Working Capital Management Study Notes
Working Capital Management
Overview of Chapter Topics
Operating Cash Flows
Cash Flow Timeline
Float
The Cash Conversion Cycle (CCC)
How Changes in Current Balance Sheet Accounts Impact External Financing
Working Capital Investment and Financing Strategies
Management of Credit and Accounts Receivable (A/R)
Management of Inventory
Management of Accounts Payable (A/P)
Multinational Working Capital Management Tools
Operating Cash Flows
Cash Inflows
Sources of cash inflows:
Concentration Account
Concentration Flows
Types of Cash Outflows:
Funding Flows
Short-Term Investments
Short-Term Borrowing
Liquidity Management Flows
Float
Definition: Float refers to the time interval, or delay, between the start and the completion of a specific phase or process occurring along the cash flow timeline.
Causes of Float:
Wait time: Time lost waiting for someone else to take action or for information to be transmitted.
Inefficiencies within a specific process: Often caused by reliance on paper processes and delivery systems.
Float Timeline
Phases in the cash flow timeline:
Purchases
Invoice Received
Invoice Paid
Payment Posted
Delays in Timeline:
Invoice Entry and Shipping Preparation delays
Payables policy and processing delays
Typical durations:
Invoicing Float: 40+ days
Payment Float: 10+ days
Disbursement/Collection Float: 1-5 days
The Cash Conversion Cycle (CCC)
Definition: The CCC measures how efficiently a company turns its investments in inventory and other resource inputs into cash flows from sales.
Cash Conversion Cycle Steps:
Day 1: Purchase of materials
Day 30: Payment for materials
Day 45: Sale of product
Day 80: Collect accounts receivable
Formula:
More on Cash Conversion Cycle (CCC)
Cash Turnover Calculation:
Example Calculations:
At $CCC = 50$ days, $Cash ext{ }Turnover = 7.3$ times
At $CCC = 39$ days, $Cash ext{ }Turnover = 9.4$ times
Problems in "Managing" CCC
Components and Challenges:
Potential lost sales
Production stoppages
Stretched payables
Foregone cost-saving trade discounts
Higher prices assessed by vendors on smaller orders or slow payments
Refusal to sell to weak customers
Excessive reliance on A/P rather than short-term bank credit
How Changes in Current Accounts Impact External Financing
Current Assets Changes: May require additional financing.
Current Liabilities Changes: Some liabilities are spontaneous and can impact cash flow.
External Financing Requirements:
Change in Net Working Capital (NWC) defined as
This reflects the amount of new net financing needed.
Working Capital Investment and Financing Strategies
Asset Breakdown:
Maturity Matching
Conservative Policy
Aggressive Policy
Differentiation between Permanent and Fluctuating Current Assets.
Sources of Financing:
Long-Term and Short-Term Sources
Current Asset Investment Strategies:
Restrictive strategy
Relaxed strategy
Management of Credit and Accounts Receivable (A/R)
Relationship Between Treasury and Credit Management:
Credit managers set credit standards, terms of sale, and credit limits.
A/R management functions:
Billing and payments processing
Monitoring payment patterns
Collecting delinquent accounts.
Trade Credit Policies
Importance of Written Policies: To ensure fairness and consistency in credit management.
Components include:
Credit standards
Credit terms
Customer discounts
Financial distress monitoring methods
Collection policies
The Five C’s of Credit
Character: Willingness to pay based on payment history.
Capacity: Current and future financial resources for obligations.
Capital: Supplemental financial resources for cash flow.
Collateral: Assets or guarantees for obligation security.
Conditions: Economic environment impacts for both customer and seller.
Credit & Payment Application
Forms of Credit Extension:
Open account
Installment credit
Revolving credit
Letter of credit (L/C)
A/R Management Goals:
Quickly convert A/R into cash while minimizing collection costs and bad debt losses.
Common Terms of Sale
Types of Terms:
Cash before delivery (CBD)
Cash on delivery (COD)
Cash terms
Net terms
Discount terms
Monthly billing
Draft/Bill of lading
Seasonal dating
Consignment
Management of Inventory
Inventory Management Techniques:
Just-In-Time (JIT) inventory management
Material Planning System (MPS)
Supplier-managed replenishment programs
Paid-on-production inventory process
Inventory Financing Alternatives:
Trade credit as a significant financing source
Supply chain financing
Collateralized loans (asset-based lending)
Use of warehouses for inventory storage
Floor planning for high-value, durable goods.
Management of Accounts Payable (A/P)
Role of A/P Manager:
Verify incoming invoices and authorize payments, also known as vouchering.
Three-way Match Disbursement System:
Importance of matching purchase orders, receiving reports, and invoices.
Centralized vs. Decentralized Management:
Description of both systems in managing A/P.
Management Working Capital Management Tools
Financial Tools and Strategies:
Multicurrency Accounts
Netting (Bilateral and Multilateral)
Leading and Lagging
Re-invoicing
Internal Factoring
In-House Banking
Export Financing
Multicurrency Accounts
Definition: Special arrangements where banks permit transactions in multiple currencies from a single or multiple accounts.
Four General Stipulations:
Base currency of the account.
Accepted portfolio of currencies.
Margin over the spot rate for currency exchange.
Value date for transactions in each currency.
Benefits/Costs of Netting System
Benefits:
Reduction in FX transactions and cross-border wire transfers due to consolidation.
More favorable FX rates for larger trades.
Improved cash and currency exposure forecasting.
Costs:
Setup, administration, and maintenance expenses.
Re-invoicing Center Purpose
Function: Buys goods from an exporting subsidiary and resells to an importing subsidiary, enhancing economic efficiency through inter-company transactions.
Benefits of In-House Banking
Key Advantages:
Reduction in general banking costs.
Aggregation of small transactions into fewer larger transactions.
Strengthening treasury’s role in company service provision.
Potential for tax benefits through better information and tax planning.
Management of global treasury management solutions.
Export Financing
Government Support: Many governments on export activities via export loans and credit guarantees through Export Credit Agencies (ECA).
Examples: In the U.S., EximBank serves as the primary ECA.
Advantages:
Lower fixed interest rates.
Protection against foreign government appropriation or interference.
Disadvantages:
Time needed for approvals.
Currency exposure if loan currency differs from cash flow currency.
Conclusion
Summary of Learned Topics: The session concluded with a recap of the discussed elements, emphasizing the importance of effective working capital management for companies.