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Working Capital

and Current
Asset
Management

Copyright © 2009 Pearson Prentice Hall. All rights reserved.

All rights reserved.Long & Short Term Assets & Liabilities Current Assets: Cash Marketable Securities Prepayments Accounts Receivable Inventory Current Liabilities: Accounts Payable Accruals Short-Term Debt Taxes Payable Fixed Assets: Investments Plant & Machinery Land and Buildings Long-Term Financing: Debt Equity Copyright © 2009 Pearson Prentice Hall. 14-2 .

The Cash Conversion Cycle • Short-term financial management—managing current assets and current liabilities—is on of the financial manager’s most important and time-consuming activities. Copyright © 2009 Pearson Prentice Hall. All rights reserved. 14-3 . • The goal of short-term financial management is to manage each of the firms’ current assets and liabilities to achieve a balance between profitability and risk that contributes positively to overall firm value.

14-4 . •The collection period consists of two parts: – the time period from the sale until the customer mails payment. Copyright © 2009 Pearson Prentice Hall. All rights reserved. and – the time from when the payment is mailed until the firm collects funds in its bank account.Accounts Receivable Management the average collection period – the average length of time from a sale on credit until the payment becomes usable funds to the firm.

All rights reserved. • Capacity: The applicant’s ability to repay the requested credit. • Conditions: Current general and industry-specific economic conditions.Accounts Receivable Management: The Five Cs of Credit • Character: The applicant’s record of meeting past obligations. Copyright © 2009 Pearson Prentice Hall. • Capital: The applicant’s debt relative to equity. • Collateral: The amount of assets the applicant has available for use in securing the credit. 14-5 .

14-6 . • The procedure results in a score that measures the applicant’s overall credit strength. and the score is used to make the accept/reject decision for granting the applicant credit. All rights reserved.Accounts Receivable Management: Credit Scoring • Credit scoring is a procedure resulting in a score that measures an applicant’s overall credit strength. derived as a weighted-average of scores of various credit characteristics. Copyright © 2009 Pearson Prentice Hall.

All rights reserved. 14-7 . Copyright © 2009 Pearson Prentice Hall.) • The purpose of credit scoring is to make a relatively informed credit decision quickly and inexpensively.Accounts Receivable Management: Credit Scoring (cont.

Copyright © 2009 Pearson Prentice Hall. 14-8 . All rights reserved.Accounts Receivable Management: Changing Credit Standards • The firm sometimes will contemplate changing its credit standards to improve its returns and generate greater value for its owners.

All rights reserved. 14-9 .Accounts Receivable Management: Changing Credit Standards Copyright © 2009 Pearson Prentice Hall.

Copyright © 2009 Pearson Prentice Hall. the discount is 2%. 14-10 . the discount period is 10 days. and the credit period is 30 days.Changing Credit Terms • A firm’s credit terms specify the repayment terms required of all of its credit customers. with credit terms of 2/10 net 30. All rights reserved. • Credit terms are composed of three parts: – The cash discount – The cash discount period – The credit period • For example.

1). All rights reserved.Changing Credit Terms Example MAX Company has an average collection period of 40 days (turnover = 365/40 = 9. process. and collect payments once they are mailed.6). Copyright © 2009 Pearson Prentice Hall. 14-11 . this period is divided into 32 days until the customers place their payments in the mail (not everyone pays within 30 days) and 8 days to receive. The firm expects this change to reduce the amount of time until the payments are placed in the mail. MAX is considering initiating a cash discount by changing its credit terms from net 30 to 2/10 net 30. In accordance with the firm’s credit terms of net 30. resulting in an average collection period of 25 days (turnover = 365/25 = 14.

14-12 . • Two frequently used techniques for credit monitoring are the average collection period and aging of accounts receivable. • Slow payments are costly to a firm because they lengthen the average collection period and increase the firm’s investment in accounts receivable.Credit Monitoring • Credit monitoring is the ongoing review of a firm’s accounts receivable to determine whether customers are paying according to the stated credit terms. All rights reserved. Copyright © 2009 Pearson Prentice Hall.

and collect payment. and – The time to receive. 14-13 .Credit Monitoring: Average Collection Period • The average collection period is the average number of days that credit sales are outstanding and has two parts: – The time from sale until the customer places the payment in the mail. All rights reserved. process. Copyright © 2009 Pearson Prentice Hall.

Credit Monitoring: Aging of Accounts Receivable Copyright © 2009 Pearson Prentice Hall. 14-14 . All rights reserved.

All rights reserved. Copyright © 2009 Pearson Prentice Hall.Credit Monitoring: Collection Policy • The firm’s collection policy is its procedures for collecting a firm’s accounts receivable when they are due. this level depends not only on collection policy but also on the firm’s credit policy. 14-15 . • As seen in the previous examples. • The effectiveness of this policy can be partly evaluated by evaluating at the level of bad expenses.