Managerial finance -- Chapter 14 -- summary

It is important for a firm to maintain a reasonable level of net working capital. To do so, it must balance the high profit and high risk associated with low levels of current assets and high levels of current liabilities against the low profit and low risk that result from high levels of current assets of low levels of current liabilities. A strategy that achieves a reasonable balance between profits and liquidity should positively contribute to the firm's value.

Similarly, the firm should manage its cash conversion cycle by turning inventory quickly; collecting accounts receivable quickly; managing mail, processing, and clearing time; and paying accounts payable slowly. The strategies should enable the firm to manage its current accounts efficiently and to minimize the amount of resources invested in operating assets.

The financial manager can manage inventory, accounts receivable, and cash receipts to minimize the firm's operating cycle investment, thereby reducing the amount of resources needed to support its business. Employing the strategies, and managing accounts payable in cash disbursements so as to shorten the cash conversion cycle, should minimize the negotiated liabilities needed to support the firm's resource requirements. Active management of the firm's working capital and current assets should positively contribute to the firm's goal of maximizing its stock price.

The cash conversion cycle
The cash conversion cycle has three components:
1. Average age of inventory
2. Average collection period
3. Average payment period
The length of the cash conversion cycle determines the amount of time resources are tied up in the firm's day-to-day operations. The firm's investment in short-term assets often consists of both permanent and seasonal funding requirements. The seasonal requirements can be financed using either an aggressive (low-cost, high risk) financing strategy or a conservative (high cost, low risk) financing strategy. The firm's funding decision for its cash conversion cycle ultimately depends on management's disposition toward risk and the strength of the firm's banking relationships. To minimize its reliance on negotiated liabilities, the financial manager seeks to:
1. Turn over inventory as quickly as possible
2. Collect accounts receivable as quickly as possible
3. Manage mail, processing, and clearing time
4. Pay accounts payable as slowly as possible.
Use of the strategies should minimize the length of the cash conversion cycle.

Inventory management
The viewpoints of marketing, manufacturing, and purchasing managers about the appropriate levels of inventory tend to cause higher inventories than those deemed appropriate by the financial manager. For commonly used techniques for effectively managing inventory to keep its level low are;
1. The ABC system
2. the economic order quantity (EOQ) model
3. The just-in-time (JIT) system
4. Computerized systems for resource control -- MRP, MRP II, and ERP.

International inventory managers place greater emphasis on making sure that sufficient quantities of inventory are delivered where and when needed, and in the right condition, then on ordering the economically optimal quantities.

Credit selection
Credit selection techniques determined which customer's creditworthiness is consistent with the firm's credit standards. Two popular credit selection techniques are the five C's of credit and credit scoring. Changes in credit standards can be evaluated mathematically by assessing the effects of a proposed change on profits from sales, the cost of accounts receivable investment, and bad debt costs.

Cash discounts
Changes in credit terms -- the cash discount, the cash discount period, and the credit. -- can be quantified similarly to changes in credit standards. Credit monitoring, the ongoing review of accounts receivable, frequently involves use of the average collection period and an aging schedule. A number of popular collection techniques are used by firms.

Float
Float refers to funds that have been sent by the payor but are not yet usable funds to the payee. The components of float our mail time, processing time, and clearing time. Float occurs in both the average collection period and the average payment period. One technique for speeding up collections to reduce collection float is a lockbox system. A popular technique for slowing payments to increase payment of float is controlled disbursing.

The goal for managing operating cash is to balance the opportunity cost of nonearning balances against the transaction cost of temporary investments. Firms commonly used depository transfer checks (DTCs) ,ACH transfers, and wire transfers to transfer lockbox receipts to their concentration banks quickly. Zero balance accounts (ZBAs) can be used to eliminate nonearning cash balances and corporate checking accounts. Marketable securities are short-term, interest-earning, money market instruments used by the firm to earn a return on temporarily idle funds. They may be government or nongovernment issues.