Chapter 12 – Working Capital Management

1. Chapter 12 – Working Capital Management • Learning Objectives • Illustrate how to manage accounts receivable • Explain the components of credit policy • Explains how to • Speed up receivables • Slow down payables • Diagram the float • Explain inventory management and EOQ • Account for working capital in capital budgeting

2. Managing Accounts Receivable • Objective in accounts receivable management: speed up receivables • Want payment from customers as soon as practical • Must be aware of standard business practices • Collecting Accounts • How do customers pay (cash or credit) • When do customers pay (cash now…but credit?) • Credit sales over extended period of time

3. Managing Accounts Receivable • Aging receivables • Identifies chronic late payers • Assigns late fees to proper accounts • Follow-up with late paying customers • Example 12.2, page 352 • Age customer account • Follow-up invoice with late fees • Late fees billed by individual invoices

4. Credit • Granting of credit to customers • Policy on qualifying customers for credit • Policy on payment plan • Policy on follow-up for late payments • Qualifying for credit • Credit screening • Self scoring – credit card or gasoline company card • Some verification of information and ability – car loan • Substantial verification of ability to repay – home loan • Increasing cost usually match the increase in the size of the credit • Example 12.3 – Inflatable boats – How much to spend on screening activities (NPV decision)

5. Credit • Payment Policy • Methods to speed up receivables • Discount for speedy payment (implicit cost?) • Lock boxes for faster processing of payments • Wire transfers • Collecting Overdue Debt • Cost and Benefits of each stage • Collection agent, court, write of as bad debt • Methods to slow down payables • Check payment • Playing the float with remote disbursements

6. Inventory Management • Keeping track of inventory • ABC Method • A goods are critical goods, or high priced goods • B goods are moderately priced or essential goods • C goods are low priced or non-essential goods • Most effort is spent on A goods • Little effort is spent on C goods • Redundant Inventory Items • Economic Order Quantity – how much inventory to keep on hand

7. Inventory Management • Cost components of inventory • Ordering Costs • The cost paid to ship inventory from supplier to company • Does not include the cost of the item • Carrying Costs • The storage and handling costs while inventory is in “store” or “manufacturing facility” • Costs include space and utilities • Smooth inventory consumption (big assumption of model) • EOQ finds optimal trade-off between carrying costs and ordering costs

8. Inventory Management • Carrying Costs (cc), per unit carrying costs times average inventory • Ordering Costs (oc) number of orders times cost per order • Total Inventory Costs = CC + OC • EOQ is optimal order quantity that minimizes total inventory costs with S being annual sales

9. Inventory Management • Additional Issues with EOQ • Reorder Point • Placement of order quantity before inventory hits zero due to shipping time • Does not alter the actual order quantity or average inventory on hand • Safety Stock • Placement of order quantity before inventory hits zero and with additional days in case order is delayed • Does not alter quantity but does increase average inventory on hand • JIT – Just in Time, system that sets safety stock to zero

10. Effect of Working Capital on Capital Budgeting • Working Capital usually a necessary component of a project • Build up current assets and current liabilities at start of a project • Necessary components for making products • Expensed as products are sold • Maintained inventory levels during the project but could build as production increases • Recover working capital at end of project • Draw down of inventory items supporting production • Because items are expensed in COGS must show recovery of current assets and current liabilities

11. Homework • Problem 4 – Aging of Accounts Receivable • Problem 8 – Credit Terms • Problem 9 – EOQ • Problem 12 – Working Capital Impact