F307 Lecture Notes

STF&WCM: Chapters 8/9
Working Capital Mgmt & Tools

F307-Breeze Session
Lecture #5
Fall 2014
Copyright 2014 - The Treasury Academy - All Rights Reserved
Upcoming Items
Excel #2 (Account Analysis) due on
Friday, 10/17/14
Work on Team Case #2 Chap. 8/9
Deliverable should be about 3-4 pages,

including some calculations on cash tied
up in current system and how to free it
Bring report to class on 10/13-15/14 to
hand in and be prepared to discuss
Exam #2 (Chap 6, 7, 8, & 9)

50 M/C questions
Scheduled in class on 10/20-22/14
Overview of Chapter 8 Topics
Overview of Working Capital

Timelines and Float
The Working Capital Cash
Conversion Cycle (CCC)
How Changes in Current Accounts
Impact External Financing
Working Capital Investment and
Financing Strategies
Management of Credit and A/R
Management of Inventory
Management of A/P
Global Management of Working
Capital
Cash Conversion Cycle

Build Inventory
Borrow or
Liquidate
Investments
Purchase
Supplies,
Facilities, Etc.
Invest or
Pay Down
Borrowings
Provide/Sell
Services &
Products
Collect
Revenues (A/R)
Operating Cash Flows

Short-Term Investments
Cash
Inflows
Concentration
Flows
Liquidity Funding
Mgmt Flows Flows
Cash
Outflows
Concentration
Account
Cash
Inflows
Concentration
Flows
Liquidity
Mgmt Flows
Cash
Funding
FlowsOutflows
Cash
Inflows
Short-Term Borrowing
Cash
Outflows
5
Purchase-to-Pay Cycle
Float and the Cash Flow Timeline
Different Types of Float
Collection float
Disbursement float
Invoicing float
Payment float
Benefits of Float Reduction
Reducing float on collections

Lengthening float on disbursements
Possible of win-win approach
Reducing cycle times
JIT inventory
Supply chain management
E-commerce and electronic payment
1) Which type of float do you think

would be most important for a large
B2B manufacturing company?
Collection Float
2. Disbursement Float
3. Invoicing Float
4. Payment Float
1.
Focus of Treasury on Cash Flow

Timeline
Treasury focus is on the payment portion

of the cycle
Calculation: Float Neutral Calculation
TD = total days difference in payment timing
r = Opportunity cost as an annual rate
Discount 1
r
1 TD 365
Float Neutral Calculation
Assume r = 12% and TD = 3 days
1
Discount 1
12%
1 3 365
1
1
1 0.99901467
1.0009863
0.00098533
0.001 (Rounded) or 0.10%
If the buyer is allowed to take a discount of 0.10 %, they
would be indifferent (in present value terms) between paying
by check or by electronic transfer (a speedup of 3 days in
loss of
Copyright
2014value)
- The Treasury Academy - All Rights Reserved
10
2) Assuming an opportunity cost of

8% and a 60-day change in payment
timing, what discount rate would
make the payment float neutral?
0.5%
2. 1.0%
3. 1.3%
4. 1.6%
1.
Discount 1
r
1 TD 365
11
Float Neutral Calculation
Assume: r = 8% and TD = 60 days

Discount 1
8%
1 60 365
1
1
1 0.98702
1.01315
0.01298 = 1.3% (Rounded)
If the buyer is allowed to take a discount of 1.3 %, they would

be indifferent (in present value terms) between paying
electronically today or on day 60 by check (a speedup of 60
days in
loss
value)
Copyright
2014
- Theof
Treasury
Academy - All Rights Reserved
12
Collection/Disbursement Float
Components
Mail Float
Mail Time
Processing Float
Deposit Preparation Time
Availability Float
Check Availability Time
Clearing Float
Check Clearing Time
Measurement of Float
Dollar-Days
13
3) Which of the following is NOT

part of the Cash Conversion Cycle?
1.
2.
3.
4.
Days Inventory
Days Cash
Days Receivables
Days Payables
14
The Working Capital Cash

Conversion Cycle (CCC)
Purchase
Of Materials
Payment For
Materials
Sale of
Product
Collect
Accounts
Receivable
Days Inventory
Days Receivables
Days Payables
Day 1
Day 30
Day 45
Day 80
15
Problems in Managing CCC

Components
Potential lost sales

Production stoppages
Stretched payables
Foregone cost-saving trade
discounts
Higher prices assessed by
vendors on smaller orders or
slow payments
Refusal to sell to weak
customers
Excessive reliance on A/P
rather than S/T bank credit
16
4) What do you think is the most

important problem in managing the
CCC?
1.
2.
3.
4.
Potential lost sales

Stretched payables
Production stoppages
Foregone trade
discounts
17
Working Capital Investment and

Financing Strategies
Selecting a Current Asset Investment Strategy

Restrictive current asset investment
Relaxed current asset investment
Selecting a Current Asset Financing Strategy
Asset
Breakdown
Maturity
Matching
Conservative
Policy
Aggressive
Policy
Fixed Assets
Permanent
Current Assets
Long-Term Sources
Long-Term Sources
Long-Term Sources
Fluctuating
Current Assets
Short-Term
Sources
S/T
Sources
Short-Term
Sources
18
5) Credit management and

accounts receivable
management are essentially
the same thing.
True
2. False
1.
19
Relationship Between Treasury and

Credit Management
Separate functions
Credit manager administers policies
that establish credit standards, define
terms of sale, approve credit sales, and
set individual and aggregate credit limits
A/R is created once a sale is made and
trade credit is extended
A/R management includes billing
and processing payments,
monitoring payment patterns, and
collecting delinquent accounts
20
6) Short and long-term financial

resources to supplement insufficient
cash flow for payments is known as
what?
1.
2.
3.
4.
5.
Character
Capacity
Capital
Collateral
Conditions
21
The Five Cs of Credit

Character
An intent or willingness to pay as evidenced

by payment history
Capacity
Current and future financial resources that

can be committed to pay obligations
Capital
Short- and long-term financial resources to

supplement insufficient cash flow for
payments
Collateral
Assets or guarantees available to secure an

obligation if payment is not made
Conditions
General economic environment and

economic conditions for the customer and
the seller
22
Quantitative Credit Analysis

Most often used measures:
Liquidity and WC ratios
Debt management and
coverage ratios
Profitability measures
Consumer Credit Scoring Process
1. Differentiating risks
2. FICO Score
3. Set cutoff score
4. Applying further analysis
where necessary
23
7) Which of the following is NOT a

reason why B2B quantitative credit
analysis is less effective than for
consumer analysis?
B2B has smaller per
transaction exposure
2. Smaller B2B database
3. Impact of one large default
4. Difficulty in obtaining private
company data
1.
24
Why Quantitative Credit Analysis is

Not as Effective for B2B
The available databases are
much smaller for B2B
The per-transaction exposure
is usually much larger
Impact of one large default
Difficult to obtain financial info
for some customers, especially
for smaller, private companies
25
Key Inventory Factors
Types of Inventory
Levels of Inventory
Raw Materials
Work in Progress (WIP)
Finished Goods
Scraps or Obsolete Items
Stores and Supplies
Impact of excess inventory
Just-In-Time (JIT) inventory
Supplier-managed replenishment programs
Paid-on-production inventory process
Benefits and Costs of Inventory
26
Inventory Financing
If not financed as part of general working
capital requirements, alternatives may be
tied directly to the amount of inventory
Trade credit often finances a significant
portion of inventory
Collateralized loans (asset-based lending)
Use of public or field warehouse
to store inventory
Floor planning for
high-value durable
goods
27
Three-Way Match
Purchase
Order
Invoice
Approved
Vendor
List ??
Receiving
Advice
28
Considerations for Global

Management of Working Capital
Global Working Capital Management
Tools and Techniques
Multicurrency Accounts
Netting
Leading and Lagging
Re-invoicing Center
Internal Factoring
Export Financing
29
Before Netting
Source: ETM3 - AFP
30
With Multilateral Netting
Source: ETM3 - AFP
31
Re-invoicing Center Purpose

Company Owned
Subsidiary
Buys goods from an

exporting subsidiary
Resells the goods to

an importing
subsidiary
Source: ETM3 - AFP
32
Before Re-invoicing
Source: ETM3 - AFP
33
With Re-invoicing
Source: ETM3 - AFP
34
Overview of Chapter 9 Topics

Introduction
Cash Discount
Calculations
Buyers Perspective
Sellers Perspective
Accounts Receivable (A/R)

Monitoring and Control
DSO & Aging Schedule
Balance Pattern

(CCC)
35
Cost of a Buyer Not Taking a Cash

Discount
D
365
100 D N T
2
365
=
100 2 30 10
2 365
=
= .0204 18.25 = .3723 or 37.23%

98 20
Discount Cost =
Where
D = Discount percentage is 2%
N = Net period is 30 days
T = Discount period is 10 days
The cost of not taking the discount can be compared with
the organizations opportunity cost to borrow short-term
funds. If we assume a rate of 8% for this example, then
borrowing cost would be less than the cost of not taking the
discount so the organization should borrow the funds and
TAKE the discount.
36
8) A company is offered terms

of 1/10, Net 50. What is the
cost of not taking this discount?
1.
2.
3.
4.
9.2%
7.4%
7.9%
12.3%
Discount Cost =
D
365
100 D N T
37
Cost of a Buyer Not Taking a Cash

Discount
D
365
100 D N T
1
365
=
100 1 50 10
1 365
=
= .0101 9.125 = .09216 or 9.2%

99 40
Discount Cost =
Where
D = Discount percentage is 1%
N = Net period is 50 days
T = Discount period is 10 days
The cost of not taking the discount can be compared with
the organizations opportunity cost to borrow short-term
funds. If we assume a rate of 8% for this example, then
borrowing cost would be less than the cost of not taking the
discount so the organization should borrow the funds and
TAKE the discount.
38
Benefit to Seller of Offering a Cash Discount
Assume credit terms of 2/10, net 30 and opp. cost = 15%
Present Value of Receiving Discounted Payment Amou

PVDisc Pmt
PVDisc Pmt
Total Amount of Full Pmt 1 Disc Rate

Annual Opp Cost
1 Days in Disc Period

365

$100,000 1 .02
$98,000

1 .0041096
.15
1
10

365

$98,000
$97.598.91
1.0041096
39
Benefit to Seller of Offering a Cash Discount
Assume credit terms of 2/10, net 30 and opp. cost = 15%

Present Value of Receiving Full Payment Amount
PVFull Pmt
Total Amount of Full Pmt

Annual Opp Cost
1 Days in Net Period

365
PVFull Pmt
$100,000
$100,000

.15 1 .0123288
1 30 365
$100,000
$98,782.13
1.0123288
NPV = PVDay 10 PVDay 30 = $97,598.91 $98,782.13 = $1,183.22
40
Cash Conversion Cycle (CCC)

Days
Inventory
Days Receivables
Days Payables
Cash Turnover Ratio
Days Inventory
Days Payables
Days Receivables
Working Capital Gap
41
Aging Schedule
Separates A/R into current and past-due
receivables in 30-day increments (on a customer
or aggregate basis) and can determine the
percent past due
Age of A/R
Amount of A/R
% of Total A/R
Current
$1,750,000
70%
1-30 Days Past Due
375,000
15%
31-60 Days Past Due
250,000
10%
Over 60 Days Past

Due
125,000
5%
Total
$2,500,000
100%
42
A/R Balance Pattern for March
43

Days
Inventory
Days Receivables
Days Payables
Cash Turnover Ratio
Days Inventory
Days Payables
Days Receivables
Working Capital Gap
44

Elements in the cash
conversion cycle:
Days Inventory
Inventory
365
Cost of Goods Sold
Days
Receivables
Accounts Receivable
365
Sales
Days Payables
Accounts Payable
365
Cost of Goods Sold
45

Elements in the cash
conversion cycle:
Days
Inventory
Inv
2,600
365
365 103.15 Days
COGS
9,200
Days
Receivables
A/R
1,700
365
365 41.36 Days
Sales
15,000
Days
Payables
A/P
1,600
365
365 63.48 Days
COGS
9,200
46

Calculates the time required to
convert cash outflows
(necessary to produce
goods) into cash inflows
(through the collection of
accounts receivable)
CCC Days' Inv. Days' Rec. - Days' Pay.

103.15 41.36 - 63.48 81.03 Days
47
Cash Turnover Ratio

If a company has a cash
conversion cycle of
81.03 days, how many
cash conversion cycles
does the company go
through in a year (cash
turnover)?
365 Days
Cash Turnover =
365
=
81.03 Days
= 4.5 Times
48
Chapter 8 & 9: Wrap-up
Dont forget to work on the

Chap 8-9 team case Report
due and discussion in class
on 10/13 and 10/15
Excel #2 (Account Analysis)

due on Friday, 10/17/14
Exam #2 covering Chapters 6,

7, 8, & 9 will be given in class
on 10/20 and 10/22
49

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STF&WCM: Chapters 8/9

Working Capital Mgmt & Tools

Copyright 2014 - The Treasury Academy - All Rights Reserved

Deliverable should be about 3-4 pages,

Exam #2 (Chap 6, 7, 8, & 9)

Copyright 2014 - The Treasury Academy - All Rights Reserved

Overview of Chapter 8 Topics

Overview of Working Capital

Copyright 2014 - The Treasury Academy - All Rights Reserved

Cash Conversion Cycle

Copyright 2014 - The Treasury Academy - All Rights Reserved

Operating Cash Flows

Copyright 2014 - The Treasury Academy - All Rights Reserved

Float and the Cash Flow Timeline

Different Types of Float

Benefits of Float Reduction

Reducing float on collections

Copyright 2014 - The Treasury Academy - All Rights Reserved

1) Which type of float do you think

Copyright 2013 - The Treasury Academy - All Rights Reserved

Focus of Treasury on Cash Flow

Treasury focus is on the payment portion

Copyright 2014 - The Treasury Academy - All Rights Reserved

Float Neutral Calculation

Assume r = 12% and TD = 3 days

2) Assuming an opportunity cost of

Copyright 2013 - The Treasury Academy - All Rights Reserved

Float Neutral Calculation

Assume: r = 8% and TD = 60 days

If the buyer is allowed to take a discount of 1.3 %, they would

Copyright 2014 - The Treasury Academy - All Rights Reserved

3) Which of the following is NOT

Copyright 2013 - The Treasury Academy - All Rights Reserved

The Working Capital Cash

Cash Conversion Cycle

Copyright 2014 - The Treasury Academy - All Rights Reserved

Problems in Managing CCC

Potential lost sales

Copyright 2014 - The Treasury Academy - All Rights Reserved

4) What do you think is the most

Potential lost sales

Copyright 2013 - The Treasury Academy - All Rights Reserved

Working Capital Investment and

Selecting a Current Asset Investment Strategy

Selecting a Current Asset Financing Strategy

Copyright 2014 - The Treasury Academy - All Rights Reserved

5) Credit management and

Copyright 2013 - The Treasury Academy - All Rights Reserved

Relationship Between Treasury and

Copyright 2014 - The Treasury Academy - All Rights Reserved

6) Short and long-term financial

Copyright 2013 - The Treasury Academy - All Rights Reserved

The Five Cs of Credit

An intent or willingness to pay as evidenced

Current and future financial resources that

Short- and long-term financial resources to

Assets or guarantees available to secure an

General economic environment and

Copyright 2014 - The Treasury Academy - All Rights Reserved

Quantitative Credit Analysis