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Title: This is the chapter core slideshow. ... Working Capital


1
CHAPTER 20 Working Capital Management
  • Working Capital Definitions and Policies
  • Cash Management
  • Inventory Management
  • Credit Management
  • Short-Term Financing
  • Trade Credit
  • Bank Debt and Commercial Paper
  • Secured Loans

2
Basic Definitions
  • Gross working capital
  • Total current assets.
  • Net working capital
  • Current assets - Current liabilities.
  • Net operating working capital (NOWC)
  • Operating CA Operating CL
  • (Cash Inv. A/R) (Accruals A/P)

(More)
3
  • Working capital management
  • Includes both establishing working capital
    policy and then the day-to-day control of cash,
    inventories, receivables, accruals, and accounts
    payable.
  • Working capital policy
  • The level of each current asset.
  • How current assets are financed

Please meet Danny the Banker.
4
Selected Ratios for SKI

  • SKI Industry
  • Current 1.75x 2.25x
  • Quick 0.83x 1.20x
  • Debt/Assets 58.76 50.00
  • Turnover of cash 16.67x 22.22x
  • DSO (365-day basis) 45.63 32.00
  • Inv. turnover 4.82x 7.00x
  • F. A. turnover 11.35x 12.00x
  • T. A. turnover 2.08x 3.00x
  • Profit margin 2.07 3.50
  • ROE 10.45 21.00
  • Payables deferral 30.00 33.00

5
How does SKIs working capital policy compare
with the industry?
  • Working capital policy is reflected in a firms
    current ratio, quick ratio, turnover of cash and
    securities, inventory turnover, and DSO.
  • These ratios indicate SKI has large amounts of
    working capital relative to its level of sales.
    Thus, SKI is following a relaxed policy.

6
Alternative Current Asset Investment Policies
Current Assets ()
Relaxed
Moderate
Restricted
Sales ()
7
Is SKI inefficient or just conservative?
  • A relaxed policy may be appropriate if it reduces
    risk more than profitability.
  • However, SKI is much less profitable than the
    average firm in the industry. This suggests that
    the company probably has excessive working
    capital.

8
Cash Conversion Cycle
  • The cash conversion cycle focuses on the time
    between payments made for materials and labor and
    payments received from sales
  • Cash Inventory Receivables
    Payables
  • conversion conversion collection -
    deferral .
  • cycle period
    period period
  • What does the cash conversion cycle tell us
    about working capital management?

9
Cash Conversion Cycle (Cont.)
CCC
CCC 45.6 30 CCC 75.7
45.6 30 CCC 91.3 days.
10
Shortening the Cash Conversion Cycle
  • Reduce the Inventory Conversion Period by
    processing and selling goods more quickly
  • Reduce the Receivables Collection Period by
    speeding up collections
  • Lengthening the Payables Deferral Period by
    slowing down the firms own payments

11
Cash Management Cash doesnt earn interest, so
why hold it?
  • Transactions Must have some cash to pay current
    bills.
  • Precaution Safety stock. But lessened by
    credit line and marketable securities.
  • Speculation To take advantage of bargains, to
    take discounts, and so on. Reduced by credit
    line, marketable securities.
  • Compensating balances For loans and/or services
    provided. But, Fee-Based Systems are rapidly
    replacing compensating balances.

12
What is the goal of cash management?
  • To reduce cash held to the minimum necessary to
    conduct business, yet maintain sufficient cash
    balances to
  • Make timely payments,
  • Take trade discounts,
  • Maintain firms credit rating, and
  • Meet unexpected cash needs.
  • However, since cash is a non-earning asset, the
    goal is to have not one dollar more than
    necessary.
  • The Internet and telecommunications technology
    have dramatically affected cash management.

13
What are precautionary and speculative
balances?
  • Precautionary balances Cash reserves for
    unforeseen inflow/outflow fluctuations.
  • Speculative balances Cash held for possible
    bargain purchases.
  • Both are better met with borrowing capacity
    and/or liquid securities.

14
Two Internet Addresses for Cash Management
Techniques
  • Bank of America
  • http//www.bankofamerica.com/index.cfm?pagecorp
  • Wachovia
  • http//www.wachovia.com/corp_inst

15
Ways to Minimize Cash Holdings
  • Use lockboxes.
  • Insist on wire transfers from customers.
  • Synchronize inflows and outflows.
  • Use a remote disbursement account.

(More)
16
  • Increase forecast accuracy to reduce the need for
    a cash safety stock.
  • Hold marketable securities instead of a cash
    safety stock.
  • Negotiate a line of credit (also reduces need for
    a safety stock).

17
How can a firm synchronize its cash flows and
what good would this do?
  • Synchronize cash flows by arranging to bill
    customers and pay bills on regular billing
    cycles throughout the month.
  • Synchronized cash flows reduce the need for cash
    balances and required bank loans, thus lower
    interest expense and boost profits.

18
Define disbursement float, collections float, and
net float.
  • Float The difference between the balance shown
    in a firms checkbook and the balance on the
    banks books.
  • Red Book Balances
  • Disbursement float Amount of funds tied up in
    checks the firm has written but which the bank
    has not yet deducted from its checking account
    balance. (More...)

19
  • Collections float The time it takes a firm to
    deposit checks it has received and for the bank
    to process them and credit the firms account
    with good funds.
  • Ledger Balances vs. Available Balances
  • Net float positive disbursement float (Good)
    negative collections float (Bad)

20
What is float and how can it be affected by cash
management?
  • Float is the difference between the balance shown
    on the firms books and the balance on its banks
    records.
  • If it takes SKI 1 day to deposit checks it
    receives and it takes its bank another day to
    clear those checks, SKI has 2 days of collections
    float.

21
  • If it takes 6 days for the checks that SKI writes
    to clear and be deducted from SKIs account, SKI
    has 6 days of disbursement float.
  • SKIs net float is the difference between the
    disbursement float and the collections float
  • Net float 6 days - 2 days 4 days.
  • If SKI wrote and received 1 million of checks
    per day, it would be able to operate with 4
    million less working capital than if it had zero
    net float.

22
Components of Float
  • Mail-Time Float
  • Processing Float
  • Clearing or Availability Float

23
Techniques to Accelerate Inflows
  • Lock Box System - Post Office Box
  • Retail - Large Number of Consumers
  • Wholesale - Typically Businesses
  • Automatic Debit - Automated Clearing House (ACH)
    Debits (Preauthorized)
  • e.g. Utilities debit users on a monthly basis
  • Payment by Wires
  • Field System
  • Concentration Banking

24
Funds transfer tools between banks are used to
accelerate inflows
  • Electronic (ACH) depository transfer. Uses data
    files to transfer funds. One Day Clearing.
  • Wires. The concentration bank instructs the field
    bank to initiate a wire transfer.

25
Techniques to Manage Disbursements
  • Payables Centralization
  • Internet Disbursement
  • Controlled Disbursement Accounts
  • Formerly Remote Disbursement
  • Zero-Balance Accounts
  • Money is moved from the Master Account to the
    Subsidiary Account to zero it out.
  • Breakdown by type of account and division
  • Payable Through Drafts
  • An order to pay, but not payable on demand

26
Additional Disbursement Techniques
  • Automated Clearing House (ACH) Credits
  • e. g. Direct Deposit of Payroll
  • GM automatically wires funds on 13th day to
    regular suppliers no float but GM gets
    discounts (2/10, n/30).
  • With lower interest rates, emphasis has shifted
    to increased information benefits, ethical
    behavior, and decreased administrative costs.

27
Account Analysis
  • Bank Provides Monthly
  • Summary of the Charges for Services Used
  • Analysis of the Balances Maintained
  • Credits Earned on the Balances

28
Why would a firm hold low- yielding marketable
securities?
  • Substitute for cash balances
  • Reduces risk and transactions costs
  • Available for bargain purchases
  • Temporary investment resulting from
  • Seasonal or cyclical operations.
  • Need to meet some unknown financial requirement.
  • Firm has just sold long-term assets.

29
What factors should a firm consider when building
its marketable securities portfolio?
  • Default risk (safety first)
  • Interest rate (price) risk
  • Purchasing power (inflation) risk
  • Liquidity and marketability risk
  • Returns on securities (yield)
  • Taxability
  • When it might need funds
  • Alternatively negotiate a line of credit

30
Securities suitable to hold as liquid reserves
  • U.S. Treasury bills
  • Commercial paper
  • Negotiable CDs
  • Money market mutual funds
  • Eurodollar market time deposits

31
Securities not suitable to hold as liquid
reserves
  • Speculative derivatives
  • U.S. Treasury notes, bonds
  • Corporate bonds
  • State and local government bonds
  • Preferred stocks
  • Common stocks

32
Cash Budget The Primary Cash Management Tool
  • Purpose Uses forecasts of cash inflows,
    outflows, and ending cash balances to predict
    loan needs and funds available for temporary
    investment.
  • Timing Daily, weekly, or monthly, depending
    upon budgets purpose. Monthly for annual
    planning, daily for actual cash management.

33
Data Required for Cash Budget
  • 1. Sales forecast.
  • 2. Information on collections delay.
  • 3. Forecast of purchases and payment terms.
  • 4. Forecast of cash expenses wages, taxes,
    utilities, and so on.
  • 5. Initial cash on hand.
  • Target cash balance.
  • Interest rate on outstanding loans

34
SKIs Cash Budget for January and February
Net Cash
Inflows January
February Collections 67,651.95 62,755.40 Purch
ases 44,603.75 36,472.65 Wages 6,690.56 5,470.90 R
ent 2,500.00 2,500.00 Total
payments 53,794.31 44,443.55 Net
CF 13,857.64 18,311.85
35
Cash Budget (Continued)
January
February Cash at start if no borrowing
3,000.00 16,857.64 Net CF (slide 34)
13,857.64 18,311.85 Cumulative
cash 16,857.64 35,169.49 Less target cash
1,500.00 1,500.00 Surplus 15,357.64 33,669.4
9
36
Should depreciation be explicitly included in the
cash budget?
  • No. Depreciation is a noncash charge. Only cash
    payments and receipts appear in the cash budget.
  • However, depreciation does affect taxes, which do
    appear in the cash budget.

37
What are some other potential cash inflows
besides collections?
  • Proceeds from fixed asset sales.
  • Proceeds from stock and bond sales.
  • Interest earned.
  • Court settlements.

38
How can interest earned or paid on short-term
securities or loans be incorporated in the cash
budget?
  • Interest earned Add line in the collections
    section.
  • Interest paid Add line in the payments section.
  • Found as interest rate x surplus/loan line of
    cash budget for preceding month.
  • Note Interest on any other debt would need to
    be incorporated as well.
  • Use Spreadsheet systems such as EXCEL.

39
How could bad debts be worked into the cash
budget?
  • Collections would be reduced by the amount of bad
    debt losses.
  • For example, if the firm had 3 bad debt losses,
    collections would total only 97 of sales.
  • Lower collections would lead to lower surpluses
    and higher borrowing requirements.

40
SKIs forecasted cash budget indicates that the
companys cash holdings will exceed the
targeted cash balance every month, except for
October and November.
  • Cash budget indicates the company probably might
    be holding too much cash.
  • SKI could improve its EVA by either investing its
    excess cash in more productive assets or by
    paying it out to the firms shareholders.

41
What reasons might SKI have for maintaining a
relatively high amount of cash?
  • If sales turn out to be considerably less than
    expected, SKI could face a cash shortfall.
  • A company may choose to hold large amounts of
    cash if it does not have much faith in its sales
    forecast, or if it is very conservative.
  • The cash may be there, in part, to fund a planned
    fixed asset acquisition.

42
Inventory Management Categories of Inventory
Costs
  • Carrying Costs Cost of Capital tied up, storage
    and handling costs, insurance, property taxes,
    depreciation, and obsolescence.
  • Ordering Costs Cost of placing orders,
    shipping, and handling costs. Supply Chain
    Management.
  • Costs of Running Short Loss of sales (from
    stockouts), loss of customer goodwill, and the
    disruption of production schedules.

43
Effect of Inventory Size on Costs
  • Reducing the average amount of inventory held
    generally
  • Reduces carrying costs.
  • Increases ordering costs.
  • Increases probability of a stockout.
  • Air freight was stopped for a week or so after
    September 11, 2001
  • Effects of hurricanes

44
Is SKI holding too much inventory?
  • SKIs inventory turnover (4.82) is considerably
    lower than the industry average (7.00). The firm
    is carrying a lot of inventory per dollar of
    sales.
  • By holding excessive inventory, the firm is
    increasing its operating costs which reduces its
    NOPAT. Moreover, the excess inventory must be
    financed, so EVA is further lowered.

45
If SKI reduces its inventory, without adversely
affecting sales, what effect will this have on
its cash position?
  • Short run Cash will increase as inventory
    purchases decline.
  • Long run Company is likely to then take steps
    to reduce its cash holdings.

46
Inventory Control Systems
  • Computerized Inventory Control Systems
  • Supply Chain Management
  • Just-In-Time (JIT) Systems
  • Out-Sourcing
  • Relationship between production scheduling and
    inventory levels
  • This topic will be discussed further in Chapter
    22.

47
Accounts Receivable Management Do SKIs
customers pay more or less promptly than those of
its competitors?
  • SKIs days sales outstanding (DSO) of 45.6 days
    is well above the industry average (32 days).
  • SKIs customers apparently are paying less
    promptly.
  • SKI should consider tightening its credit policy
    to reduce its DSO.

48
Does SKI face any risk if it tightens its credit
policy?
YES! A tighter credit policy may discourage
sales. Some customers may choose to go elsewhere
if they are pressured to pay their bills sooner.
49
If SKI succeeds in reducing DSO without adversely
affecting sales, what effect would this have on
its cash position?
  • Short run if customers pay sooner, this
    increases cash holdings.
  • Long run over time, the company would hopefully
    invest the cash in more productive assets, or pay
    it out to shareholders. Both of these actions
    would increase EVA.

50
Credit Management
  • What terms of credit should the firm use?
  • To whom should the firm grant credit?

51
Amount of Credit Outstanding
  • The amount of Credit Outstanding at any given
    time is dependent on two factors
  • The volume of credit sales
  • The average length of time between sales and
    collections

52
Monitoring Accounts Receivable
  • Days Sales Outstanding (DSO) or Average
    Collection Period (ACP)
  • Aging Schedules

53
Monitoring A/R and Seasonal Fluctuations
  • A seasonal increase in sales will increase the
    numerator more than the denominator, and will
    raise the DSO
  • Thus the DSO will look worse, but nothing has
    happened
  • A seasonal increase in sales will increase the
    amount of A/R that are less than 30 days
    outstanding
  • The Aging Schedule will look better, but
    nothing has happened
  • This topic will also be covered in Chapter 21.

54
What five variables make up a firms credit
policy?
  • Cash discounts
  • Credit period
  • Credit standards
  • Collection policy
  • Size of credit line

55
Elements of Credit Policy
  • Cash Discounts Lowers price. Attracts new
    customers and reduces DSO.
  • Credit Period How long to pay? Shorter period
    reduces DSO and average A/R, but it may
    discourage sales.

(More)
56
  • Credit Standards Tighter standards reduce bad
    debt losses, but may reduce sales. Fewer bad
    debts reduces DSO.
  • Collection Policy Tougher policy will reduce
    DSO, but may damage customer relationships.
  • Credit Line The firm determines the size of the
    line of credit extended to a particular customer.

57
Credit Terms
  • Discounts
  • For example, 2/10...
  • Credit Period
  • For example, n/30 or n/30 EOM
  • Seasonal Dating, for example n/30, July 1st
  • Promotes Sales
  • Reduces Inventory
  • Smoothes Production
  • Transfers Risk of Obsolescence
  • Might offer Anticipation Discount
  • Covered more fully in Chapter 21

58
The six Cs of Credit Extension and Standards
  • Character
  • Capital
  • Collateral
  • Capacity
  • Conditions
  • Country

59
Credit Standards
  • Might use Dun Bradstreet ratings
  • 1 excellent
  • 2 good
  • 3 fair
  • 4 limited
  • Credit Scoring Systems
  • Multiple Discriminant Analysis (MDA)
  • Judgmental Scoring Systems

60
Sources of Credit Information
  • The Sellers Prior Experience
  • Credit Associations
  • Credit Interchange
  • Credit Rating Agencies
  • Dun Bradstreet
  • Equifax
  • Experian
  • Trans Union
  • Fair Isaac
  • Analysis of Customers Financial Statements
  • Customer Visit

61
Credit Investigation
Proceed Sequentially in examining credit
worthiness and making the credit decision. Begin
with the least costly and time consuming method.
Then ask, is it worth it to continue further? Use
of computers in Relational Data Bases and Data
Warehouses.
62
Collection Policy
  • Procedures the firm uses to collect past-due
    accounts
  • Charges for late payments
  • Letters
  • Phone calls
  • Legal action

63
If a firm has no bad debts, does that mean that
the credit manager is doing a good job?
  • No! The credit policy may be too restrictive, and
    the firm may be losing sales, profits and
    stockholder wealth.

64
Size of Credit Line
  • A key option is that the seller may grant a
    limited amount of credit, called a credit line or
    credit limit.
  • Possible reasons for this limit
  • Limits are not as enforced as rejection
  • Increases in production costs
  • Funds Constraints

65
Working Capital Financing Policies
  • Moderate matches the maturity of the assets
    with the maturity of the financing.
  • Self-liquidating approach
  • Aggressive uses short-term (temporary) capital
    to finance some permanent assets.
  • Conservative uses long-term (permanent) capital
    to finance some temporary assets.

66
  • The choice of working capital financing policy is
    a classic risk/return tradeoff.
  • The aggressive policy promises the highest return
    but carries the greatest risk.
  • The conservative policy has the least risk but
    also the lowest expected return.
  • The moderate (maturity matching) policy falls
    between the two extremes.

67
Moderate Financing Policy

Temp. NOWC
S-T Debt (Temporary)
L-T Fin Stock, Bonds, Spon. C.L. (Permanent)
Perm NOWC
Fixed Assets
Years
What are permanent current assets?
68
Relatively Aggressive Financing Policy

Temp. NOWC
S-T (temporary) Debt
L-T Fin Stock, Bonds, Spon. C.L.
Perm NOWC
Fixed Assets
Years
More aggressive the lower the dashed line.
69
Conservative Financing Policy

Marketable Securities
S-T Financing Requirements
L-T Fin Stock, Bonds, Spon. C.L.
Perm NOWC
Fixed Assets
Years
70
What Is Short-term Credit? What Are the Major
Sources?
  • Short-term credit Debt requiring repayment
    within one year.
  • Major sources
  • Accruals
  • Accounts payable (trade credit)
  • Commercial paper
  • Bank loans
  • Unsecured Loans
  • Secured Loans - Accounts Receivable
  • Secured Loans - Inventory

71
Choosing a Source of Short Term Financing
  • Cost
  • Annual Percentage Rate
  • Effective Annual Rate (Compounded Rate)
  • Impact on credit rating
  • Reliability
  • Restrictions
  • Degree to which assets are encumbered
  • Flexibility
  • Availability

72
What are the advantages of short-term debt vs.
long-term debt?
  • Lower cost-- yield curve usually slopes upward.
  • Can get funds relatively quickly with lower
    flotation costs.
  • Repayment penalties can be expensive for
    long-term debt
  • Long-term debt typically contain more restrictive
    covenants.

73
What are the disadvantages of short-term debt vs.
long-term debt?
  • Short-term debt is riskier than long-term debt
    for the borrower.
  • The required repayment comes quicker.
  • May have trouble rolling debt over.
  • Short-term rates may rise
  • With long-term debt, interest rates will be
    relatively stable over time.

74
Is There a Cost to Accruals, and Do Firms Have
Much Control Over Them?
  • Accruals increase automatically as a firms
    operations expand.
  • Accruals are free in the sense that no
    explicit interest is charged.
  • A firm has little control over the level of
    accruals, They are influenced more by industry
    custom, economic factors, and tax laws than by
    managerial actions.
  • Spontaneous source of funds.

75
What Is Trade Credit?
  • Trade credit is credit furnished by a firms
    suppliers.
  • Trade credit is often the largest source of
    short-term credit for small firms.
  • Trade credit is spontaneous and relatively easy
    to get, but the cost can be high.

76
Advantages of Trade Credit
  • Flexible in amount
  • Informal - no restrictions placed on the user
  • Very convenient and easy to obtain
  • Easy for the small firm to obtain

77
Disadvantages of Trade Credit
  • Limited in amount
  • Not a direct source to pay other bills
  • Can affect credit rating
  • Stretching accounts payable
  • Pay beyond the due date -

78
SKI buys 506,985 net, on terms of 1/10, net 30,
and pays on Day 40. How much free and costly
trade credit, and whats the cost of costly trade
credit?
  • Net daily purchases 506,985/365
  • 1,389.
  • Annual gross purch. 506,985/(1-0.01)
  • 512,106

79
Gross/Net Breakdown
  • Company buys goods worth 506,985. Thats the
    cash price.
  • They must pay 5,121 more if they dont take
    discounts.
  • Think of the extra 5,121 as a financing cost
    similar to the interest on a loan.
  • Want to compare that cost with the cost of a bank
    loan.

80
Payables level if take discount Payables
1,389(10) 13,890.
Payables level if dont take discount
Payables 1,389(40) 55,560.
Credit Breakdown Total trade credit
55,560 Free trade credit 13,890
Costly trade credit 41,670
81
Nominal Annual Percentage Rate (APR) Cost of
Costly Trade Credit
Firm loses 0.01(512,106) 5,121 of discounts
to obtain 41,670 in extra trade credit, so
But the 5,121 is paid all during the year, not
at year-end, so Effective Annual Rate (EAR) rate
is higher. Record purchases on books as net
purchases and discounts lost as an interest
expense.
82
Nominal (APR) Cost Formula, 1/10, net 40
Pays 1.01 12.167 times per year.
83
Effective Annual Rate (EAR), 1/10, net 40
Periodic rate 0.01/0.99 1.01. Periods/year
365/(40 10) 12.1667. EAR (1 Periodic
rate)n 1.0 (1.0101)12.1667 1.0 13.01.
Normally, it is cheaper to borrow the money from
the bank and take discounts.
84
Stretching Accounts Payable
  • Effect on credit rating - reputation as a slow
    payer
  • Suppliers start requiring the firm to pay cash
  • Late payment penalties

85
Choosing a Bank (Negotiated Source of Funds)
  • Willingness to assume risks
  • Advise and counsel
  • Loyalty to customers
  • Maximum loan size
  • Specialization
  • Merchant Banking capabilities
  • Other Services
  • Technology and telecommunications
  • Discussed in Chapter 21

86
Bank Short Term Credit Forms
  • A Line of Credit is a informal or formal
    understanding between the bank and the borrower
    indicating the maximum credit the bank will
    extend to the borrower.
  • One year or less
  • Can be tied to LIBOR, Prime, Fed Funds Rate
  • Often includes a cleanup provision

more
87
Bank Short Term Credit Forms - continued
  • A Revolving Credit Agreement (Revolver) is a
    formal (legal) arrangement often used by large
    firms.
  • Can be more than one year , e. g. three years.
  • Usually calls for a commitment fee.
  • We will calculate the APR and EAR of bank loans
    in Chapter 21.

88
Promissory Note
  • Negotiated source of funds
  • Amount borrowed
  • Percentage interest rate
  • Repayment schedule
  • Series of Installments
  • or Lump sum
  • Collateral specified as security
  • Other terms and conditions
  • Typically 90 days and renewable

89
Commercial Paper
  • A type of unsecured (normally), discounted, large
    denomination, promissory note, typically issued
    by large, strong firms (Net Worthgt100 million)
  • Sold to other business firms, money market funds,
    pension funds, foundations, wealthy individuals,
    and insurance companies
  • Maturities vary from one to nine months
  • Can be asset-backed
  • Direct Placement vs. Dealer Placement
  • Rated by Moodys, Standard Poors, Fitchs

90
Advantages of Commercial Paper
  • Cheaper, as the effective interest rate is
    typically less than the prime rate
  • Size of market available is large
  • Medium-sized firms may use bank guarantees and
    enter the market

91
Disadvantages of Commercial Paper
  • Impersonal market
  • Dealers prefer to handle the paper of firms where
    borrowings are 10 million or more
  • Cant pay off prior to maturity
  • 270 day maximum maturity
  • 100 credit line needed to back up commercial
    paper in most cases
  • Amount of funds in market may be limited

92
Commercial Paper (CP)
  • Short term notes issued by large, strong
    companies. SKI couldnt issue CP--its too
    small.
  • CP trades in the market at rates just above
    T-bill rate.
  • CP is bought with surplus cash by banks and other
    companies, then held as a marketable security for
    liquidity purposes.

93
What Is a Secured Loan?
  • In a secured loan, the borrower pledges assets as
    collateral for the loan.
  • For short-term loans, the most commonly pledged
    assets are receivables and inventories.
  • Securities are great collateral, but firms
    needing short-term loans generally do not have
    securities on hand.

94
Important Legal Forms
  • UCC form-1 filed with Secretary of State to
    establish collateral claim. Prospective lenders
    will do a claims search, and wont make the loan
    if a prior UCC-1 has been filed.
  • Security Agreement standard form under the
    Uniform Commercial Code. Specifies when lender
    can claim collateral if default occurs.

95
What Are the Differences Between Pledging and
Factoring Receivables?
  • If receivables are pledged, the lender has
    recourse against both the original buyer of the
    goods and the borrower.
  • Normally non-notification for remittances
  • When receivables are factored, they are generally
    sold, and the lender has no recourse to the
    borrower.
  • Normally notification for remittances
  • Credit Cards are an example

96
Aspects of Factoring
  • Maturity Factoring
  • Continuous process
  • Funds are received at maturity
  • Factor performs
  • Credit Checking and Investigation
  • Collections
  • Absorbs Bad Debt Expenses (Risk Bearing)
  • Discount Factoring
  • Additional function of lending is performed as
    firm receives the funds in advance
  • Flexible financing

97
Drawbacks of Factoring
  • Non-interest costs - e.g. 1 to 3 of the
    amount of the invoice accepted by Factor
  • Constraints imposed on the seller
  • Administrative costs
  • Other creditors are placed at a disadvantage
    because A/R is used as collateral
  • Interest costs if Discount Factoring is used

98
Shakespeare and Factoring
  • King Henry IV
  • The Merchant of Venice
  • The Comedy of Errors
  • Othello

99
What Are the Three Forms of Inventory Financing?
  • Blanket lien Gives the lender a lien against
    all of the borrowers inventory.
  • Trust receipt An instrument that acknowledges
    goods held in trust for the lender. A specific
    registration number is needed. Automobile dealer
    financing is a widely used example.
  • Warehouse receipt Uses inventory as security.
  • Form used depends upon type of inventory and
    situation at hand. Provides flexible financing.

100
Public Vs. Field Warehouse
  • Public Warehouse is an independent third party
    engaged in the business of storing goods.
  • Field Warehouse may be established at the
    borrowers place of business
  • Physical Control of inventory - e.g. canned
    peaches
  • Public notification
  • Supervision by custodian of Field Warehouse
    company

101
Inventory Financing Costs
  • Minimum of 5,000 plus 1 to 2 of amount of
    credit extended
  • Interest charges typically set at 2 to 3 above
    prime
  • But, necessity for warehouse control may improve
    warehouse practices

102
What Is securitization and Why Is It Used?
  • Pension funds and mutual funds have money to
    lend, but they typically dont make short term
    loans.
  • Companies like GM and Ford can bundle up their
    receivables, use them as security for a low-risk
    bond, and sell the bond to pension funds, etc.
  • This is securitization, and its purpose is to
    get funds at a low cost. However, the risk is
    substantial for the final investor.

103
Sequential Method for Managing Current Debt
  • List all the potential sources from the lowest
    effective rate to the highest
  • Start with the cheapest and proceed sequentially
    (typically) to the more expensive source

104
Working Capital Management
  • Working Capital Policies
  • Cash Management
  • Short-Term Investments
  • Inventory Management
  • Accounts Receivable Management
  • Short-Term Financing
  • Trade Credit
  • Bank Loans
  • Commercial Paper
  • Secured Loans
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