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Working Capital Management

Session 5, Module Three:


Chapter 9:
Working Capital Metrics
Chapter 10:
Collections,
Concentration
and
Disbursements
Session 5, Module Three:
Working Capital Management
v4.0 2013 Association for Financial Professionals. All rights reserved. Session 5: Module 3, Overview - 2
Outline:
Basic Financial Concepts
Working Capital Metrics
Cash Conversion Cycle (CCC)
Cash Discount Calculations
A/R Monitoring and Control
Collections and Concentration Calculations
Chapter 9: Working Capital Metrics
v4.0 2013 Association for Financial Professionals. All rights reserved. Session 5: Module 3, Chapter 9 - 3
Time Value of Money
Dollar today worth
more than dollar
tomorrow
How much to cash
settle future debt
now?
Cash flow value:
Amounts
Interest rate
When expected

v4.0 2013 Association for Financial Professionals. All rights reserved. Session 5: Module 3, Chapter 9 - 4
What is the future value of $100 invested for 2
years, compounded annually, at 10%/year?
Future Value
v4.0 2013 Association for Financial Professionals. All rights reserved. Session 5: Module 3, Chapter 9 - 5
n
2
Future Value= PV (1 + i)
= $100 (1 + .10)
= $100 (1.21) = $121
Where:
FV = Future value
PV = Present value
i= Periodic interest rate
n = Number of periods
What is the present value of $2,382 to be
received after 3 years, discounted at 6.00%
annually?
Present Value
v4.0 2013 Association for Financial Professionals. All rights reserved. Session 5: Module 3, Chapter 9 - 6
Where:
FV = Future value
i = Periodic interest rate
n = Number of periods
( ) ( )
n 3
$2,382 FV
Present Value= =
1 + i 1 + 0.06
$2,382
= = $2,000
1.191
Degree current obligations covered by current
assets
Example: Per $1 of short-term liabilities, $2.35
of cash and short-term assets expected to
become cash in next year
Working Capital: Current Ratio
v4.0 2013 Association for Financial Professionals. All rights reserved. Session 5: Module 3, Chapter 9 - 7
Total Current Assets $8,000
Current Ratio = = = 2.35
Total Current Liabilities $3,400
Degree companys current liabilities covered
by most liquid current assets
Example: $1.32 of very liquid assets for each
$1 of short-term liabilities
Working Capital: Quick Ratio
v4.0 2013 Association for Financial Professionals. All rights reserved. Session 5: Module 3, Chapter 9 - 8
(Cash) + (Short-Term Investments) + (Accounts Receivable)
Quick Ratio =
Total Current Liabilities
($1,500 + $1,300 + $1,700)
= = 1.32
$3,400
Ability to repay debt
Low ratio is weak ability to repay debt
Reliable predictor of financial failure
High ratio implies more safety
Working Capital: Cash Flow to Total Debt
Ratio
v4.0 2013 Association for Financial Professionals. All rights reserved. Session 5: Module 3, Chapter 9 - 9
( )
( )
( )
( )
Net Income + Depreciation
Cash Flow to Total Debt Ratio =
Short-Term Debt + Long-Term Debt
$850 + $200
$1,050
= = = 0.184
$1,800 + $3,900 $5,700
Amount current assets exceed current
liabilities (not a ratio)
Example: If all current assets convert to cash,
would have $4,600 over what needed to pay off
short-term liabilities
Working Capital
v4.0 2013 Association for Financial Professionals. All rights reserved. Session 5: Module 3, Chapter 9 - 10

Working Capital = Current Assets Current Liabilities


= $8,000 $3,400 = $4,600
Elements in the CCC:
Cash Conversion Cycle (CCC)
v4.0 2013 Association for Financial Professionals. All rights reserved. Session 5: Module 3, Chapter 9 - 11

Days inventory


Days receivables


Days payables


Inventory
365
Cost of Goods Sold

Accounts Receivable
365
Revenues

Accounts Payable
365
Cost of Goods Sold
Time to convert
Cash outflow (payment to supplier)
into
Cash inflow (customer collection)
Calculation of the CCC
v4.0 2013 Association for Financial Professionals. All rights reserved. Session 5: Module 3, Chapter 9 - 12

Cash Conversion Cycle = Days' Inventory + Days' Receivables Days' Payables


= 103.15 Days + 41.37 Days 63.48 Days = 81.04 Days
Discussion Question
Given a cash conversion cycle of 81.03 days,
how many CCCs are there in a year (cash
turnover ratio)?
Answer (p.3-86):
v4.0 2013 Association for Financial Professionals. All rights reserved. Session 5: Module 3, Chapter 9 - 13
365 Days
Cash Turnover =
Cash Conversion Cycle
365
=
81.03
= 4.5 Times
Company-to-company (days not $s)
Less frees up cash
Days of Working Capital (DWC)
v4.0 2013 Association for Financial Professionals. All rights reserved. Session 5: Module 3, Chapter 9 - 14
DWC = DSI + DSO - DP
= 103.15 + 82.74 - 63.48 Days
Where:
DSI = Days Sales in Inventory103.15 days
DSO = Days Sales Outstanding82.74 days
DP = Days payables63.48 days
Example:
Should a discount be taken if the cost of short-
term funds is 8%?

Cost for Buyer Not Taking Cash Discount
v4.0 2013 Association for Financial Professionals. All rights reserved. Session 5: Module 3, Chapter 9 - 15



D 365
Discount Cost =
100 D N T
2 365
=
100 2 30 10
2 365
= = 0.0204 18.25 =.3723 or 37.23%
98 20
Where:
D = Discount percentage2%
N = Net period30 days
T = Discount period10 days
Discussion Question
Which is a situation when a buyer should forgo
an offered cash discount?

a) Firm invests in short-term funds that earn less than
discount rate
b) Firm has insufficient cash to pay now but has short-
term credit with lower interest rate than cost of not
taking discount
c) Firm has ability to change discount terms by
stretching A/P terms
d) The discount should never be foregone
Answer: c (p.3-89)
v4.0 2013 Association for Financial Professionals. All rights reserved. Session 5: Module 3, Chapter 9 - 16
Sellers induce early payment or offer competitive
discount.
Example of sellers NPV loss if discount taken: Credit
sale of $100, terms 2/10, net 30, 8% annual interest.

Impact to Seller of Offering Cash Discount
v4.0 2013 Association for Financial Professionals. All rights reserved. Session 5: Module 3, Chapter 9 - 17
( ) ( )
( (

( (
| | | |

| |
( (
\ . \ .

| |

|
\ .

Receive on Day 10
Receive on Day 30
Credit Sale 1 D $100 1 .02
PV = = =$97.78
Annual Interest .08
1 + T 1 + 10
365 365
Credit Sale
PV =
Annual Interest
1 + N
365
( (
| |

|
( (
\ .


Day 10 Day 30
$100
= =$99.34
.08
1 + 30
365
NPV = PV PV = $97.78 $99.34 = $1.56
Where: D = discount rate; T = days in discount period; N = days in net period
Discussion Question
What can a treasury professional discover by
monitoring individual accounts receivable?

a) Errors or delays in payments by credit card that are
slowing collections
b) Customers who may delay payment intentionally
until follow-up is initiated
c) Change in financial condition that may result in
slower payments and require extension of
longer credit terms
d) Increase in receivables that affects
liquidity
Answer: b (p.3-92)
v4.0 2013 Association for Financial Professionals. All rights reserved. Session 5: Module 3, Chapter 9 - 18
Company has outstanding receivables of $285,000
and credit sales of $310,000 at first quarter end.
Using a 90-day averaging period, DSO is:
Days Sales Outstanding (DSO)
v4.0 2013 Association for Financial Professionals. All rights reserved. Session 5: Module 3, Chapter 9 - 19
$310,000 Credit Sales in Period
Daily Credit Sales = = = $3,444.44
Days in Period 90
$285,000.00 Accounts Receivable
DSO = = = 82.74 Days
Daily Credit Sales for Period $3,444.44

Average Past Due = DSO Avg. Days of Credit Terms


= 82.74 Days 30 Days = 52.74 Days
Could be bad, e.g., if credit terms are net 30:
A/R current and past-due
30-day increments
Customer or aggregate basis
Percent past due

Aging Schedule
v4.0 2013 Association for Financial Professionals. All rights reserved. Session 5: Module 3, Chapter 9 - 20
Age of A/R Amount of A/R % of Total A/R
Current $1,750,000 70%
1-30 days past due 375,000 15%
31-60 days past due 250,000 10%
Over 60 days past due 125,000 5%
Total $2,500,000 100%
A/R Balance Pattern
v4.0 2013 Association for Financial Professionals. All rights reserved. Session 5: Module 3, Chapter 9 - 21
Interval
Since Sale
Percentage
Collected
Month 0 5%
Month 1 40%
Month 2 35%
Month 3 15%
Month 4 5%
End of March Calculation Collected
January sales $250,000
January collections (5% of sales) $12,500
February collections (40% of sales) $100,000
March collections (35% of sales) $87,500
Total collections (80% of sales) $200,000
Total outstanding A/R from
January sales
(January sales total collections)
$50,000
Or (100% - outstanding%) x outstanding:
0.20 x $250,000 = $50,000
Discussion Question
Internal processing has $99k annual float, 9% opportunity
cost and $3k in variable internal processing. A lockbox
has $24m dollar-days in 30 days, $10k in fixed costs and
$6k in variable costs. Method with net benefit?

a) Internal processing: $14k
b) Internal processing: $685k
c) Lockbox: $14k
d) Lockbox: $685k
Answer: c. $24m/30 = $800k;
$800k x 0.09 = $72k; $99k - $72k = $27k;
$27k - $10k - 6k + $3k = $14k lockbox (p.3-98)
v4.0 2013 Association for Financial Professionals. All rights reserved. Session 5: Module 3, Chapter 9 - 22
Total ACH costs = $1.00
Total wire transfer costs = $10.00
Opportunity cost of funds = 3.5%
Break-Even Wire Transfer Amount
v4.0 2013 Association for Financial Professionals. All rights reserved. Session 5: Module 3, Chapter 9 - 23

(
| |

|
(
\ .

(
| |

|
(
\ .

Wire Cost ACH Cost
Minimum Transfer =
Opportunity Cost
Days Accelerated
365 Days
$10.00 $1.00
=
0.035
1 Day
365 Days
= $93,858
Outline:
Disbursements
Collections
Concentration of Funds
Payments Fraud
Chapter 10: Collections, Concentration and
Disbursements
v4.0 2013 Association for Financial Professionals. All rights reserved. Session 5: Module 3, Chapter 10 - 24
Disbursements
v4.0 2013 Association for Financial Professionals. All rights reserved. Session 5: Module 3, Chapter 10 - 25
Disbursement Products
v4.0 2013 Association for Financial Professionals. All rights reserved. Session 5: Module 3, Chapter 10 - 26
ZBA
Multi-tiered
Deposit-only
Master account
Payment info
Positive pay
Reverse
Disbursement bank
Fraudulent endorsement
Controlled
disbursement
Clearing
notification
e.g., ZBA
Discussion Question
Which requires indemnity from the alternate
bank for losses including fraud?

a) Debit filters
b) Default pay all or pay none
c) Multiple drawee checks
d) Imprest accounts
Answer: c (p.3-111)
v4.0 2013 Association for Financial Professionals. All rights reserved. Session 5: Module 3, Chapter 10 - 27
Direct
Deposit
(ACH)
Payments
Global expansion (SEPA, cross-
border ACH)
Payroll, reimbursement, interest,
tax, dividend and B2B
Tax
Payments
US EFTPS
Sub-sovereign electronic payment
NACHA: ACH TXP
Wire
Transfers
Immediate and final
Telephone and online initiation
Electronic Disbursement Products
v4.0 2013 Association for Financial Professionals. All rights reserved. Session 5: Module 3, Chapter 10 - 28
Repetitive
Semi-repetitive
Non-repetitive
(free form)
Drawdown
Standing
Wire Transfer Usage Categories
v4.0 2013 Association for Financial Professionals. All rights reserved. Session 5: Module 3, Chapter 10 - 29
P-cards
T&E cards
Fleet cards
Combined cards
Payroll/stored value cards
EBT cards
Card Payments
v4.0 2013 Association for Financial Professionals. All rights reserved. Session 5: Module 3, Chapter 10 - 30
Freight payments Payroll services
Integrated or
comprehensive
A/P
Payment factories
Outsourced A/P Services
v4.0 2013 Association for Financial Professionals. All rights reserved. Session 5: Module 3, Chapter 10 - 31
Discussion Question
Which integrated or comprehensive A/P service
sends only limited information to the FSP and
staggers payments by transaction date?

a) Send data file with list of all warehoused payments to be
made
b) Send data file with list of all immediate payments to be
made
c) FSP maintains database of payees and warehouses
the items
d) FSP maintains database of payees and issues
payments immediately


Answer: c (p.3-118)
v4.0 2013 Association for Financial Professionals. All rights reserved. Session 5: Module 3, Chapter 10 - 32
Discussion Question
Which provides same day or prior day
information to help with fraud control?

a) Balance reporting services
b) Interface with A/P
c) Account reconciliation program
d) Imaging technology
Answer: a (p.3-119)
v4.0 2013 Association for Financial Professionals. All rights reserved. Session 5: Module 3, Chapter 10 - 33
Partial reconciliation
Serial number, dollar amount and date paid
Full reconciliation
Bank matches payments to companys electronic file
Stop payments
Not honor item already issued, not cleared
High-order prefix sort
Sort payments by operating unit
Account Reconciliation Program (ARP)
v4.0 2013 Association for Financial Professionals. All rights reserved. Session 5: Module 3, Chapter 10 - 34
Collect
Speed
Security
Remittance
Information
Availability
Cost
Collections
v4.0 2013 Association for Financial Professionals. All rights reserved. Session 5: Module 3, Chapter 10 - 35
Discussion Question
A retailers over-the-counter/field deposit
system gets cash and checks from local banks
at each POS. Which offers cash/coin pickup
and delivery and immediate provisional credit?

a) A depository institution near each field location
b) Virtual vault services
c) Remote deposit capture (RDC)
d) Armored carriers

Answer: b (p.3-122)
v4.0 2013 Association for Financial Professionals. All rights reserved. Session 5: Module 3, Chapter 10 - 36

S
c
a
n

a
n
d

I
m
a
g
e

Eliminates check
transit
Can incorporate
virtual vault
Faster, cheaper


D
e
p
o
s
i
t
o
r
y

B
a
n
k

Eliminates local
bank
consolidation
Service distant
locations
USD only

Remote Deposit Capture (RDC)
v4.0 2013 Association for Financial Professionals. All rights reserved. Session 5: Module 3, Chapter 10 - 37
Merchant services
Check conversion
Mail payments
Lockbox
Retail
Wholesale
Hybrid
Other Domestic Collection Products
v4.0 2013 Association for Financial Professionals. All rights reserved. Session 5: Module 3, Chapter 10 - 38
Reduced mail and processing float
Improved access to remittance information
Reduced risk and improved security
Improved control and record keeping
Uninterrupted service
Scalability
Proper segregation of duties
Lockbox Advantages vs. Internal
Processing
v4.0 2013 Association for Financial Professionals. All rights reserved. Session 5: Module 3, Chapter 10 - 39
Electronic bill/invoice presentment and
payment
Send billing data to customers
E-mail link to companys billing portal
Customer triggers EFT debit
Control of remittance information
Less exception processing
EBPP and EIPP
v4.0 2013 Association for Financial Professionals. All rights reserved. Session 5: Module 3, Chapter 10 - 40
Discussion Question
What is a successor to the electronic lockbox
that consolidates all remittances into a
common stream of data in a common format?

a) EFT with remittance information
b) EBPP and EIPP
c) Consolidated remittance processing
(CRP)
d) Imaging technology

Answer: c (p.3-127)
v4.0 2013 Association for Financial Professionals. All rights reserved. Session 5: Module 3, Chapter 10 - 41
Cross-Border Collections and Trade
v4.0 2013 Association for Financial Professionals. All rights reserved. Session 5: Module 3, Chapter 10 - 42
Other methods:
Bankers acceptance (BA)
Trade acceptance
Barter, countertrade, trading companies
Seller
Most Protection
Least Protection
Buyer
Most Protection
Least Protection
CASH IN ADVANCE
LETTER OF CREDIT
DOCUMENTARY COLLECTION
OPEN ACCOUNT
Collection letter
Name of seller (exporter)
Name and address of buyer (importer)
Collecting bank information
Details of accompanying documentation
Date, tenor and value
Details of bank/other charges by party
Recourse procedures
Nonstandard terms or conditions
Documentary Collection
v4.0 2013 Association for Financial Professionals. All rights reserved. Session 5: Module 3, Chapter 10 - 43
Discussion Question
A _____ draft requires the ______ bank to
receive full and final payment before releasing
documents.

a) sight; collecting
b) sight; remitting
c) time; collecting
d) time; remitting

Answer: d (Sight a.k.a. documents against
payment; time a.k.a. documents against
acceptance.) (p.3-130)
v4.0 2013 Association for Financial Professionals. All rights reserved. Session 5: Module 3, Chapter 10 - 44
Documentary Collection
v4.0 2013 Association for Financial Professionals. All rights reserved. Session 5: Module 3, Chapter 10 - 45
1
4
DC
7
Pays
Seller
Remitting Bank
2
DC
3
L/C
8
Pays
Buyer
Collecting Bank
5
DC
6
Docs
Debit
+
Commercial L/C
To ship domestic or
international goods
Bank roles
Issuing
Advising
Confirming
Typically requires
Draft
Commercial invoice
Shipping documents
Standby L/C (Guarantee)
Issued primarily by
banks
Ensure financial
performance of banks
customer to a 3
rd
-party
Payable events
Typically requires
Sight draft
Documentation
Letter of Credit (L/C)
v4.0 2013 Association for Financial Professionals. All rights reserved. Session 5: Module 3, Chapter 10 - 46
Letter of Credit (L/C)
v4.0 2013 Association for Financial Professionals. All rights reserved. Session 5: Module 3, Chapter 10 - 47
Seller (Beneficiary)
Advising Bank
2
L/C
Buyer (Applicant)
Issuing Bank
Purchase
agreement
requiring L/C
1
Please
issue
3
L/C
4
L/C
Bankers Acceptance (BA)
Unconditional written
order directing bank to
pay sum of money
On demand
At a definite time
By accepting, bank
agrees to pay face
value if buyer fails to
pay
Hold to maturity
Sell at discount
BA financing cost:
Discount rate
Commission

v4.0 2013 Association for Financial Professionals. All rights reserved. Session 5: Module 3, Chapter 10 - 48
Accepted
Major objectives:
Efficiently move funds
from deposit banks to
concentration bank
Minimize excess
balances
Concentration enables:
Excess- -Deficit cash
Locations
Entities
Currencies
Invest more,
interest income
Pay debt faster,
interest expense
Use discount terms,
COGS or operating
expenses
Cash Concentration System Objectives
v4.0 2013 Association for Financial Professionals. All rights reserved. Session 5: Module 3, Chapter 10 - 49
Cash Concentration System
v4.0 2013 Association for Financial Professionals. All rights reserved. Session 5: Module 3, Chapter 10 - 50
Sources Intermediaries Transfer Uses
Loan
Repayment
S/T
Investment
Payroll
Vendor
Payments
Dividends
Field/
Branch
Field
Bank
Lockbox/
Electronic
S/T
Borrowing
Maturing S/T
Investments
Cash, Check or
Card
Check, Wire,
ACH
Subsidiary
Payments
Domestic Concentration of Funds
Large retailers
transmit receipts
from POS to
headquarters
Wires expedite funds
transfers over ACH
Large amounts
Same-day value
Finality
Sweeping (sweep
account differs)
Collect receipts
Local offices
Local branches
Retail stores
Was field banks, now
RDC and virtual vault
v4.0 2013 Association for Financial Professionals. All rights reserved. Session 5: Module 3, Chapter 10 - 51
Entities use distinct depository
accounts
Full end-of-day balance transfer
to master concentration account
ZBA
Multiple location deposits
credited to one account
Location-specific deposit reports
via unique location identifiers
Deposit
reconciliation
Bank Services for Domestic Concentration
v4.0 2013 Association for Financial Professionals. All rights reserved. Session 5: Module 3, Chapter 10 - 52
Both must
use
multiple
branches
of single
bank.
Physical pooling
Automatic ZBA of
subaccounts
Multiple legal entities,
countries
Same currency
Intercompany loans at
arms length
Notional pooling
Balancing entries on
virtual accounts
No physical moves
Cross-guarantees
Disallowed in US,
Germany, Mexico,
Japan and Brazil

Global Concentration of Funds
v4.0 2013 Association for Financial Professionals. All rights reserved. Session 5: Module 3, Chapter 10 - 53
Notional Pooling Physical Pooling
Interest earned/paid as
bank interest.
COMPENSATION Must use arms length, track
loans and allocate interest.
Can provide tax efficiency. TAX Withholding taxes can apply
to intercompany loans.
Is highly complex due
banks and jurisdictions.
COMPLEXITY Greater transparency lowers
regulatory concern.
Can be used across
multiple currencies.
APPLICABILITY Must be done on a
currency-by-currency basis.
Is restricted in many
countries
AVAILABILITY Is widely available and most
common form of pooling.
Pooling Comparison
v4.0 2013 Association for Financial Professionals. All rights reserved. Session 5: Module 3, Chapter 10 - 54
Discussion Question
Which is true of a bank overlay structure?

a) It uses sweeping not pooling.
b) It is used when primary bank has branches in
several countries but not full domestic banking.
c) It uses primary bank for domestic transactions and
to sweep surplus funds to local banks.
d) Local bank notionally pools balances on
overlay accounts for a multi-country
solution.

Answer: b (p.3-142)
v4.0 2013 Association for Financial Professionals. All rights reserved. Session 5: Module 3, Chapter 10 - 55
Bank Overlay Structure
v4.0 2013 Association for Financial Professionals. All rights reserved. Session 5: Module 3, Chapter 10 - 56
Home Country
Notional Pooling and/or
Physical Funds Transfer
Primary Overlay
Account
Primary Bank Concentration Account
Primary Overlay
Account
Primary Overlay
Account
Local Account
Local Account
Local Account
Local Account
Local Account
Local Account
Attempted fraud common, success less so
Controls
Positive pay
ACH filters and blocks
Daily reconciliations
Security feature check stock
Segregation of duties
Dual EFT authentication
No or few non-repetitive wires
Separate deposit and disbursement accounts
Dedicated EFT computer
Payments Fraud
v4.0 2013 Association for Financial Professionals. All rights reserved. Session 5: Module 3, Chapter 10 - 57
Discussion Question
Which is a good way to reduce credit card
identity theft?

a) Use holder in due course
b) Use non-photo-reproducible features
c) Use address verification service
d) Use neural networks to eliminate card verification
values or codes

Answer: c (p.3-144)
v4.0 2013 Association for Financial Professionals. All rights reserved. Session 5: Module 3, Chapter 10 - 58
Assignment:
Complete the following tasks
for Module Three, Chapter 11:
Review the chapter.
Complete the test-your-understanding questions at
the end of the chapter.
Review the online flashcards.
Complete the online calculations.
Complete the online module-specific test.
Complete the Exam Practice (Describe and
Differentiate) questions (located at the end of the
module textbook).
End of Session 5
v4.0 2013 Association for Financial Professionals. All rights reserved. Session 5: Module 3, Chapter 10 - 59

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