Working
capital management is the management of the short-term
investment and financing of a company.
Liquidity
Liquidity
is the ability of the company to satisfy its short-term obligations using
assets that are readily converted into cash.
Liquidity
management is the ability of the company to generate cash when
and where needed.
Liquidity management requires addressing drags and
pulls on liquidity.
- Drags on liquidity are forces that delay the collection of cash, such as slow payments by customers and obsolete inventory.
- Pulls
on liquidity are decisions that result in
paying cash too soon, such as paying trade credit early or a bank reducing
a line of credit.
Operating
and Cash Conversion Cycle
The operating
cycle is the length of time it takes a company’s investment in inventory to
be collected in cash from customers.
The net operating cycle (or the cash conversion cycle) is the length of time it takes for a company’s
investment in inventory to generate cash, considering that some or all of the
inventory is purchased using credit.
The length of the company’s operating and cash
conversion cycles is a factor that determines how much liquidity a company
needs.
The
longer the cycle, the greater the company’s need for liquidity.
Management
of the Cash Position
Management
of the cash position of a company has a goal of maintaining
positive cash balances throughout the day.
Forecasting short-term cash flows is difficult
because of outside, unpredictable influences (e.g., the general economy).
Companies tend to maintain a minimum balance of cash
(a target cash balance) to protect against a negative cash balance.
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Examples of Cash Inflows and Outflows
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Inflows
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Outflows
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Working
Capital Management
1.
Managing
accounts Receivable
- Consider the terms of credit given to customers:
- Ordinary: Net days or, if a discount for paying within a period, discount/discount period, net days (for example, 2/10, net 30).
- Cash before delivery (CBD): Payment before delivery is scheduled.
- Cash on delivery (COD): Payment made at the time of delivery.
- Bill-to-bill: Prior bill must be paid before next delivery.
- Monthly billing: Similar to ordinary, but the net days are the end of the month.
- Consider the method of credit evaluation that the company uses:
- Companies
may use a credit-scoring model to make decisions of whether to extend
credit, based on characteristics of the customer and prior experience
with extending credit to the customer.
·
Aging
schedule, which is a breakdown of accounts by length of time
outstanding:
o
Use a weighted average collection period
measure to get a better picture of how long accounts are outstanding.
o
Examine changes from the typical
pattern.
·
Number
of days receivable:
o
Compare with credit terms.
o
Compare with competitors.
2.
Managing
Inventory
- Approaches to managing levels of inventory:
- Economic order quantity: Reorder point—the point when the company orders more inventory, minimizing the sum of order costs and carrying costs.
- Just in time (JIT): Order only when needed, when inventory falls below a specific level
- Materials or manufacturing resource planning (MRP): Coordinates production planning and inventory management.
3.
Managing
Accounts Payable
- Factors to consider:
- Company’s centralization of the financial function
- Number, size, and location of vendors
- Trade credit and the cost of alternative forms of short-term financing
- Control of disbursement float (i.e., amount paid but not yet credited to the payer’s account)
- Inventory management system
- E-commerce
and electronic data interchange (EDI), which is the customer-to-business
payment connection through the internet
4.
Managing
Short-term Financing
- Characteristics that determine the choice of financing:
- Size of borrower
- Creditworthiness of borrower
- Access to different forms of financing
- Flexibility of borrowing options
- Asset-based
loans are loans secured by an asset
