2. Revisiting the Balance Sheet Model of
the Firm
• Current assets
– Most liquid
– Less profitable than fixed assets
– Represent net amount firm has to fund
14-2
3. Revisiting the
Balance Sheet Model
• Net working capital =
Current Assets – Current Liabilities
– Firm’s objective is to fund the least amount of net
working capital possible
14-3
4. Tracing Cash and
Net Working Capital
• Operating Cycle is the time needed to
– Acquire raw materials and turn into finished goods
– Sell and receive payment for them
14-4
6. Cash Cycle
• Portion of operating cycle firm must finance
• Time between payment for inventory and sales
receipts
14-6
7. Short Term Financial Policy
• Firms reduce net working capital needs
– Manage need for current assets
– Obtain current liabilities to fund current assets
14-7
8. Size of Current Assets Investment
Two categories of carrying costs:
1) Opportunity costs with capital tied up in current
assets
2) Explicit costs to maintain value of current assets
14-8
14. Short-Term Financial Plans
• Firms not using flexible financing will need to
seek short-term solutions
– Unsecured loans
– Secured loans
– Other short-term financing alternatives
14-14
15. Unsecured Loans
• Commercial loan from bank
– Usually a line of credit
– Fees can be explicit and implicit
14-15
16. Secured Loans
• Asset-based loans
– Lenders charge lower interest rates
– Real estate, accounts receivable, inventory used as
collateral
14-16
18. Cash Management
• Clarification on terminology cash flow vs. cash
account
– Cash flows are good
– Cash account is a current asset with high liquidity
and low profitability
14-18
26. Ethical and Legal Questions
Illegal practices
– Using collected cash before receiving it
– Continuing to use disbursed cash after check sent
– Check kiting is drawing money against account
with insufficient funds
14-26
27. Investing Idle Cash
• Most large firms invest in their own
marketable securities
• Smaller firms invest in money-market fund or
bank sweep account
14-27
28. Why Firms Have Excess Cash
• Seasonal fluctuations
• Preparation for a planned expenditure
14-28
29. What to Do with Surplus Cash
• Appropriate investments
– Treasury bills
– Federal Funds
– Repurchase agreements
– Commercial paper
– Negotiable CDs
– Banker’s acceptances
14-29
30. Credit Management
Trade-off between the opportunity cost of lost
sales, and the carrying costs of funding
Accounts Receivable (AR) plus the expected
costs of default on AR
14-30
31. Credit Policy: Terms of the Sale
Credit terms include
– Credit period
– Cash discount
– Description of the type of credit instrument
14-31
32. Credit Analysis
• Determination of the borrower’s ability and
willingness to pay
• 5 C’s of credit:
1. Capacity
2. Character
3. Capital
4. Collateral
5. Conditions
14-32