Working Capital Management

1. Working Capital Management FIN 292 Chapter 6: Cash Management

2. Cash Management • Cash Management Objectives; • Get payments received into firm’s bank account. • Redeploy newly acquired cash resources to their most efficient utilization. • Cash Management Tools; • Internal Controls • Lockboxes, EFT, EDI, ACH

3. Cash Management • Players in the Cash Flow Process • Treasury Managers - checkbook, capital and money market access; external inflows • Payroll Managers - cash outflow • Accounts Payable Managers - cash outflow • Inventory Control Managers - cash outflow • Accounts Receivable Managers - cash inflow

4. Cash Management • Cash versus Credit • We buy much using credit. • Ultimately, we must pay all in cash. • Some Caveats • Too much credit adversely impacts income. • Too much cash can also have an adverse impact.

5. Cash Management • Cash Conversion Cycle • Cash into inventory (labor & materials) • Inventory (finished goods) into receivables • Receivables into cash • CCC = ICP + RCP - PDP (in days) • Where: ICP = inventory conversion period • RCP = receivables collection period • PDP = payables deferral period

6. Cash Conversion Cycle Estimating the Cash Conversion Cycle Time CCC=360 *

7. Cash Conversion Cycle • Decomposing the CCC Equation: • (INV / COGS) * 360 • The Inverse of the Inventory Turnover (ITO) ratio times 360 is an estimate of the number of days to convert inputs to outputs. It is sensitive to the inventory control strategy pursued by management. It does not necessarily reflect the firm’s production function.

8. Cash Conversion Cycle • Decomposing the CCC Equation: • (A/R / Credit Sales) * 360 • The inverse of the Accounts Receivable Turnover (ARTO) ratio times 360 yields the Average Collection Period (Days Sales Outstanding) or number of days the firm must wait (on average) to collect money owed to it from credit sales.

9. Cash Conversion Cycle • Decomposing the CCC Equation: • {(A/P + Accruals) / (COGS + SGA)}*360 • A portion of the firm’s direct and indirect expenses are financed by credit extended by our suppliers and the human capital of the firm’s employees; i.e., Accounts Payable & Accruals. • This equation is the same as dividing the A/P + Accruals by the average daily cash expenses; i.e., (COGS+SGA) / 360.

10. Cash Conversion Cycle • Other Factors in the RCP Time: • Dealing with Mailing and Clearing Times (Float) • Using Lockboxes and Remote Depositories • Using Electronic (wire) Funds Transfers • Using Electronic Data Interchange (EDI) • Using Automatic Clearing House (ACH) • Using Netting Services

11. Cash Management • Cash Management Control Instrument: • The Cash Budget: Estimate of expected inflows and outflows. Actual is compared to Forecast and the variance resolved.

12. Cash Management • Cash Budget as Simulation Tool: • Computerized spreadsheets containing the cash budget assist cash managers in visualizing impact of dislocations in the firm’s cash flow assumptions and their impact on profitability and external cash requirements.

13. Organizing the Cash Budget s/s Quadrant I: Sales, CC Fees

14. Organizing the Cash Budget s/s Quadrant 2: Repair Services

15. Organizing the Cash Budget s/s Quadrant 3: Overhead

16. Organizing the Cash Budget s/s Quadrant 4: Non-Operating Expense

17. Organizing the Cash Budget S/S • Making Some Preliminary Decisions • Identify Policy Simulation Variables: • These are variables you may want to change in some form to gauge the impact of policy/strategy changes. For Example: Price, Sales, Collections. • Locking Formula Cells: • You may want to lock certain cells to prevent inadvertent alterations. You must first “unlock” the cells containing simulation variables. Then protect the worksheet or the workbook.

18. Organizing the Cash Budget S/S • Techniques to Minimize Math Errors: • Write formula in first cell and copy to other cells in row as required. Be careful when absolute references must be preserved; e.g., use of $ to anchor the row or column reference. • Excel has an automatic/manual recalc feature. When Building a new spreadsheet select the manual recalc from the Tools - Options - Calculation tab.

19. Organizing the Cash Budget S/S • Iteration Feature in the Calculation Option: • When the spreadsheet has been completed, there will be numerous circular references - a second result affected by a first result which affects yet another result. Unlike Lotus, Excel sees this as an error UNLESS you check the Iteration block of the Calculation options. Before loading a spreadsheet, set the Iteration feature to “on.”