Lecture2 - working capital management

Equaltotheoperatingcyclelesstheaccounts payableperiod

Info iconThis preview shows page 1. Sign up to view the full content.

View Full Document Right Arrow Icon
This is the end of the preview. Sign up to access the rest of the document.

Unformatted text preview: ­9,750 ­3,300 62,525 21 Statement of Cash Flows Investing activities Purchase of fixed assets CF from investing activities Financing activities Issues of new equity Reduction in long­term debt Dividends paid CF from financing activities Change in cash ­12,725 ­12,725 3,000 ­15,000 ­30,800 ­42,800 7,000 22 The Operating Cycle & the Cash Cycle Raw material purchased Finished goods sold Cash received Order Stock Placed Arrives Inventory period Accounts receivable period Time Accounts payable period Firm receives invoice Cash paid for materials Operating cycle Cash2cycle 3 Operating Cycle • The operating cycle: time interval between arrival of inventory stock and date when cash is collected from receivables • Equal to the inventory period plus the accounts receivable period 24 Cash Cycle • The cash cycle: time interval between when cash is paid for materials and collection of receivables. • Equal to the operating cycle less the accounts payable period • Need for short­term finance is determined by the gap between cash outflows and inflows (the cash cycle) 25 Inventory Period • Inventory turnover = COGS / Average Inventory (per year) – How many time you must stock inventory in a year • Inventory period = 365 / Inventory turnover (days) – How long each turnover period is 26 AR Period & AP Period • Receivables turnover = Credit sales / Average AR (per year) • Receivables period = 365 / Receivables turnover (days) • Payables turnover = COGS / Average AP (per year) • Payables period = 365 / Payables turnover (days) 27 ABC Inc. Example • ABC Inc. had COGS of $200 million and credit sales of $240 million in 1998. The following data are from its balance sheets. Inventory Accounts receivable Accounts payable 12/31/97 40 30 10 12/31/98 60 50 30 28 Calculation • How many days is ABC’s operating cycle? Inventory period = [ { (40 + 60) / 2} / 200 ] * 365 = 91.25 days Receivables period = [ { (30 + 50) / 2 } / 240 ] * 365 = 60.83 days Operating cycle = 152.08 days • How many days is ABC’s cash cycle? Accts. payable period = [ { (10 +30) / 2} / 200 ] * 365 = 36.5 days Cash cycle = 115.58 days 29 Managing Operating & Cash Cycles • How do these relate to the profitability of the firm? How should we think about managing them? • The length of the cash cycle affects the firm’s investment in working capital. • A long cash cycle implies greater short term financing needs and thus carries financing costs 30 Cost of Reducing the Cash Cycle • However, if a firm is able to reduce its cash cycle, there will be some associated cost in addition to the financing benefit • Investment in new technology or additional labor needed to cut processing costs • Reduced sales due to tighter credit policy • Exposure to bottlenecks due to low inventories • Increased financing costs from stretching payables 31 The Short­Term...
View Full Document

This document was uploaded on 03/09/2014 for the course COMM 371 at The University of British Columbia.

Ask a homework question - tutors are online