Working Capital Management and Cash Conversion Cycle

Flashcards covering key concepts from the lecture on Working Capital Management and Cash Conversion Cycle, including cash management models and inventory/receivables management.

What is working capital?

Short-term assets (inventory, debtors, cash) less current liabilities (trade creditors, short-term borrowings, other creditors repayable within a year).

What is the Cash Conversion Cycle (CCC)?

The length of time between a company's outlay on inputs and the receipt of money from the sale of goods.

What are the three categories of motives for holding cash?

Transaction motive, precautionary motive, and speculative motive.

What are the costs of holding too little cash?

Annoyance of those to whom payment is due, inability to cope with emergencies, missed opportunities, loss of discounts, higher borrowing costs, falling credit rating, and regular payments to top up cash balances.

What are the costs of holding too much cash?

Loss of interest and loss of purchasing power due to inflation.

What does Baumol's cash model assume?

A steady state environment where the company uses cash at a constant, predictable rate.

What is the formula for the optimal cash balance (Q*) according to Baumol's model?

EOQ or Q∗ = √2CA / K Where C = Transaction costs, A = Total new cash needed for period, and K = holding cost of cash opportunity cost

What is Economic Order Quantity (EOQ)?

Economic Order Quantity (EOQ) = √2AC / H where A = The annual usage of inventory items (in units), C = Cost of placing each order and H = cost of holding 1 unit of stock for 1 year

What does the Miller-Orr cash management model deal with?

Cash inflows/outflows that change daily.

According to the Miller-Orr model, what happens when a firm's cash flows touch the upper limit?

The firm buys sufficient marketable securities to come back to a normal level of cash balance i.e., the return point.

What are some considerations for cash management?

Create a policy framework, plan cash flows, and manage cash surpluses.

What are the risks of low inventory levels?

High ordering cost and Cost of 'stock-outs' - loss of sales, profits, goodwill, and production dislocation

What are the drawbacks of high inventory levels?

Cost of tying up cash (lost interest), storage costs, management costs, obsolescence, deterioration, insurance costs, and protection costs.

What are the steps in managing recievables?

Decide which customers should receive credit, decide how much credit should be offered, what length of credit is it prepared to offer, whether discounts will be offered for prompt payment, what collection policies should be adopted and How the risk of non-payment can be reduced