Chapter 14

Working Capital Management

Working-Capital Management n Current Assets u cash, marketable securities, inventory, accounts receivable n Long-Term Assets u equipment, buildings, land n Which earn higher rates of return? n Which help avoid risk of illiquidity?

Working-Capital Management n Current Assets u cash, marketable securities, inventory, accounts receivable n Long-Term Assets u equipment, buildings, land n Risk-Return Trade-off: Current assets earn low returns, but help reduce the risk of illiquidity. Current assets earn low returns, but help reduce the risk of illiquidity.

Working-Capital Management n Current Liabilities u short-term notes, accrued expenses, accounts payable n Long-Term Debt and Equity u bonds, preferred stock, common stock n Which are more expensive for the firm? n Which help avoid risk of illiquidity?

Working-Capital Management n Current Liabilities u short-term notes, accrued expenses, accounts payable n Long-Term Debt and Equity u bonds, preferred stock, common stock n Risk-Return Trade-off: Current liabilities are less expensive, but increase the risk of illiquidity. Current liabilities are less expensive, but increase the risk of illiquidity.

Balance Sheet Current Assets Current Liabilities Current Assets Current Liabilities Fixed Assets Long-Term Debt Fixed Assets Long-Term Debt Preferred Stock Preferred Stock Common Stock Common Stock To illustrate, let’s finance all current assets with current liabilities,

Balance Sheet Current Assets Current Liabilities Current Assets Current Liabilities Fixed Assets Long-Term Debt Fixed Assets Long-Term Debt Preferred Stock Preferred Stock Common Stock Common Stock To illustrate, let’s finance all current assets with current liabilities, and finance all fixed assets with long-term financing.

Balance Sheet Current Assets Current Liabilities Current Assets Current Liabilities Fixed Assets Long-Term Debt Fixed Assets Long-Term Debt Preferred Stock Preferred Stock Common Stock Common Stock Suppose we use long-term financing to finance some of our current assets.

Balance Sheet Current Assets Current Liabilities Current Assets Current Liabilities Fixed Assets Long-Term Debt Fixed Assets Long-Term Debt Preferred Stock Preferred Stock Common Stock Common Stock Suppose we use long-term financing to finance some of our current assets.

Balance Sheet Current Assets Current Liabilities Current Assets Current Liabilities Fixed Assets Long-Term Debt Fixed Assets Long-Term Debt Preferred Stock Preferred Stock Common Stock Common Stock Suppose we use long-term financing to finance some of our current assets. This strategy would be less risky, but more expensive!

Balance Sheet Current Assets Current Liabilities Current Assets Current Liabilities Fixed Assets Long-Term Debt Fixed Assets Long-Term Debt Preferred Stock Preferred Stock Common Stock Common Stock Suppose we use current liabilities to finance some of our fixed assets.

Balance Sheet Current Assets Current Liabilities Current Assets Current Liabilities Fixed Assets Long-Term Debt Fixed Assets Long-Term Debt Preferred Stock Preferred Stock Common Stock Common Stock Suppose we use current liabilities to finance some of our fixed assets.

Balance Sheet Current Assets Current Liabilities Current Assets Current Liabilities Fixed Assets Long-Term Debt Fixed Assets Long-Term Debt Preferred Stock Preferred Stock Common Stock Common Stock Suppose we use current liabilities to finance some of our fixed assets. This strategy would be less expensive, but more risky!

The Hedging Principle Permanent Assets (those held > 1 year) Permanent Assets (those held > 1 year) u should be financed with permanent and spontaneous sources of financing. Temporary Assets (those held < 1 year) Temporary Assets (those held < 1 year) u should be financed with temporary sources of financing.

Balance Sheet Temporary Current Assets

Balance Sheet Temporary Temporary Current Assets Short-term financing

Balance Sheet Temporary Temporary Current Assets Short-term financing Permanent Fixed Assets

Balance Sheet Temporary Temporary Current Assets Short-term financing Permanent Permanent Fixed Assets Financing and Spontaneous Spontaneous Financing Financing

The Hedging Principle n Permanent Financing u intermediate-term loans, long-term debt, preferred stock, common stock n Spontaneous Financing u accounts payable that arise spontaneously in day-to-day operations (trade credit, wages payable, accrued interest and taxes) n Short-term financing u unsecured bank loans, commercial paper, loans secured by A/R or inventory