. SKI is either very conservative or inefficient

5 Is SKI inefficient or just conservative? A conservative (relaxed) policy may be appropriate if it leads to greater profitability. However, SKI is not as profitable as the average firm in the industry. This suggests the company has excessive working capital

6 Working Capital Management Short-Term Investment  Cash Management  Account Receivable Management  Inventory Management Short-Term Financing  Trade Credit  Bank Loans  Commercial Paper  Account Receivable and/or Inventory Financing

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8 Working Capital Management Trade-off of Short-Term Investment Cost 1 Cost 2 ___________________________________________________________________________________ Short-Term Assets Cash and Marketable Opportunity costIlliquidity and solvency Securitiesof fundscosts Accounts receivableCost of investment Opportunity cost of lost in accounts sales due to overly receivable and restrictive credit policy bad debts and/or terms Inventory Carrying costs of Order and setup costs inventory, including associated with replenishment financing, and production of finished warehousing cost, goods etc.

9 Working capital financing policies Moderate – Match the maturity of the assets with the maturity of the financing. Aggressive – Use short-term financing to finance permanent assets. Conservative – Use permanent capital for permanent assets and temporary assets.

10 Conservative financing policy $ Years Perm C.A. Fixed Assets Marketable securities Zero S-T Debt L-T Fin: Stock, Bonds, Spon. C.L.

11 Accrued liabilities Continually recurring short-term liabilities, such as accrued wages or taxes. Is there a cost to accrued liabilities?  They are free in the sense that no explicit interest is charged.  However, firms have little control over the level of accrued liabilities.

12 What is trade credit? Trade credit is credit furnished by a firm’s suppliers. Trade credit is often the largest source of short-term credit, especially for small firms. Spontaneous, easy to get, but cost can be high.

13 The cost of trade credit A firm buys $506,985 net ($512,106 gross) on terms of 1/10, net 30. The firm can forego discounts and pay on Day 40, without penalty. Net daily purchases = $506,985 / 365 = $1,389

14 Breaking down net and gross expenditures Firm buys goods worth $506,985. That’s the cash price. They must pay $5,121 more if they don’t take discounts. Think of the extra $5,121 as a financing cost similar to the interest on a loan. Want to compare that cost with the cost of a bank loan.

15 Breaking down trade credit Payables level, if the firm takes discounts  Payables = $1,389 (10) = $13,890 Payables level, if the firm takes no discounts  Payables = $1,389 (40) = $55,560 Credit breakdown Total trade credit$55,560 Free trade credit- 13,890 Costly trade credit$ 41,670

16 Nominal cost of costly trade credit The firm loses 0.01($512,106) = $5,121 of discounts to obtain $41,670 in extra trade credit: k NOM = $5,121 / $41,670 = = 12.29% The $5,121 is paid throughout the year, so the effective cost of costly trade credit is higher.

17 Nominal trade credit cost formula

18 Effective cost of trade credit Periodic rate = 0.01 / 0.99 = 1.01% Periods/year = 365 / (40-10) = Effective cost of trade credit  EAR= (1 + periodic rate) n – 1 = (1.0101) – 1 = 13.01%

19 Bank Loans A firm is choosing among three alternative bank loans. The firm wishes to minimize the borrowing costs on a $200,000 borrowing. Analyze the cost of each of these alternatives: 1. An 18% rate of interest with interest paid at year-end and no compensating balance requirement. 2. A 16% rate of interest but carrying a 20% compensating balance requirement. This loan also calls for interest to be paid at year-end. 3. A 14% rate of interest that is discounted, plus a 20% compensating balance requirement.

20 Bank Loans Solutions: 1. Effective rate of interest = 18%. 2. Effective rate of interest  = $32,000/($200,000-$40,000) = 20%. 3. Effective rate of interest  = $28,000/($200,000-$40,000-$28,000)  = 21.21%

21 Commercial paper (CP) Short-term notes issued by large, strong companies. B&B couldn’t issue CP--it’s too small. CP trades in the market at rates just above T-bill rate. CP is bought with surplus cash by banks and other companies, then held as a marketable security for liquidity purposes.

22 Alternative Financing: Example Suncoast Boats Inc. estimates that because of the seasonal nature of its business, it will required an additional $2m of cash for the month of July. Suncoast has the following 4 options available for raising the needed funds: 1. Establish a 1-year line of credit for $2m with a bank. The commitment fee will be 0.5% per year on the unused portion, and the interest charge on the used funds will be 11% per annum. Assume that the funds are needed only in July, and that there are 30 days in July and 365 days in the year.

23 Alternative Financing: Example 2. Forgo the trade discount of 2/10, net 40, on $2m of purchases during July. 3. Issue $2m of 30-day commercial paper at a 9.5% per annum interest rate. The total transactions fee, including the cost of a backup credit line, on using commercial paper is 0.5% of the amount of the issue. 4. Issue $2m of 60-day commercial paper at a 9% per annum interest rate, plus a transaction cost of 0.5%. Since the funds are required for only 30 days, the excess funds ($2m) can be invested in 9.4% per annum marketable securities for the month of August. The total transaction costs of purchasing and selling the marketable securities is 0.4% of the amount of the issue.

24 Alternative Financing: Example A. What is the dollar cost of each financing arrangement? B. Is the source with the lowest expected cost necessarily the one to select? Why or why not?

25 Alternative Financing: Example Solutions: a.1.Line of credit: Commitment fee = (0.005)($2,000,000)(335/365) = $ 9,178 Interest = (0.11)(30/365)($2,000,000) = 18,082 Total = $27,260

26 Alternative Financing: Example Solutions: 2.Trade discount:  a. = = = 24.83%. Total cost = ($2,000,000)(30/365) = $40,816.  b. Effective cost = (1 + 2/98) 365/  = = 27.86%. Total cost = ($2,000,000)(30/365) = $45,804.

27 Alternative Financing: Example Solutions: 3.30-day commercial paper:  Interest = (0.095)($2,000,000)(30/365) = $15,616  Transaction fee = (0.005)($2,000,000) = 10,000 Total = $25,616

28 Alternative Financing: Example Solutions: 4.60-day commercial paper: Interest = (0.09)($2,000,000)(60/365) = $29,589 Transaction fee = (0.005)($2,000,000) = 10,000 Total Costs = $39,589 Marketable securities interest received = (0.094)($2,000,000)(30/365) = $15,452 Transactions cost, marketable securities = (0.004)($2,000,000) = $8,000 Total = $32,137 The 30-day commercial paper has the lowest cost.