AFP Corporate Treasury
Management Program
Chapter 1: The Role of Treasury
Management Outline
Trends in Treasury Management
The Corporate Financial Objective
The Finance Function
Financial Decisions
Financial Organization
Treasury Management Objectives and the
Cash Flow Timeline
The Operating Cycle and the Cash Flow Timeline
Cash Flows
Cash Flow Timeline and Float
The Future of Treasury Management
© 2004 Association for Financial Professionals. All rights reserved. Review 1 - 2
Corporate Financial Decisions
Capital Structure Decisions
Investment Decisions
Financing Decisions
Dividend Decisions
© 2004 Association for Financial Professionals. All rights reserved. Review 1 - 3
Operating Cycle
1.
Acquire Materials
or Resources
2.
Convert Materials to Goods
Convert Resources to
Services
3.
Sell Goods
or Services
4.
Collect Payment
for Goods or Services
© 2004 Association for Financial Professionals. All rights reserved. Review 1 - 4
Discussion Question
What are seven major objectives of
treasury management?
Answer:
Maintaining liquidity
Optimizing cash resources
Establishing and maintaining access to short-term financing
Maintaining access to medium- and long-term financing (capital
budgeting)
Maintaining shareholder relations
Managing risk
Coordinating financial functions and sharing financial information
© 2004 Association for Financial Professionals. All rights reserved. Review 1 - 5
General Cash Flow Timeline
Purchase of
Resources
Payment for
Resources
Sale of Goods
or Services
Collection of
Sales Receipts
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A Company’s Cash Flow Timeline
Supplier
Order
Placed
Customer
Order
Received
Customer
Invoice
Sent
Customer
Receives
Invoice
Payment
Sent
Receives
Payment
Check
Deposited
Funds
Debited
Customer
Sends
Payment
Customer
Payment
Received
Check
Deposited
Funds
Available
Supplier
Invoice
Received
O
rder E
ntry
O
rder
S
hipping
Invoice P
rep
M
ail D
elay
Credit Terms
& Payment
Processing
Invoice
Processing &
Credit Terms
M
ail D
elay
A
vailability
D
elay
M
ail D
elay
P
rocessing
D
elay
C
learing
D
elay
P
rocessing
D
elay
Collection Float
A/RInvoicing Float
Disbursement FloatA/P
Payment Float
A
cquire &
C
onvert
S
ell &
C
ollect
© 2004 Association for Financial Professionals. All rights reserved. Review 1 - 7
Chapter 2: Treasury Organizational
Structure Outline
Treasury Objectives and Policies
Treasury Policies
Financial Organization
Financial Organizational Structure
Key Roles and Responsibilities
Daily Cash Management
Treasury Management Organization
Treasury Linkages and Interfaces
Enterprise Treasury Management
© 2004 Association for Financial Professionals. All rights reserved. Review 1 - 8
Treasury Policies
Areas for developing treasury
policy:
Establishing treasury
objectives
Determining funding
requirements
Establishing an investment
policy
Measuring and managing
financial exposures
Evaluating treasury
performance
Policies must outline roles and
responsibilities for:
Calculating a daily cash
position
Initiating and approving
internal and external transfers
Determining methods of short
-term funding
Establishing financial
reporting methods, formats
and timeframes
Selecting and managing 3rd-
party vendor and banking
relationships
© 2004 Association for Financial Professionals. All rights reserved. Review 1 - 9
Typical Organization of the
Financial Function—Treasurer
External financing
Borrowing
Leasing
Investor relations
Cash management
Collection/
concentration
Disbursements
Short-term investing
Financial institution
administration
Risk management
Interest rate risk
management
Insurance
Foreign exchange
risk management
Employee benefit
fund management
© 2004 Association for Financial Professionals. All rights reserved. Review 1 - 10
Typical Organization of the
Financial Function—Controller
Accounting
Financial reporting
Internal accounting/
auditing
Tax reports and filing
Payables
Accounts payable
Payroll
Budget and financial
planning
Capital budgeting
Financial planning
Management
information systems
Credit and accounts
receivable
External auditor
relations
© 2004 Association for Financial Professionals. All rights reserved. Review 1 - 11
Daily Cash Management
Daily funds
management
Prepare cash position
worksheet
Monitor cash balances
Mobilize funds
Research and reconcile
exception items
Coordinate finance
functions with A/R, A/P
and accounting
Banking system
administration
Liquidity management
Forecasting
Systems design,
implementation and
evaluation
Financial risk
management
© 2004 Association for Financial Professionals. All rights reserved. Review 1 - 12
Treasury Linkages & Interfaces
Treasury
$
A/R
Risk
Mgt.
Investment
Borrowing
Pension
Mgt.
Purchasing A/P
General
Ledger
Internal
Audit
Treasury
$
Banks
Regulatory
Agencies
Suppliers
Customers
External
Investment
Mgrs.
Financial
Markets A/P
Industry
Trade
Groups
External
Auditors
Intracorporate Integration Intercorporate Integration
© 2004 Association for Financial Professionals. All rights reserved. Review 1 - 13
Chapter 3: Financial Environment
Outline
Financial Markets
Financial Institutions: Functions and Services
Regulatory Agencies
Federal Legislation
Legislation Governing:
Regulation and Supervision
Types of Financial Services Offered
Geographic Boundaries
Consumer Protection
Federal Reserve Regulations
Uniform Commercial Code (UCC)
© 2004 Association for Financial Professionals. All rights reserved. Review 1 - 14
Security and Exchanges Markets
NYSE
AMEX
NASD
NASDAQ (national over-
the-counter exchange)
Regional exchanges
Continuous market with
frequent fast trading
reducing price volatility
Prices subject to
changing supply and
demand
Companies raise capital
Regulated environment
Primary markets: debt and equity offered for first time
to investors
Secondary markets: previously issued debt and
equity are traded by brokers and bankers
© 2004 Association for Financial Professionals. All rights reserved. Review 1 - 15
Deposit Accounts
Checking account
Interest bearing for
individuals, sole
proprietorships, government
entities and nonprofits
Not interest bearing for “sub
chapter S” and “C”
corporations
Purposes for holding
balances:
Transaction balances
Compensating balances
Correspondent balances
Must be held for specified
period
CDs (under $100K)
Jumbo CDs (over $100K)
Fully negotiable CDs ($1 mil.
blocks)
Savings accounts
MMDAs
NOW accounts
Demand deposit accounts
(DDAs)
Time deposit accounts
(TDAs)
© 2004 Association for Financial Professionals. All rights reserved. Review 1 - 16
Commercial Banks’ Products and
Services
Deposit accounts
Credit services
Investment banking
services
Payment and
collection services
Trade services
Foreign exchange
(FX) services
Agent or fiduciary
services
Risk management
services
Consulting services
Broker/dealer
services
Insurance company
affiliation
© 2004 Association for Financial Professionals. All rights reserved. Review 1 - 17
Investment Banks
Underwriting
Distribution
Advising
© 2004 Association for Financial Professionals. All rights reserved. Review 1 - 18
The Federal Reserve System
(the Fed)
Organization:
Board of Governors
Federal Open Market Committee (FOMC)
12 banks and 25 branches of the Federal Reserve
Roles:
Supervision and regulation
Monetary policy
Banking services wholesaler
Fiscal agency of the . Treasury
Consumer protection
© 2004 Association for Financial Professionals. All rights reserved. Review 1 - 19
Office of the Comptroller of the
Currency (OCC)
Regulates the national
banking system
Administers nationally-
chartered banks
Oversees the execution of laws
relating to national banks
Promulgates rules and
regulations governing the
operations of national banks
Supervises a nationwide
staff of bank examiners
Approves/denies
national bank
charters, branches,
capital & other
banking structure
changes
Examines national
banks for asset (loan)
quality, capital
adequacy, and key
regulations
© 2004 Association for Financial Professionals. All rights reserved. Review 1 - 20
Federal Deposit Insurance
Corporation (FDIC)
Description:
An independent
agency of the federal
government
Primary role is to
protect depositors
from losses caused
by bank insolvency
Responsibilities:
Deposit insurance
Supervision
Acting as a trustee in
event of bank
failures
© 2004 Association for Financial Professionals. All rights reserved. Review 1 - 21
Office of Thrift Supervision (OTS)
Primary regulator of all
federal and many state-
chartered thrifts
Serves as the primary
regulator of all federal
and state-chartered
savings institutions
belonging to Savings
Association Insurance
Fund (SAIF)
Issues federal charters
for S&L associations
and savings banks
Adopts and enforces
regulations to ensure
that institutions
operate in a safe and
sound manner
© 2004 Association for Financial Professionals. All rights reserved. Review 1 - 22
The Securities and Exchange
Commission (SEC)
Registers public offerings
of debt and equity
securities by banks or bank
holding companies and
corporations
Sets financial disclosure
standards for corporations
that sell securities to the
public
Requires filing of quarterly
and annual financial
statements by companies
with publicly owned
securities
Regulates mutual funds
and investment advisors
Monitoring insider trading
© 2004 Association for Financial Professionals. All rights reserved. Review 1 - 23
Garn-St. Germain Depository
Institutions Act (1982)
Extended legal lending limit of banks to 15%
of capital and surplus (unsecured loans) and
25% (secured loans)
FDIC can arrange mergers of banks across
state lines when partners can’t be found
Allowed banks to introduce MMDAs to
compete with money market mutual funds
Thrift institutions allowed to engage in wide
range of investment and lending,
contributing to S&L crisis of 80s and 90s
© 2004 Association for Financial Professionals. All rights reserved. Review 1 - 24
Sarbanes-Oxley Act (2002)
Improve disclosure and financial reporting
SEC rule changes require companies to
Disclose code of ethics for senior management
(and any waivers)
Indicate if audit committee has a financial expert
Audit committees must pre-approve auditor’s audit
and non-audit services; be briefed on company’s
accounting (including preferable alternatives)
Regulation G
Must reconcile pro-forma financial information to financial
statements
Issue earnings releases on form 8-K
Must include material off-balance sheet arrangements in
MD&A
© 2004 Association for Financial Professionals. All rights reserved. Review 1 - 25
Glass-Steagall Act
Prohibited commercial banks from securities
underwriting except for government issues
Prohibited securities firms from engaging in bank-
like activities (., deposit gathering)
Required the Fed to establish interest rate ceilings
on all types of accounts; prohibited the payment of
interest on demand accounts
Created the FDIC to guarantee deposits up
to a stipulated maximum amount
© 2004 Association for Financial Professionals. All rights reserved. Review 1 - 26
Gramm-Leach-Bliley Act (1999)
Eliminated many barriers
among banking, insurance
and securities businesses
Permitted the creation of
financial holding companies
(FHCs)
Established the Fed as the
primary regulator of FHCs
Allowed for easier entry by
foreign banks
Placed CRA rating
stipulations on mergers of
bank holding companies with
insurance or securities firms
Required financial
institutions to establish and
regularly disclose privacy
policies; prohibited credit
card and account numbers
from being shared with third-
party marketers
© 2004 Association for Financial Professionals. All rights reserved. Review 1 - 27
Depository Institutions Deregulation
and Monetary Control Act (1980)
Required all deposit-taking institutions to
maintain reserves at the Fed
Made Fed services available to all deposit-
taking institutions
Mandated Fed to reduce/price payment
system float and price previously free
services
Phased out Regulation Q interest rate
ceilings (except sub chapter S and C corps.)
Permitted banks to offer NOW accounts
© 2004 Association for Financial Professionals. All rights reserved. Review 1 - 28
Check Clearing for the 21st Century
Act (2003) (Check 21)
Facilitates check truncation
Foster check-payment innovation without
mandating receipt of electronic checks
Improve payment system overall
Creates IRD or “substitute check” that is
legal equivalent of original check (no legal
equivalence for check images)
MICR-encoded paper reproduction with image of
front/back
Conforms to industry standards
© 2004 Association for Financial Professionals. All rights reserved. Review 1 - 29
Community Reinvestment Act
(1977, 1995)
Implemented by Regulation BB and
revised in 1995
Encourages depository institutions to
meet credit needs of community in
which they operate, including low- and
moderate-income neighborhoods
CRA examinations are conducted by all
federal agencies who supervise
depository institutions
© 2004 Association for Financial Professionals. All rights reserved. Review 1 - 30
Article 3—Negotiable Instruments
Accord and satisfaction:
Stipulates when a check
could constitute a
payment made in full
(accord and satisfaction)
Revised to permit
avoidance of inadvertent
accord and satisfaction (if
the payee discovers an
error within 90 days)
Unauthorized signatures:
Stipulates that a bank can
charge a customer’s
account only for checks
that are properly payable
Stipulates when a company
may be held liable for
situations related to check
issuance
© 2004 Association for Financial Professionals. All rights reserved. Review 1 - 31
Chapter 4: Financial Accounting
Outline
Accounting Concepts and Standards
GAAP
Cash vs. Accrual Accounting
Financial Statements
Accounting for Non-business Entities
Financial Statement Analysis
© 2004 Association for Financial Professionals. All rights reserved. Review 1 - 32
Generally Accepted Accounting
Principles (GAAP)
Four basic principles
underlying GAAP
Historical cost
Full disclosure
Revenue recognition
Matching
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Cash vs. Accrual Accounting
Cash accounting:
Records cash as it is
received
Records expenses as
they are paid
Directly relates all entries
to a cash inflow or
outflow
Accrual accounting:
Recognizes revenues as
they are earned
Recognizes expenses when
the associated revenue is
recognized
Makes entries regardless of
when the related cash flow
occurs
Earnings management:
managers can intentionally
distort estimates or make
judgments that influence
the level of reported income
© 2004 Association for Financial Professionals. All rights reserved. Review 1 - 34
Financial Accounting Standards
(FAS)
Accounting for cash, cash equivalents and
overdrafts
Accounting for short-term investments (FAS
115)
Trading securities
Held-to-maturity securities
Available for sale (AFS) securities
Accounting for derivative instruments and
hedging activities (FAS 133 & 138)
Classification of debt
Accounting for goodwill (FAS 142)
© 2004 Association for Financial Professionals. All rights reserved. Review 1 - 35
Auditor Opinions
Unqualified
Unqualified with
explanatory
paragraph or
modified unqualified
Qualified
Adverse
Disclaimed
© 2004 Association for Financial Professionals. All rights reserved. Review 1 - 36
Sample Balance Sheet
“Snapshot”
Assets
Current assets
Fixed assets
Depreciable fixed
assets
Intangible assets
Liabilities
Current liabilities
Long-term
liabilities
Equity
Assets = Liabilities +
Shareholder Equity
© 2004 Association for Financial Professionals. All rights reserved. Review 1 - 37
Sample Year-End Income Statement
The income statement, or P&L, is a record of revenues and
expenses showing the net change in shareholder equity from
operations over a specified period.
© 2004 Association for Financial Professionals. All rights reserved. Review 1 - 38
Sample Statement of Retained
Earnings
The statement of retained earnings shows how net income for the
period was used.
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Sample Statement of Cash Flows
Shows sources and
uses of cash
Sections
Operating
Investing
Financing
Cash from operations
calculated by adding
back non-cash
charges (.,
depreciation)
Cash, not earnings,
repays debt
© 2004 Association for Financial Professionals. All rights reserved. Review 1 - 40
Financial Statement Analysis
Suppliers determine whether to make sales
on credit
Trading partners assess the financial ability
of a counterparty to meet contractual
obligations
Lenders determine whether to extend or
maintain credit
Rating agencies assess credit risk of issues
Investors make decisions about purchasing
and selling corporate debt and equity
© 2004 Association for Financial Professionals. All rights reserved. Review 1 - 41
Common-Size Ratios
Common-size financial statements
Common-size income statement expresses every line item
as a percentage of revenues
Common-size profitability percentages are margins
One example of a common-size ratio is Gross Profit
Margin
© 2004 Association for Financial Professionals. All rights reserved. Review 1 - 42
Financial Statement Analysis Ratios
Liquidity or working
capital ratios
Debt management
ratios
Efficiency ratios
Performance ratios
© 2004 Association for Financial Professionals. All rights reserved. Review 1 - 43
Liquidity or Working Capital:
Current Ratio
Measures the degree to which current
obligations are covered by current assets
© 2004 Association for Financial Professionals. All rights reserved. Review 1 - 44
Liquidity or Working Capital:
Quick Ratio
Measures the degree to which a company’s current
liabilities are covered by its most liquid current assets
© 2004 Association for Financial Professionals. All rights reserved. Review 1 - 45
Liquidity or Working Capital:
Cash Flow to Total Debt Ratio
Measures ability to repay debt (a relatively low ratio
indicates an inability to repay debt) and can predict
financial failure
© 2004 Association for Financial Professionals. All rights reserved. Review 1 - 46
Liquidity or Working Capital:
Cash Turnover Ratio
If a company has a cash conversion cycle of
days, how many cash conversion cycles does the
company go through in a year (cash turnover)?
© 2004 Association for Financial Professionals. All rights reserved. Review 1 - 47
Debt Management:
Times Interest Earned (TIE) Ratio
Measures how many times a company’s EBIT exceed its
interest obligations
© 2004 Association for Financial Professionals. All rights reserved. Review 1 - 48
Debt Management:
Long-Term Debt to Capital
Measures what percentage of a company’s
capitalization is provided by long-term debt
© 2004 Association for Financial Professionals. All rights reserved. Review 1 - 49
Debt Management:
Debt to Tangible Net Worth
Measures a company’s debt as a percentage of its
tangible net worth
© 2004 Association for Financial Professionals. All rights reserved. Review 1 - 50
Debt Management:
Total Liabilities to Total Assets
Measures the percentage of all liabilities relative to the
total asset base of a company
© 2004 Association for Financial Professionals. All rights reserved. Review 1 - 51
Performance and Efficiency:
Return on Common Equity
Measures earnings available to common shareholders
(net income less any preferred stock dividends or
amortization) expressed as a percentage of common
equity
© 2004 Association for Financial Professionals. All rights reserved. Review 1 - 52
Performance and Efficiency:
Return on Sales
Measures net income as a percentage of sales
© 2004 Association for Financial Professionals. All rights reserved. Review 1 - 53
Performance and Efficiency:
Return on Total Assets
Measures net income as a
percentage of total assets
© 2004 Association for Financial Professionals. All rights reserved. Review 1 - 54
Performance and Efficiency:
Total Asset Turnover
Measures how many times the stock of assets is turned
over by the flow of revenue
© 2004 Association for Financial Professionals. All rights reserved. Review 1 - 55
Performance and Efficiency:
Fixed Asset Turnover
Measures how many times the stock of fixed assets is
turned over by the flow of revenue
© 2004 Association for Financial Professionals. All rights reserved. Review 1 - 56
Performance and Efficiency:
Cash Conversion Efficiency
Measures the efficiency with which a
company converts sales into cash
© 2004 Association for Financial Professionals. All rights reserved. Review 1 - 57
Performance and Efficiency:
Working Capital Turnover
Measures how many times the stock of working capital
assets is turned over by the flow of revenue
© 2004 Association for Financial Professionals. All rights reserved. Review 1 - 58
Use of Financial Ratios and
Performance Measures
Advantages
Easily computed
Widely used
Information easily
obtained
Allow assessment of
historical performance
Allow for comparison
between companies
Disadvantages
Express static, not dynamic,
relationships
Often miss variability of cash
flows and are not necessarily
indicative of future performance
Summarize accounting
information and do not reflect
economic value
Cannot reflect qualitative value
(managerial talent, intangibles)
Use of different accounting
methods or “window dressing”
can distort calculations
© 2004 Association for Financial Professionals. All rights reserved. Review 1 - 59
Chapter 5: Financial Planning and
Analysis Outline
Basic Financial
Concepts
Decision Evaluation
Developing a Financial
Plan (Budgeting)
Performance
Measurement
© 2004 Association for Financial Professionals. All rights reserved. Review 1 - 60
Time Value of Money
The value of cash flow
is determined by
the:
Amount of the cash
flows
Appropriate interest
rate
Number of time
periods involved
© 2004 Association for Financial Professionals. All rights reserved. Review 1 - 61
Future Value
What is the future value of $20,000 if it can be
invested for four years, compounded
annually, at a rate of %?
© 2004 Association for Financial Professionals. All rights reserved. Review 1 - 62
Present Value
What is the present value of $23,352 to be
received after four years, discounted at a rate
of % annually?
Where:
Ct = Cash flow at time t
i = Periodic interest rate
n = Number of periods
© 2004 Association for Financial Professionals. All rights reserved. Review 1 - 63
Weighted Average Cost of Capital
(WACC)
Note: The debt is adjusted by the amount of the tax rate because interest
is a tax-deductible expense. The after-tax cost of debt is calculated by
multiplying the cost of debt times 1 minus the marginal tax rate.
Cost of capital can be measured by the combined cost of equity
and cost of debt. What is the WACC of a company with:
• Capital structure of 45% debt to 55% equity
• Marginal tax rate of 33%
• Cost of debt of %
• Cost of equity of 15%
© 2004 Association for Financial Professionals. All rights reserved. Review 1 - 64
Breakeven Analysis
Breakeven point: level of activity for an
operation at which costs exactly equal
benefits
© 2004 Association for Financial Professionals. All rights reserved. Review 1 - 65
Net Present Value (NPV)
Where: Ct = Cash flow at time t; i = Periodic interest rate (10% in
this example); n = Number of periods
Evaluates the present value (PV) of all inflows and
outflows of a project using the marginal cost of
capital as a discount rate
© 2004 Association for Financial Professionals. All rights reserved. Review 1 - 66
Internal Rate of Return (IRR)
Discount rate (i) at which the net present value (NPV)
equals zero. IRR reflects the expected profit on the
expense as an annual rate
Where: Ct = Cash flow at time t; n = Number of periods
© 2004 Association for Financial Professionals. All rights reserved. Review 1 - 67
Net Present Value (NPV) versus
Profitability Index (PI)
PI puts index terms on the amount found in NPV (.,
NPV is a discrete amount; PI is a ratio that can be used
as part of a common-size comparison, it is units of
inflow present value per unit of outflow present value)
© 2004 Association for Financial Professionals. All rights reserved. Review 1 - 68
Performance Measurement
Return on investment (ROI)
ROI over a partial period may be misleading
ROI does not include charge for cost of capital
Positive NPV project can be rejected if it lowers
overall ROI
Residual Income
Assigns charge for invested capital
RI is a $ amount and any profitable project after
deducting cost of capital will increase RI
© 2004 Association for Financial Professionals. All rights reserved. Review 1 - 69
Economic Value Added (EVA)
Considers after-tax
operating profit minus
an appropriate charge
for the opportunity cost
of all capital
Parent company acts as
a bank for divisions/unit
in deciding who gets
funds
Parent uses EVA to
determine difference
between a unit’s net
operating profit and a
charge for capital
© 2004 Association for Financial Professionals. All rights reserved. Review 1 - 70
EVA
Economic value added (EVA) is a measure of the incremental value
that a company’s investments add. What is the EVA of a company
with:
• Total capital of $11,400,000 (a product of long-term debt plus
total equity).
• Marginal tax rate of 34%.
• Weighted average cost of capital (WACC) of %.
• Operating profit of $1,980,000.
© 2004 Association for Financial Professionals. All rights reserved. Review 1 - 71
Chapter 6: Philosophy of Working
Capital Outline
Overview of Working Capital (WC)
Management
WC Management Investing and Financing
Strategies
Basics of Short-Term Credit
Costs and Risks of Alternative Debt
Maturities
Financing Strategies of Multidivisional and
Multinational Companies
Cash discount calculations
© 2004 Association for Financial Professionals. All rights reserved. Review 1 - 72
Cash Flow Cycle of a Business
Purchase of
Materials
Payment for
Materials
Sale of
Product Collect A/R
Days’ Inventory
Cash Conversion Cycle
Days’
Receivables
Days’ Payables
Day 1 Day 30 Day 45 Day 75
© 2004 Association for Financial Professionals. All rights reserved. Review 1 - 73
Working Capital Cash Flow Cycle:
Cash Conversion Cycle
Formulas for three time periods are necessary to
calculate the cash conversion cycle.
© 2004 Association for Financial Professionals. All rights reserved. Review 1 - 74
Working Capital Cash Flow Cycle:
Cash Conversion Cycle
Assume that a company has:
• $2,500,000 in annual sales.
• $1,200,000 total cost of goods sold.
• $360,000 in inventory on average.
• $150,000 in accounts receivable on average.
• $120,000 in accounts payable on average.
What is the company’s average days’ inventory, days’
receivables and days’ payables, and what is the
company’s cash conversion cycle time?
© 2004 Association for Financial Professionals. All rights reserved. Review 1 - 75
Working Capital Cash Flow Cycle:
Cash Conversion Cycle
© 2004 Association for Financial Professionals. All rights reserved. Review 1 - 76
Working Capital Cash Flow Cycle:
Cash Conversion Cycle
© 2004 Association for Financial Professionals. All rights reserved. Review 1 - 77
Working Capital Policy
Asset
Breakdown
Maturity
Matching
Conservative
Policy
Aggressive
Policy
Fixed Assets PermanentCurrent Assets
Fluctuating
Current Assets
Short-Term
Sources
Short-Term
Sources
Short-Term Sources
Long-Term Sources
Long-Term Sources
Long-Term Sources
© 2004 Association for Financial Professionals. All rights reserved. Review 1 - 78
Cost for a Buyer of Not Taking the
Cash Discount
If the cost of not taking the discount (%) is greater than
the company’s cost of short term funds (. 11%), the
discount should be taken. Terms below are 2/10, net 60.
© 2004 Association for Financial Professionals. All rights reserved. Review 1 - 79
Benefit for a Seller of Offering a
Cash Discount
The discount is an early pay incentive for the buyer. A positive
NPV represents the seller’s gain by not having to finance A/R
for the discount period. Terms below are 2/10, net 60.
© 2004 Association for Financial Professionals. All rights reserved. Review 1 - 80
Chapter 7: Working Capital Tools
Outline
Credit and Accounts
Receivable
Inventory
Management
Accounts Payable
© 2004 Association for Financial Professionals. All rights reserved. Review 1 - 81
The Five Cs of Credit
Character Perceived honesty or integrity of the applicant
Capacity Current and future financial resources that can be committed to pay obligations
Capital Short- and long-term financial resources to supplement insufficient cash flow for payments
Collateral Assets or guarantees available to secure an obligation if payment is not made
Conditions General economic environment and economic conditions for the customer and the seller
© 2004 Association for Financial Professionals. All rights reserved. Review 1 - 82
Forms of Credit Extension
Open account
Installment credit
Revolving credit
Letter of credit (L/C)
© 2004 Association for Financial Professionals. All rights reserved. Review 1 - 83
Annualized Cost of Trade Credit
Given terms of 2/10 net 60, the cost of taking the discount is
calculated as follows:
If the company can borrow at a rate of less than %, they should
do so and take the discount; if borrowed funds cost more or are not
available, payment should be delayed until the net due date.
© 2004 Association for Financial Professionals. All rights reserved. Review 1 - 84
Days’ Sales Outstanding (DSO)
Assume that a company has outstanding receivables of $350,000
at the end of the first quarter and credit sales of $425,000 for the
quarter. Using a 90-day averaging period, the DSO for this
company can be computed as follows:
If the company’s credit terms are net 60, the average past due is
computed as follows:
© 2004 Association for Financial Professionals. All rights reserved. Review 1 - 85
Aging Schedule
Age of Accounts A/R % of A/R
0 – 30 days
31 – 60 days
61 – 90 days
91 + days
Total
$1,750,000
$375,000
$250,000
$125,000
$2,500,000
70%
15%
10%
5%
100%
Separates A/R into current and past due receivables
in 30-day increments (on a customer or aggregate
basis) and can determine the percent past due
© 2004 Association for Financial Professionals. All rights reserved. Review 1 - 86
A/R Balance Pattern
Month Sales Sales
Remaining A/R
from Month Sales
at End of March
February
January
March
April
$250,000
$300,000
$400,000
$500,000
20%
55%
95%
Remaining A/R
as a % of
Month Sales
$50,000
$165,000
$380,000
The total outstanding A/R balance at the end of March is:
$595,000 = ($50,000 + $165,000 + $380,000)
The estimate of cash inflows for April = 5% of April sales + 40% of March
sales + 35% of February sales + 20% of January sales:
Estimated April inflows = ( x $500,000) + ( x $400,000)
+ ( x $300,000) + ( x $250,000) = $340,000
© 2004 Association for Financial Professionals. All rights reserved. Review 1 - 87
Consumer and Commercial Credit
Legislation
Truth in Lending Act (1969)
Fair Credit Reporting Act (1971)
Fair Credit Billing Act (1975)
Equal Credit Opportunity Act (1975)
Fair Debt Collection Practices Act
(1978)
© 2004 Association for Financial Professionals. All rights reserved. Review 1 - 88
Just-In-Time (JIT) Inventory
Management
Minimize inventory by altering costs or uncertainties
underlying motives for holding inventory
Often paired with MPS
Retailers link to POS devices
Goals
Eliminate waste
Standardize the production process
Continuously improve quality
Benefits: Improved supplier relations, lower
transaction costs, better planning
Supplier-managed replenishment programs
Paid-on-production process
Accounting and purchase timing may need changes
© 2004 Association for Financial Professionals. All rights reserved. Review 1 - 89
