1-Working Capital Management Foundation Lecture

1-Working Capital Management Foundation Lecture - Working...

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Working Capital Management Foundation Lecture #1 -Net Working Capital = Current Assets – Current Liabilities -Cash Conversion Cycle = Average Age of Inventory + Average Collection Period – APP CCC = AAI + ACP – APP -Financing Alternatives: 1. Hedged Approach: -Matching the maturities of Assets and Liabilities -Most desirable but almost impossible 2. Conservative Approach: -Using long-term capital to finance capital assets, permanent current assets and part of temporary current assets -Low risk but less profitable 3. Risky Approach: -Using short-term funds to finance temporary current assets and part of permanent current assets -More profitable but risky -The Financing Decision: -A financial manager should balance short-term versus long-term financing by considering: -The composition of the firm’s assets -The firm’s willingness to accept risk - The risks and potential payoffs from each financing alternative -The term structure of interest rates -The volatility of interest rates -Short-term vs. Long-term Financing -Short-term financing is less expensive but riskier -Lower interest rates -Short-term rates are volatile -Risk of default if sales slow down -Risk that banks may not extend/renew loans -Long-term financing is more expensive but less risky -Usually higher interest rates -You may pay interest on funds you don’t always need -You have capital at all times -Firm must decide the appropriate mix -Cash Management -Financial managers want to keep cash balances to a minimum -There are two reasons for holding cash -For everyday transactions (main reason) -For precautionary needs (emergencies) -Goals are to speed up the inflow of cash (or improve collections) and slow down the outflow of cash (or extend disbursements) -Also will attempt to “play the float” -Marketable Securities:
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-Marketable Securities are short-term, interest-earning, money market instruments easily converted into cash -To be truly marketable, a security must have: -A ready market to minimize the time required to convert into cash -Safety of principal, experiences little or no loss in value of time -Inventory Management: -The first component of the CCC is the average of inventory -The objective of managing inventory is to turn over inventory as quickly as possible without l losing sales from stock-outs -Marketing manager’s view is to have large inventories of the firm’s finished products to ensure all orders could be filled quickly, eliminating the need for back orders -The ABC System
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