Chapter 12 – Working Capital Management  Learning Objectives  Illustrate how to manage accounts receivable  Explain the components of credit policy  Explains how to  Speed up receivables  Slow down payables  Diagram the float  Explain inventory management and EOQ  Account for working capital in capital budgeting

Managing Accounts Receivable  Objective in accounts receivable management: speed up receivables  Want payment from customers as soon as practical  Must be aware of standard business practices  Collecting Accounts  How do customers pay (cash or credit)  When do customers pay (cash now…but credit?)  Credit sales over extended period of time

Managing Accounts Receivable  Aging receivables  Identifies chronic late payers  Assigns late fees to proper accounts  Follow-up with late paying customers  Example 12.2, page 352  Age customer account  Follow-up invoice with late fees  Late fees billed by individual invoices

Credit  Granting of credit to customers  Policy on qualifying customers for credit  Policy on payment plan  Policy on follow-up for late payments  Qualifying for credit  Credit screening  Self scoring – credit card or gasoline company card  Some verification of information and ability – car loan  Substantial verification of ability to repay – home loan  Increasing cost usually match the increase in the size of the credit  Example 12.3 – Inflatable boats – How much to spend on screening activities (NPV decision)

Credit  Payment Policy  Methods to speed up receivables  Discount for speedy payment (implicit cost?)  Lock boxes for faster processing of payments  Wire transfers  Collecting Overdue Debt  Cost and Benefits of each stage  Collection agent, court, write of as bad debt  Methods to slow down payables  Check payment  Playing the float with remote disbursements

Inventory Management  Keeping track of inventory  ABC Method  A goods are critical goods, or high priced goods  B goods are moderately priced or essential goods  C goods are low priced or non-essential goods  Most effort is spent on A goods  Little effort is spent on C goods  Redundant Inventory Items  Economic Order Quantity – how much inventory to keep on hand

Inventory Management  Cost components of inventory  Ordering Costs  The cost paid to ship inventory from supplier to company  Does not include the cost of the item  Carrying Costs  The storage and handling costs while inventory is in “store” or “manufacturing facility”  Costs include space and utilities  Smooth inventory consumption (big assumption of model)  EOQ finds optimal trade-off between carrying costs and ordering costs

Inventory Management  Carrying Costs (cc), per unit carrying costs times average inventory  Ordering Costs (oc) number of orders times cost per order  Total Inventory Costs = CC + OC  EOQ is optimal order quantity that minimizes total inventory costs with S being annual sales

Inventory Management  Additional Issues with EOQ  Reorder Point  Placement of order quantity before inventory hits zero due to shipping time  Does not alter the actual order quantity or average inventory on hand  Safety Stock  Placement of order quantity before inventory hits zero and with additional days in case order is delayed  Does not alter quantity but does increase average inventory on hand  JIT – Just in Time, system that sets safety stock to zero

Effect of Working Capital on Capital Budgeting  Working Capital usually a necessary component of a project  Build up current assets and current liabilities at start of a project  Necessary components for making products  Expensed as products are sold  Maintained inventory levels during the project but could build as production increases  Recover working capital at end of project  Draw down of inventory items supporting production  Because items are expensed in COGS must show recovery of current assets and current liabilities

Homework  Problem 4 – Aging of Accounts Receivable  Problem 8 – Credit Terms  Problem 9 – EOQ  Problem 12 – Working Capital Impact