1. 1 Chapter 14 Working Capital Management Key Sections (pages 441 - 446) Risk/return trade-offs in Working Capital Management Hedging principle

2. 2 Introduction Net WC – current assets less current liabilities Liquidity management – establish current asset and liability levels so firm can meet its obligations Short-term – under one year. How much and from what sources? On average, 15% of sales in working capital

3. 3 Current Liabilities Advantages –Flexibility –Lower interest cost on short-term debt Disadvantages - Causes increase in risk of illiquidity especially if financial condition deteriorates - Uncertain interest costs year to year

4. 4 Risk/Return Trade-off Liquidity versus Profitability Large current assets reduce risk of production stoppages, lost sales and inability to pay bills But as WC , no increase in returns –With no increase in profits, ROI drops Greater reliance on current liabilities, greater risk of illiquidity

5. 5 Short-term, Long-term Trade-offs Risk of illiquidity –What happens if can’t obtain or roll over S-T debt? –Xerox, GM, Ford, etc as ratings deteriorated S-T less costly than L-T and more flexible Uncertainty of interest costs from year to year Trade-off – increased risk of illiquidity versus increased profitability

6. 6 Sources of Financing Assets – temporary (seasonal) or permanent Spontaneous sources – arise in normal course of business Trade credit – accounts payable Other payables and accruals Discretionary sources – from an explicit decision by management, both short and long-term borrowings

7. 7 Hedging Principle Maturity should follow cash flows of asset being financed - S-T Financing should be self-liquidating After spontaneous sources used, finance - Temporary assets with current liabilities. - Permanent assets with permanent financing, including permanent part of working capital

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9. 9 Hedging Principle

10. 10 Working Capital Management Need for Integrative Approach People are expensive so automate! –Requires external and internal teamwork to integrate systems for paperless environment Customers, suppliers, banks, company MSIS, Finance and Production