Unformatted text preview: ne had made important contributions during the morning’s
discussion, and by now the walls of the conference room were covered with the
Marie had begun the meeting with a review of the company’s receivables policy: credit standards, payment date, and discount terms. She had put her staff’s
most recent cash flow analyses on the table, and after a general discussion of
incremental analysis techniques, breakout groups had reviewed the assumptions and calculations. There was general agreement that the company’s policy
was reasonable, given the assumptions that had been made about customer
But it quickly became apparent that the group did not understand the behavior
of their customers: why they were not paying as they had been forecasted to
do. Part of the problem seemed to be with the format of the invoices since customers complained they were difficult to understand (even though they made
perfect sense to everyone in the room), and the team made plans to form a
joint controller/customer task force to work on the issue. Part of the problem
was the errors in some invoices, and another task force was formed to trace
the billing process to discover where and why errors arose.
As Marie left the room and walked toward the company’s cafeteria, she felt a
strong sense of accomplishment. She was having fun blending the traditional
skills of financial analysis with the team-based work of quality management,
and more than ever she was convinced of the need to combine the two to do
her new job well. 306 Part IV Adding Value SERVING FINANCE’S CUSTOMERS
Pacific When a survey of customers identified billing accuracy as the finance process with
which they were most dissatisfied—fully 13% of all bills were objected to as wrong,
“contentions” in the jargon of the industry—the controller’s office at Southern Pacific
Rail Corporation began a project to improve the process. Quality-improvement teams
improved the data flow from marketing to billing, realigned the billing group to be
more consistent with the marketing organization’s structure, constructed a common
pricing database, and studied how to simplify the railroad’s pricing structure. Customers active in quality management joined with Southern Pacific in the effort. Today,
contentions have been significantly reduced, and since the reduction in contested invoices represents millions of dollars of receivables per day, the company’s cash flow
has improved dramatically. Summary of Key Points
Separate working capital into permanent and temporary components. Working capital represents a
company’s liquid resources available for daily use.
Some is permanent, a base level required on an ongoing basis. The remainder is temporary, the changes
around the base level due to the business cycle, seasonality, and the vagaries of day-to-day transactions.
Organize permanent working capital data into cash
flow terms. Permanent working capital decisions
are analyzed using a cash flow table and the perpe
tuity time value of money model.
Describe the components of a firm’s cash balance
and analyze decisions involving accelerating cash
in transit. Cash includes coins and bills, demand
deposits, and time deposits, and may be held in various currencies. Traditionally, companies have accelerated collections and delayed disbursements so cash
in transit does not remain idle. Today, there is a trend
toward using electronic payment systems to further
speed up collections and reduce processing costs. Excess cash is moved to marketable securities to earn
Analyze proposed changes to a firm’s permanent accounts receivable balance. A firm establishes its
permanent accounts receivable balance through its
decisions about credit standards, payment date, and
price changes: discounts for early payment and interest added to overdue balances. Decisions are incremental, testing each proposed alternative and accepting changes that have a positive NPV or NAB or an acceptable IRR. Accounts receivable will change
temporarily in response to specific customers’ needs
and circumstances. Questions
1. What are the two usages for the term working capital?
2. Distinguish between permanent working capital and
temporary working capital. Why is the difference important to financial managers?
3. In what ways is the cash flow spreadsheet used to organize the data for permanent working capital asset
decisions similar to and different from the cash flow
spreadsheet used in capital budgeting?
4. What is a project’s “net annual benefit”? Why is this
measure used in evaluating permanent working capital asset decisions?
5. Are you comfortable with the assumption that permanent asset decisions are truly permanent—that is,
their effects continue forever? Why or why not?
6. Discuss how a corporate treasurer allocates the firm’s
cash balance. What are the factors taken into account
in making the allocation?
7. What is “float”? Why is it of concern to the f...
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