MANAGING CRRENT ASSETS following steps would increase its

cash conversion cycle

.
o .The company increases its
Working capital
average inventory without
Working capital management is increasing its sales.
essentially an accounting strategy with a o The company starts paying its
focus on the maintenance of a sufficient bills sooner, which reduces its
balance between a company's current average accounts payable
assets and liabilities. An without reducing its sales.
effective working capital
management system helps businesses reduce the length of a company’s
not only cover their financial obligations cash conversion cycle
but also boost their earnings o Adopting a new inventory
following will cause an increase in system that reduces the
working capital inventory conversion period.
o Reducing the average days
o Merchandise is sold at a profit, sales outstanding (DSO) on its
but the sale is on credit. accounts receivable.
Gross working capital represents Delaying payments to suppliers
current assets used in operations. increases the length of the cash
conversion cycle.
Net working capital is defined as
current assets minus current liabilities.
Cash budget
Cash conversion cycle
The cash budget is useful in determining
The cash conversion cycle (CCC) is a
future financing needs.
metric that expresses the time
(measured in days) it takes for a part of the cash budget
company to convert its investments in
o . Payments lag.
inventory and other resources
into cash flows from sales. o . Payment for plant
construction.
The cash conversion cycle is the cycle in o . Cumulative cash
which a firm purchases inventory, sells
goods on credit, and then collects Depreciation expense is not explicitly
accounts receivable included, but depreciation effects are
implicitly included in estimated tax
following steps would reduce its payments. - depreciation is not a cash
cash conversion cycle item. (Although depreciation will affect
o The company reduces its DSO. taxes, depreciation itself will not be
o Forgo discounts that are included in the cash budget.
currently being taken.

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Depreciation has an impact on the cash company has more cash available for
budget. its use than the amount shown in the
company’s books.
Although depreciation is a noncash .
expense, it does affect taxes, which are
a cash expense
A lockbox speeds collections of
receivables; it doesn’t ensure that
explicitly include in its monthly cash petty cash will be safe..
budget
A firm that has such an efficient cash
o Its cash proceeds from selling management system that it has
one of its divisions. positive net float can have a negative
o Interest paid on its bank loans checkbook balance at most times and
still not have its checks bounce.
The typical actual cash budget will
reflect interest on loans and income
A very efficient cash management
from investment of surplus cash. These
system could allow a firm to operate
numbers are expected values and
with positive net float where the firm
actual results might turn out
has a negative checkbook balance at
different. most times but still does not bounce its
Cash management checks.

A cash management system that A good cash management system

minimizes collections float and maximizes disbursement float and
maximizes disbursement float is better minimizes collections float.
than one with higher collections float
and lower disbursement float. A well-designed lockbox system
minimizes collections float which would
Net float = Disbursements float -
increase a firm’s net float.
Collections float; therefore the larger
the disbursements float and the lower
Increases in interest rates raise the
the collections float the better the cash
opportunity cost of idle cash.
management system.
A firm prefers to write checks,
A lockbox is used to speed cash
maximizing its disbursement float and
collections. If a firm’s outflows come
increasing its net float.
due early in the month rather than
uniformly this will necessitate a
lockbox plan is
large line of credit.
A system for speeding up a firm’s
collections of checks received.
Use of a lockbox reduces the
possibility that petty cash will be lost.
lockbox plan is most beneficial to
firms that Make collections over a wide
positive net float means that a
geographic area

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Marketable securities
Marketable securities are assets that
can be liquidated to cash quickly.
These short-term liquid securities can
be bought or sold on a public stock
exchange or a public bond exchange.
These securities tend to mature in a
year or less and can be either debt or
equity
not a situation that might lead a firm
to hold marketable securities
o The firm has purchased a
fixed asset that will require a
large writeoff of depreciable
expense.
a situation that might lead a firm to
hold marketable securities
o The firm must meet a known
financial commitment, such as
financing an ongoing
construction project.
o The firm must finance
seasonal operations.
o The firm has just sold long-
term securities and has not
yet invested the proceeds in
earning assets.
if the yield curve is upward sloping,
then a firm’s marketable securities
portfolio, assumed to be held for
liquidity purposes, should be
Weighted toward short-term securities
to avoid interest rate risk
For some firms, holding highly liquid
marketable securities is a substitute for
holding cash because the marketable
securities accomplish the same
objective as cash.
Monitoring receivables
Analyzing days sales outstanding
(DSO) and the aging schedule are
two common methods for monitoring
receivables. However, they can provide
erroneous signals to credit managers
when Sales fluctuate seasonally.
Credit policy
credit policy variables.
o Credit period.
o Collection policy.
o Credit standards.
o Cash discounts.
If easing a firm’s credit policy
lengthens the collection period and
results in a worsening of the aging
schedule, then why do firms take such
actions It normally stimulates sales.
And . To meet competitive pressures
Inventory management
“red-line method” refers A method of
controlling inventories by drawing a red
line on the inside of a bin.
following might be attributed to
efficient inventory management
o High inventory turnover ratio.
o Low incidence of production
schedule disruptions.
o .High total assets turnover.
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 terms that encourage additional sales
to financially “weak” firms. A major
disadvantage of such a policy is that it is
likely to increase uncollectible accounts.

Miscellaneous working capital concepts

Working capital management DSO and aging schedule
involves both setting working capital
The DSO of a firm with seasonal
policy and carrying out that policy in
sales can vary. While the sales per day
day-to-day operations
figure is usually based on the total
The best and most comprehensive annual sales, the accounts receivable
picture of a firm’s liquidity position is balance will be high or low depending
shown by its cash budget, which on the season.
forecasts cash inflows and outflows
Days sales outstanding (DSO)
Float
If a firm sells on terms of 2/10, net 30,
Poor synchronization of cash flows and its DSO is 30 days, then its aging
that results in high cash management schedule would probably show some
costs can be partially offset by past due accounts.
increasing disbursement float and
Working capital policy
decreasing collections float.
A company may hold a relatively
Compensating balances
large amount of cash if it anticipates
If the required compensating balance uncertain sales levels in the coming
is larger than the transactions year.
balance the firm would ordinarily
Credit policy has an impact on working
hold, then the effective cost of any
capital since it has the potential to
loan requiring such a balance is
influence sales levels and the speed
increased.
with which cash is collected.
Receivables management
Managing working capital levels is
In managing a firm’s accounts important to the financial staff since it
receivable it is possible to increase influences financing decisions and
credit sales per day yet still keep overall profitability of the firm.
accounts receivable fairly steady if
Holding minimal levels of inventory may
the firm can shorten the length of its
result in lost sales
collection period
Credit policy and seasonal dating
It is possible for a firm to overstate
profits by offering very lenient credit

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FINANCING CURRENT ASSESTS
Current asset financing policy
Firms generally choose to finance
temporary assets with short-term
debt because Matching the maturities of
assets and liabilities reduces risk.
Current asset financing
TEMPORARY CURRENT ASSETS are
those current assets that must be
increased when sales increase during
an upswing.
PERMANENT CURRENT ASSETS are
those current assets on hand at the low
point of the business cycle.
maturity matching is considered
conservative financing policy.
conservative approach to working
capital financing; that is, some of its
short-term needs are met by
permanent capital.
A conservative approach to working
capital will result in all permanent assets
being financed using long-term
securities.
aggressive current asset financing
policy uses the greatest amount of
short-term debt.- finances all of its
fixed assets with long-term capital
and part of its permanent current assets
with short-term, nonspontaneous credit.
Commercial paper
o Commercial paper is generally
written for terms less than 270
days.
o Commercial paper generally
carries an interest rate below
the prime rate.
o Commercial paper is sold to
money market mutual funds,
as well as to other financial
institutions and nonfinancial
corporations.
o Commercial paper is a type of
unsecured promissory note
issued by large, strong firms.
o .Commercial paper is a form of
short-term financing that is
primarily used by large,
financially stable companies.
Working capital financing
Trade credit is provided to a business
only when purchases are made.
a
Trade credit is often the largest source
of short-term credit
Short-term debt, while often cheaper
than long-term debt, exposes a firm to
the potential problems associated with
rolling over loans.
Accrued liabilities represent a source
of “free” financing in the sense that no
explicit interest is paid on these funds.
The risk to the firm of borrowing with
short-term credit is usually greater
than with long-term debt. Added risk
can stem from greater variability of
interest costs on short-term debt.
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Although short-term interest rates have
historically averaged less than long-term
rates, the heavy use of short-term
debt is considered to be an
aggressive strategy because of the
inherent risks of using short term
financing.
If a company receives trade credit under
the terms 2/10 net 30, this implies the
company has 10 days of free trade
credit.
Under normal conditions, a firm’s
expected ROE would probably be
higher if it financed with short-term
rather than with long-term debt, but
the use of short-term debt would
probably increase the firm’s risk.
Under normal conditions the yield
curve is upward sloping, thus, short-
term interest rates are lower than long-
term interest rates. Consequently, a firm
financing with short-term debt will pay less
interest than a firm financing with long-
term debt--increasing its ROE. However,
a firm increases its risk by financing with
short-term debt because such debt must
be “rolled over” frequently, and the firm is
exposed to the volatility of short-term
rates.
Short-term versus long-term
financing
Statements about the flexibility, cost,
and riskiness of short-term versus
long-term credit are dependent on the
type of credit that is actually used.
aspects of banks is considered most
relevant to businesses when choosing a
bank- Loyalty and willingness to
assume lending risks

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