Module 6 Working Capital Management

• Working capital management involves oversight of operating cash flows, cash flow timelines, and management of current assets and liabilities.

• Key Topics:
    - Operating Cash Flows, Cash Flow Timeline, and Float
    - The Cash Conversion Cycle (CCC)
    - Impact of Current Balance Sheet Account changes on 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 and Liquidity Management

• Types of Cash Flows:
    - Cash Inflows: Funds entering from sales or other sources
    - Concentration Flows: Movement of funds through a Concentration Account
    - Cash Outflows: Payments made to vendors, employees, or creditors
    - Funding Flows: Internal movement to ensure account balances
    - Liquidity Mgmt Flows: Involves Short-Term Investments and Short-Term Borrowing

Understanding Float in the Cash Flow Timeline

• Float Definition: The delay in a process along the cash flow timeline.

• Causes of Float:
    - Wait Time: Time lost waiting for third parties
    - Inefficiencies: Manual processes causing delays

• Float Timeline Components:
    - Order and Invoice Preparation (I.e., Invoicing Float): Typically 40+ days.
    - Credit Period: Time between Invoice Receipt and Payment, managed by Payables Policy
    - Payment Collection & Application (Payment Float): Typically 10+ days.
    - Disbursement/Collection Float: Typically 1-5 days.

The Cash Conversion Cycle (CCC)

• Timeline Example:
    - Day 1: Purchase of Materials
    - Day 30: Payment for Materials
    - Day 45: Sale of Product
    - Day 80: Collection of A/R

• Calculation of CCC Segments:
    - Days Inventory: Day 1 to Day 45 (45 days)
    - Days Receivables: Day 45 to Day 80 (35 days)
    - Days Payables: Day 1 to Day 30 (30 days)

• Mathematical Formula for CCC:
    $CCC = ext{Days’ Inventory} + ext{Days’ Receivables} - ext{Days’ Payables}$

• Cash Turnover Relationship:
    $ext{Cash Turnover} = rac{365}{CCC}$
    - E.g., If $CCC = 50$ days, Cash Turnover is $7.3$ times; if $CCC = 39$ days, Cash Turnover improves to $9.4$ times.

• Risks in Managing CCC:
    - Potential lost sales, production stoppages, strained vendor relationships, and higher costs.

Impact of Current Accounts on External Financing

• Current Assets (CA): Increases generally require additional financing.

• Current Liabilities (CL): Some liabilities are spontaneous and rise with sales.

• External Financing Requirements: Change in Net Working Capital (NWC) indicates net financing needed.
    $NWC = CA - CL$

Working Capital Investment and Financing Strategies

• Asset Breakdown:
    - Fixed Assets: Long-term production assets
    - Permanent Current Assets: Minimum level maintained
    - Fluctuating Current Assets: Seasonal spikes

• Financing Strategies:
    - Maturity Matching: Matching asset life with financing life
    - Conservative Policy: Long-Term (L/T) financing for all assets
    - Aggressive Policy: Short-Term (S/T) financing for fluctuating assets

• Investment Strategies:
    - Restrictive: Minimize cash, inventory, receivables
    - Relaxed: High liquidity to support sales

Management of Credit and Accounts Receivable (A/R)

• Treasury and Credit Management Relationship:
    - Responsibilities include administering policies and monitoring accounts.

• Trade Credit Policies Elements:
    - Credit standards, terms, discounts, monitoring distress, collection policies.

The Five C's of Credit

1. Character: Willingness to pay, shown by payment history.

2. Capacity: Financial resources to pay obligations.

3. Capital: Resources available to supplement cash flow if needed.

4. Collateral: Assets to secure obligations in case of default.

5. Conditions: Economic and specific market conditions affecting customer and seller.

Forms of Credit Extension and Terms of Sale

• Forms: Open account, installment, revolving credit, letters of credit.

• A/R Management Goal: Quickly convert A/R into cash while minimizing losses.

• Common Terms of Sale: Cash before delivery, cash on delivery, net terms, discount terms, seasonal dating.

Management of Inventory and Accounts Payable

• Inventory Management Techniques: JIT, material planning systems, supplier-managed replenishment.

• Inventory Financing Alternatives: Trade credit, supply chain financing, collateralized loans.

• A/P Management Responsibilities: Verify invoices, perform three-way match, choose disbursement systems.

Multinational Working Capital Management Tools

• Multicurrency Accounts: Facilitates payments in multiple currencies.

• Netting Systems: Reduce transactions, improve cash forecasting.

• Re-invoicing Center: Centralizes FX risk and liquidity.

• In-House Banking Benefits: Reduces costs, solidifies treasury service role, potential tax benefits.

• Export Financing: Supported by governments; advantages and disadvantages outlined.