Chapter 12 – Working Capital Chapter 12 – Working Capital ManagementManagement
Learning ObjectivesLearning Objectives Illustrate how to manage accounts receivable Illustrate how to manage accounts receivable Explain the components of credit policyExplain the components of credit policy Explains how toExplains how to
Speed up receivablesSpeed up receivables Slow down payablesSlow down payables
Diagram the floatDiagram the float Explain inventory management and EOQExplain inventory management and EOQ Account for working capital in capital Account for working capital in capital
budgetingbudgeting
Managing Accounts ReceivableManaging Accounts Receivable
Objective in accounts receivable Objective in accounts receivable management: speed up receivablesmanagement: speed up receivables Want payment from customers as soon as Want payment from customers as soon as
practicalpractical Must be aware of standard business practicesMust be aware of standard business practices
Collecting AccountsCollecting Accounts How do customers pay (cash or credit)How do customers pay (cash or credit) When do customers pay (cash now…but When do customers pay (cash now…but
credit?)credit?) Credit sales over extended period of timeCredit sales over extended period of time
Managing Accounts ReceivableManaging Accounts Receivable
Aging receivablesAging receivables Identifies chronic late payersIdentifies chronic late payers Assigns late fees to proper accountsAssigns late fees to proper accounts Follow-up with late paying customersFollow-up with late paying customers
Example 12.2, page 352Example 12.2, page 352 Age customer accountAge customer account Follow-up invoice with late feesFollow-up invoice with late fees Late fees billed by individual invoicesLate fees billed by individual invoices
CreditCredit
Granting of credit to customersGranting of credit to customers Policy on qualifying customers for creditPolicy on qualifying customers for credit Policy on payment planPolicy on payment plan Policy on follow-up for late paymentsPolicy on follow-up for late payments
Qualifying for creditQualifying for credit Credit screeningCredit screening
Self scoring – credit card or gasoline company cardSelf scoring – credit card or gasoline company card Some verification of information and ability – car loanSome verification of information and ability – car loan Substantial verification of ability to repay – home loanSubstantial verification of ability to repay – home loan Increasing cost usually match the increase in the size of the Increasing cost usually match the increase in the size of the
creditcredit Example 12.3 – Inflatable boats – How much to spend Example 12.3 – Inflatable boats – How much to spend
on screening activities (NPV decision)on screening activities (NPV decision)
CreditCredit Payment PolicyPayment Policy
Methods to speed up receivablesMethods to speed up receivables Discount for speedy payment (implicit cost?)Discount for speedy payment (implicit cost?) Lock boxes for faster processing of paymentsLock boxes for faster processing of payments Wire transfersWire transfers
Collecting Overdue DebtCollecting Overdue Debt Cost and Benefits of each stageCost and Benefits of each stage
Collection agent, court, write of as bad debtCollection agent, court, write of as bad debt
Methods to slow down payablesMethods to slow down payables Check payment Check payment Playing the float with remote disbursementsPlaying the float with remote disbursements
Inventory ManagementInventory Management
Keeping track of inventoryKeeping track of inventory ABC MethodABC Method
A goods are critical goods, or high priced goodsA goods are critical goods, or high priced goods B goods are moderately priced or essential goodsB goods are moderately priced or essential goods C goods are low priced or non-essential goodsC goods are low priced or non-essential goods
Most effort is spent on A goodsMost effort is spent on A goods Little effort is spent on C goodsLittle effort is spent on C goods Redundant Inventory ItemsRedundant Inventory Items
Economic Order Quantity – how much inventory Economic Order Quantity – how much inventory to keep on handto keep on hand
Inventory ManagementInventory Management
Cost components of inventoryCost components of inventory Ordering CostsOrdering Costs
The cost paid to ship inventory from supplier to companyThe cost paid to ship inventory from supplier to company Does not include the cost of the itemDoes not include the cost of the item
Carrying CostsCarrying Costs The storage and handling costs while inventory is in “store” The storage and handling costs while inventory is in “store”
or “manufacturing facility”or “manufacturing facility” Costs include space and utilitiesCosts include space and utilities Smooth inventory consumption (big assumption of model)Smooth inventory consumption (big assumption of model)
EOQ finds optimal trade-off between carrying EOQ finds optimal trade-off between carrying costs and ordering costs costs and ordering costs
Inventory ManagementInventory Management
Carrying Costs (cc), per unit carrying costs times Carrying Costs (cc), per unit carrying costs times average inventoryaverage inventory
Ordering Costs (oc) number of orders times cost per Ordering Costs (oc) number of orders times cost per orderorder
Total Inventory Costs = CC + OCTotal Inventory Costs = CC + OC EOQ is optimal order quantity that minimizes total EOQ is optimal order quantity that minimizes total
inventory costs with S being annual salesinventory costs with S being annual sales
Inventory ManagementInventory Management
Additional Issues with EOQAdditional Issues with EOQ Reorder PointReorder Point
Placement of order quantity before inventory hits zero due to Placement of order quantity before inventory hits zero due to shipping timeshipping time
Does not alter the actual order quantity or average inventory Does not alter the actual order quantity or average inventory on handon hand
Safety StockSafety Stock Placement of order quantity before inventory hits zero and Placement of order quantity before inventory hits zero and
with additional days in case order is delayedwith additional days in case order is delayed Does not alter quantity but does increase average inventory Does not alter quantity but does increase average inventory
on handon hand
JIT – Just in Time, system that sets safety stock JIT – Just in Time, system that sets safety stock to zero to zero
Effect of Working Capital on Capital Effect of Working Capital on Capital BudgetingBudgeting
Working Capital usually a necessary component Working Capital usually a necessary component of a projectof a project Build up current assets and current liabilities at start Build up current assets and current liabilities at start
of a projectof a project Necessary components for making productsNecessary components for making products Expensed as products are soldExpensed as products are sold
Maintained inventory levels during the project Maintained inventory levels during the project but could build as production increasesbut could build as production increases
Recover working capital at end of projectRecover working capital at end of project Draw down of inventory items supporting productionDraw down of inventory items supporting production Because items are expensed in COGS must show Because items are expensed in COGS must show
recovery of current assets and current liabilities recovery of current assets and current liabilities
HomeworkHomework
Problem 4 – Aging of Accounts ReceivableProblem 4 – Aging of Accounts Receivable Problem 8 – Credit TermsProblem 8 – Credit Terms Problem 9 – EOQProblem 9 – EOQ Problem 12 – Working Capital Impact Problem 12 – Working Capital Impact