IFM10 Ch21 Solutions Manual

IFM10 Ch21 Solutions Manual - Chapter 21 Working Capital...

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Unformatted text preview: Chapter 21 Working Capital Management 21-1 The CCC is defined as the number of days between a companys paying for some product or service that it sells and the receipt of cash from the sale of the product or service. Other things held constant, it is better to have a shorter than a longer CCC, because the lower the CCC, the less the firms investment in working capital. With less working capital, total capital requirement decline, causing the dollar cost of capital to decline. This increases net income and the value of the firm. As shown in the BOC model, the illustrative companys inventory conversion period is 28 days, its receivables collection period (or DSO) is 20 days, and its payables deferral period is 28 days, resulting in a CCC of 20 days. The company has a $380 million cost of goods sold, or $380/360 = $1.0556 per day. With a 20 day CCC, its average investment in working capital is 20($1.0556) = $21.11 million. With a 10% cost of capital, the cost of carrying working capital is $2.11 million. If the CCC could be reduced by 5 days, to 15 days, the average working capital balance would be 15($1.0556) = $15.83 million, with a carrying cost of $1.58 million. Thus, the savings would be $2.11 million - $1.58 million = $530,000. The kinds of actions that companies take to shorten their CCCs include speeding up the manufacturing process, offering discounts or tightening credit terms and standards to speed up collections, and negotiating better credit terms or paying from remote locations to defer payments. Of course, the costs of taking such actions must be balanced against the benefits of the lower CCC. 21-2 A cash budget is a forecast of inflows and outflows of cash, generally on a monthly or daily basis. The primary purpose of the cash budget is to forecast when loans will be needed and/or when surplus funds that can be invested will be on hand. A cash budget is also very useful when negotiating bank loans. The BOC model provides a detailed example of a monthly cash budget. It shows that, other things held constant, shortening the CCC will cause cash to come in faster, thus increasing investable funds and/or reducing borrowing requirements. A change in credit policy will have several effects on the cash budget. A tightening will probably lower the sales forecast, which will reduce both collections and payments for purchases, and possibly also taxes payable. Tightening should also alter the percentages of sales collected during each month, increasing the percentages for the first and second months and reducing the percentage for the third month. Those changes would probably lower the need for loans. However, a lot depends on the profitability of sales, and if a tightening reduced sales substantially, this might lower profits and adversely affect cash flow. Our conclusion is that one should not jump to quick Answers and Solutions: 21 - 1 ANSWERS TO BEGINNING-OF-CHAPTER QUESTIONS conclusions about how a credit policy change will affect operations. conclusions about how a credit policy change will affect operations....
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This note was uploaded on 05/12/2010 for the course BA 464 taught by Professor Kien-quocvanpham during the Spring '10 term at Humboldt State University.

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IFM10 Ch21 Solutions Manual - Chapter 21 Working Capital...

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