Working Capital Management

1
Fall 2008

• Chapter 21
• Part 2
• Working Capital Management

2
ALTERNATIVE WORKING CAPITAL POLICIES

• Do all companies follow the same working capital
  policy?
• No. _____ in sales, costs, lead times on
  inventory shipments, payment periods, and
  collection periods force companies to hold _____
  in w/c.
• Otherwise, everyone would hold _____ levels of
  w/c.

3

• At the extremes are the restrictive vs relaxed
  working capital policies
• With a restrictive w/c policy, firms _____ their
  safety stocks of cash and inventories, and are
  _____ with their credit terms (even at the risk
  of losing some sales).
• Risk is higher, but so is expected profit.

4

• With a relaxed w/c policy, firms carry _____
  levels of safety stocks of cash and inventories,
  and are more _____ with their credit terms.
• _____ is lower, but so is expected _____.

5

• A restrictive w/c policy requires the NOWC to
  work harder. (NOWC turn.)
• Policy NOWC/Sales Sales/NOWC
• Relaxed 30 3.3x
• Moderate 23 4.3x
• Restrictive 16 6.3x

6

• How do you tell if a firm with low liquidity is
  pursuing a restrictive policy, or is poorly
  managed and experiencing cash flow difficulties?
• Look at _____
• A restrictive policy should be marked by _____
  liquidity ratios and high ___
• A company in trouble should be marked by _____
  liquidity and _____ profit.

7
In-Class Exercise

• Determine the ROIC for MicroDrive Corp for
  2006.
• If the industry average for ROIC is 15.0,
  MicroDrive appears to be
• a) following an aggressive w/c policy
• b) poorly managed and in difficulty

8
Final Thoughts on W/C Policy

• Many companies today strive for zero working
  capital, defined as
• view w/c as an idle resource providing little in
  _____
• assume value is created by _____ assets that
  produce the product demanded by consumers

9

• Inventory is created by _____ between production
  and sales
• Greater time delays and waste in the production
  process _____ the need for inventories
• Dells move to a build-to-order system greatly
  _____ inventory at all levels

10

• Forecasting uncertainties still prevent inventory
  from being reduced to _____.
• As production processes become more ____ and JIT
  inventory processes apply universally, delays
  that create the need for inventory will be _____.

11

• Trade credit exists because of inefficiencies in
  the _____ market
• If trade credit were eliminated, about _____ of
  the working capital would also be
  eliminated.
• As the Fed continues to encourage the use of
  _____ forms of payment, the need for w/c
  investment will be reduced.

12
CASH MANAGEMENT

• Cash is a _____ of funds
• The average industrial firm holds cash (currency
  demand deposits) equal to roughly _____ of
  total assets.
• Cash typically earns no _____, but it is needed
  to pay for labor, raw materials, take trade
  discounts, buy fixed assets, pay interest on
  debt, pay taxes, and pay dividends.

13

• Why do companies hold cash?
• for planned disbursements (_____ motive)
• for unplanned disbursements due to uncertainty in
  CF (_____ motive)
• to meet _____ requirements of banks for providing
  services and loans

14
CASH BUDGET

• A cash budget helps with cash management by
  allowing a company
• to _____ its future cash needs
• know _____ and _____ it needs to borrow
• to know when it will have _____ funds available
  for investment

15

• Monthly cash budgets are used for _____
  purposes.
• Daily cash budgets are used for _____ cash
  management

16
What data are needed to construct a cash budget?

• _____ forecast.
• Information on collections _____.
• Forecast of _____ and payment terms.
• Forecast of cash expenses wages, taxes,
  utilities, and so on.
• _____ cash on hand.
• _____ cash balance.

17
SKIs Cash Budget for January and February
Net Cash
Inflows January
February Collections 67,652 62,756 Purchases 44,
604 36,473 Wages 6,691 5,471 Rent 2,500
2,500 Total pmt.s 53,794 44,444 Net
CF 13,858 18,312
18
SKIs Cash Budget (Continued)

January February Cash at start (w/o
borrowing) 3,000 16,858 Net CF
(prior slide) 13,858
18,312 Cumulative cash 16,858
35,169 Less target cash 1,500
1,500 Surplus 15,358
33,669
19
Which items do not appear in a cash budget?

• depreciation expense
• sale of fixed assets
• sale of stocks
• sale of bonds
• interest earned
• interest paid
• bad debt losses
• proceeds or payments from court settlements

20

• Does it appear that SKI is managing its cash
  well?
• How does idle cash affect EVA?
• Why might SKI be planning to carry excess cash
  balances?

21
In-Class Exercise

• Use the format on the following slide to
  determine a cash budget for Koehls Doll Shop.
  (problem 14, p. 755)

22

• December January February
• sales __________ __________ _________
• purchases __________ __________ _________
• payments __________ __________ _________
• receipts from sales________ ________ _______
• payments for
• purchases __________ __________ _________
• salaries __________ __________ _________
• rent __________ __________ _________
• taxes ________ ________ _______
• total payments ________ ________ _______
• net cash gain ________ ________ _______
• cash (start of mo.)__________ __________ ________
  _
• cumulative cash __________ __________ _________
• target cash balance_______ ________ _______
• cum. cash surplus ________ ________ _______

23

• How would the cash budget for Koehls Doll Shop
  be affected if it began business on December
  1?
• What additional items or factors could have been
  included?