pp08
pp08
pp08
2.
3. 4. 5.
6.
7.
8.2
Explain how the definition of "working capital" differs between financial analysts and accountants. Understand the two fundamental decision issues in working capital management and the trade-offs involved in making these decisions. Discuss how to determine the optimal level of current assets. Describe the relationship between profitability, liquidity, and risk in the management of working capital. Explain how to classify working capital according to its components and according to time (i.e., either permanent or temporary). Describe the hedging (maturity matching) approach to financing and the advantages/disadvantages of short- versus long-term financing. Explain how the financial manager combines the current asset decision with the liability structure decision.
Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Financing Current Assets: ShortTerm and Long-Term Mix Combining Liability Structure and Current Asset Decisions
Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
8.3
In a typical manufacturing firm, current assets exceed one-half of total assets. Excessive levels can result in a substandard Return on Investment (ROI). Current liabilities are the principal source of external financing for small firms. Requires continuous, day-to-day managerial supervision. Working capital management affects the companys risk, return, and share price.
Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
8.5
Policy A Policy B
Policy C
Current Assets
50,000
Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Impact on Liquidity
Optimal Amount (Level) of Current Assets Liquidity Analysis Policy Liquidity A High B Average C Low Greater current asset levels generate more liquidity; all other factors held constant.
8.7
Policy A
Policy B
Policy C
Current Assets
50,000
Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Policy A
Policy B Policy C
Current Assets
50,000
8.8
Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Policy A
Policy B
Policy C
Current Assets
50,000
Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Impact on Risk
Optimal Amount (Level) of Current Assets
Decreasing cash reduces the firms ability to meet its financial obligations. More risk! Stricter credit policies reduce receivables and possibly lose sales and customers. More risk! Lower inventory levels increase stockouts and lost sales. More risk!
Policy A
Policy B
Policy C
Current Assets
50,000
8.10
Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Impact on Risk
Optimal Amount (Level) of Current Assets Risk Analysis Policy Risk A Low B Average C High
Risk increases as the level of current assets are reduced.
8.11
Policy A
Policy B
Policy C
Current Assets
50,000
Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
1. Profitability varies inversely with liquidity. 2. Profitability moves together with risk. (risk and return go hand in hand!)
8.12 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Components
Cash, marketable securities, receivables, and inventory Time
Permanent Temporary
Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
8.13
DOLLAR AMOUNT
TIME
8.14 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
DOLLAR AMOUNT
TIME
8.15 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
DOLLAR AMOUNT
TIME
8.17 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
DOLLAR AMOUNT
Current assets*
Long-term financing
Fixed assets
TIME
8.18 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Result
8.21
DOLLAR AMOUNT
Current assets
Long-term financing
Fixed assets
TIME
8.22 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
Financing long-term needs with a lower interest cost than short-term debt Borrowing only what is necessary
Refinancing short-term obligations in the future Uncertain future interest costs
Result
8.23
Manager accepts greater expected profits in exchange for taking greater risk.
Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
DOLLAR AMOUNT
Current assets
Long-term financing
Fixed assets
TIME
8.24 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
SHORT-TERM
LONG-TERM
Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
The level of current assets and the method of financing those assets are interdependent. A conservative policy of high levels of current assets allows a more aggressive method of financing current assets. A conservative method of financing (all-equity) allows an aggressive policy of low levels of current assets.
Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
8.26