Working Capital

and Current
Asset
Management

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Long & Short Term Assets & Liabilities

Current Assets:
Cash
Marketable Securities
Prepayments
Accounts Receivable
Inventory

Current Liabilities:
Accounts Payable
Accruals
Short-Term Debt
Taxes Payable

Fixed Assets:
Investments
Plant & Machinery
Land and Buildings

Long-Term Financing:
Debt
Equity

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The Cash Conversion Cycle

Short-term financial managementmanaging current
assets and current liabilitiesis on of the financial
managers most important and time-consuming activities.
The goal of short-term financial management is to
manage each of the firms current assets and liabilities to
achieve a balance between profitability and risk that
contributes positively to overall firm value.

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14-3

Accounts Receivable Management

the average collection period the average length of
time from a sale on credit until the payment becomes
usable funds to the firm.
The collection period consists of two parts:
the time period from the sale until the customer mails
payment, and
the time from when the payment is mailed until the firm
collects funds in its bank account.

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14-4

Accounts Receivable Management:

The Five Cs of Credit
Character: The applicants record of meeting past
obligations.
Capacity: The applicants ability to repay the requested
credit.
Capital: The applicants debt relative to equity.
Collateral: The amount of assets the applicant has
available for use in securing the credit.
Conditions: Current general and industry-specific
economic conditions.
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Accounts Receivable Management:

Credit Scoring
Credit scoring is a procedure resulting in a
score that measures an applicants overall credit
strength, derived as a weighted-average of
scores of various credit characteristics.
The procedure results in a score that measures
the applicants overall credit strength, and the
score is used to make the accept/reject decision
for granting the applicant credit.
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14-6

Accounts Receivable Management:

Credit Scoring (cont.)
The purpose of credit scoring is to make a
relatively informed credit decision quickly and
inexpensively.

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14-7

Accounts Receivable Management:

Changing Credit Standards
The firm sometimes will contemplate changing its credit
standards to improve its returns and generate greater
value for its owners.

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14-8

Accounts Receivable Management:

Changing Credit Standards

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14-9

Changing Credit Terms

A firms credit terms specify the repayment terms
required of all of its credit customers.
Credit terms are composed of three parts:
The cash discount
The cash discount period
The credit period

For example, with credit terms of 2/10 net 30, the discount
is 2%, the discount period is 10 days, and the credit period
is 30 days.
Copyright 2009 Pearson Prentice Hall. All rights reserved.

14-10

Changing Credit Terms Example

MAX Company has an average collection period of 40
days (turnover = 365/40 = 9.1). In accordance with the
firms credit terms of net 30, this period is divided into 32
days until the customers place their payments in the mail
(not everyone pays within 30 days) and 8 days to receive,
process, and collect payments once they are mailed.
MAX is considering initiating a cash discount by changing
its credit terms from net 30 to 2/10 net 30. The firm
expects this change to reduce the amount of time until the
payments are placed in the mail, resulting in an average
collection period of 25 days (turnover = 365/25 = 14.6).
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14-11

Credit Monitoring
Credit monitoring is the ongoing review of a firms
accounts receivable to determine whether customers are
paying according to the stated credit terms.
Slow payments are costly to a firm because they
lengthen the average collection period and increase the
firms investment in accounts receivable.
Two frequently used techniques for credit monitoring
are the average collection period and aging of accounts
receivable.

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Credit Monitoring:
Average Collection Period
The average collection period is the average number of
days that credit sales are outstanding and has two parts:
The time from sale until the customer places the payment in
the mail, and
The time to receive, process, and collect payment.

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14-13

Credit Monitoring:
Aging of Accounts Receivable

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14-14

Credit Monitoring:
Collection Policy
The firms collection policy is its procedures for
collecting a firms accounts receivable when they are
due.
The effectiveness of this policy can be partly evaluated
by evaluating at the level of bad expenses.
As seen in the previous examples, this level depends
not only on collection policy but also on the firms
credit policy.

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