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Transcript of 16 - 1 Copyright © 1999 by the Foundation of the American College of Healthcare Executives CHAPTER...
16 - 1
Copyright © 1999 by the Foundation of the American College of Healthcare Executives
CHAPTER 16Current Asset Management
and Financing
Investment and financing policies
Cash and marketable securities management
Receivables and inventory management
Short-term financing
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Copyright © 1999 by the Foundation of the American College of Healthcare Executives
Short-Term Financial Management
Short-term financial management involves all current asset accounts and most current liability accounts.
The primary goal of short-term financial management is to support operations at the lowest possible cost:Must have sufficient current assets.Must ensure liquidity
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Copyright © 1999 by the Foundation of the American College of Healthcare Executives
Current Asset Investment Policies
CA ($)
Utilization
High
Moderate
Low
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Copyright © 1999 by the Foundation of the American College of Healthcare Executives
Current Asset Investment Policies
Factors affecting current asset levelsLevel of business risk
• High business risk - greater level of current assets required (safety stocks)
• Low business risk - lower level of current assets required
Opportunity costs of capital• Interest rates• Market returns on investment capital
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Copyright © 1999 by the Foundation of the American College of Healthcare Executives
Current Asset Financing Policies
Moderate. Matches the maturity of the assets with the maturity of the financing.Uses permanent capital to finance permanent
assets.Uses temporary financing to finance temporary
assets.Aggressive. Uses short-term financing to
finance permanent assets.Conservative. Uses permanent capital to
finance temporary assets.
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Copyright © 1999 by the Foundation of the American College of Healthcare Executives
Years
$
Permanent CA
Fixed Assets
Temporary CA
Lower dashed line, more aggressive. Higher dotted line, more conservative.
ST Financing:Loans
LT Financing:Stock andBonds
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Copyright © 1999 by the Foundation of the American College of Healthcare Executives
Cash Management
The goal of cash management is to hold the minimum amount necessary to meet liquidity requirements.
The primary cash management techniques are:Cash flow synchronizationFloat management
• Acceleration of receipts• Disbursement control
Costs of cash management initiatives must have corresponding benefits.
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Copyright © 1999 by the Foundation of the American College of Healthcare Executives
Cash Flow Synchronization
The greater the timing match between a business’ cash inflows and outflows, the lower the required cash balance.
Some businesses are able to bill customers on a cycle that promotes cash flow synchronization.
The cash budget is the best method for monitoring cash management.
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Copyright © 1999 by the Foundation of the American College of Healthcare Executives
Float
Net float is the difference between the cash amount on the firm’s books and the amount on the bank’s books.Suppose Family Healthcare writes $2,000 in checks daily.
It takes 6 days for these to be received and clear the banking system, so its disbursement float is $12,000.
Family Healthcare receives $3,000 in checks daily which are cleared in 3 days. Thus, its collections float is $9,000.
Its net float is $12,000 - $9,000 = $3,000.
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Copyright © 1999 by the Foundation of the American College of Healthcare Executives
Acceleration of Receipts
Net float is maximized by accelerating receipts and slowing disbursements.
Some techniques used for receipt acceleration are:LockboxesConcentration bankingAutomated clearinghousesFederal Reserve wire system
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Copyright © 1999 by the Foundation of the American College of Healthcare Executives
Disbursement Control
Disbursement control is the “flip side” of receipt acceleration.
Some techniques used for disburse-ment control are:Payables centralizationMaster and zero-balance accountsControlled (remote) disbursement
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Copyright © 1999 by the Foundation of the American College of Healthcare Executives
Marketable Securities Management
Businesses hold marketable securities for two primary reasons:As an interest earning substitute for cash.As a temporary repository for cash being accumulated
to meet a specific need.
In reality, cash management and marketable securities management are accomplished simultaneously.
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Copyright © 1999 by the Foundation of the American College of Healthcare Executives
Marketable Securities (Cont.)
Characteristics of marketable securities In general, marketable securities are chosen on the
basis of safety:Protection of principal is primary.Amount of return is secondary.
Specific securities used depend on the:Expected holding period.
Size of the business.
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Copyright © 1999 by the Foundation of the American College of Healthcare Executives
Receivables Management
Importance of receivables management to HSO’s (third party predominance)
Financing of A/R with short-term debt vs. equity (cost of capital issues)
Goal of A/R mgmt. is to minimize the carrying costs
Acceleration of A/R receipts
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Copyright © 1999 by the Foundation of the American College of Healthcare Executives
Receivables Management
Monitoring A/R positionFactors affecting A/R balance -- credit sales volume
and avg. collection period (ACP)ACP = Avg. A/R balance divided by average daily
credit salesComparison of ACP to historical/industryLimitations of using ACP to monitor A/R position
(influence of sales volume)
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Copyright © 1999 by the Foundation of the American College of Healthcare Executives
Receivables Management
Monitoring A/R positionAging schedules of A/R accountsInfluence of sales volume changes on average age
of A/R accountsUncollected A/R balance schedule -- factors out
influence of fluctuations in sales volume on A/R balance and ACP
Interpretation of uncollected A/R balance schedule
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Copyright © 1999 by the Foundation of the American College of Healthcare Executives
Receivables Management
Management interventions to improve A/R positionReasonably aggressive collections policy“Early payment” discountsElectronic billing/payment methods
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Copyright © 1999 by the Foundation of the American College of Healthcare Executives
Inventory Management
Relationship to receivables management
Consequences of poor inventory mgmt.Too little inventory (stockouts)
Too much inventory (tied up cash)
Inventory management methodsComputerized inventory control systems
Just in time inventory methods
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Copyright © 1999 by the Foundation of the American College of Healthcare Executives
Inventory Management
Inventory Management MethodsEconomic Ordering Quantity (EOQ) model
• Minimize the costs of holding inventory
• Total inventory costs as a function of inventory carrying costs and inventory ordering costs
• Does not consider the cost of the inventory
• Allow for identification of optimal “ordering quantity” per order to minimize costs (ICC, IOC)
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Copyright © 1999 by the Foundation of the American College of Healthcare Executives
Inventory Management
Inventory Management MethodsEconomic Ordering Quantity (EOQ) model
• Examples of ICC (storage, insurance, financing)
• Estimation of ICC as a percentage of total inventory purchase (10-20%)
• Relationship of ICC to total inventory purchases
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Copyright © 1999 by the Foundation of the American College of Healthcare Executives
Inventory Management
Inventory Management MethodsEconomic Ordering Quantity (EOQ) model
• Fixed nature of IOC assumed
• Examples of IOC (costs of ordering)
• Estimation of IOC as a function of average inventory purchases
• Relationship of IOC to total inventory purchases
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Copyright © 1999 by the Foundation of the American College of Healthcare Executives
Inventory Management
Inventory Management MethodsEconomic Ordering Quantity (EOQ) model
• Total inventory holding costs (TIC) = ICC + IOC
• Estimation of EOQ using formula
• Interpretation of EOQ
• Equivalence of ICC and IOC at EOQ
• Minimization of TIC at EOQ
• Application of EOQ model -- reorder points, safety stock estimation, quantity discounts
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Copyright © 1999 by the Foundation of the American College of Healthcare Executives
Current Liability Management
Current liabilities as source of WCShort-term financing has three
primary advantages over long-term:Lower issuance costsFewer restrictive covenantsGenerally lower interest rate
Major sources for providers:AccrualsAccounts payable (trade credit)Bank loans
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Copyright © 1999 by the Foundation of the American College of Healthcare Executives
Accruals
Accruals consist primarily of wages owed to employees and taxes owed to governments.
Accruals are free in the sense that no explicit interest is charged.
However, managers have little control over the level of accruals, which is influenced more by industry custom and tax laws.
Management of accrual accounts (source of short-term financing)
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Copyright © 1999 by the Foundation of the American College of Healthcare Executives
Accounts Payable (Trade Credit)
Trade credit is credit furnished by a firm’s suppliers.
Trade credit is often the largest source of short-term credit for most firms.
Categories of trade creditFree trade creditCostly trade credit
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Copyright © 1999 by the Foundation of the American College of Healthcare Executives
Northwest Healthcare buys $3,000,000 (at net) of medical supplies from one of
its vendors on terms of 2/10, net 30. How much free and costly trade credit
is available from this vendor?
Net daily purchases = $3,000,000/360
= $8,333.
Calculate net daily purchases
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Copyright © 1999 by the Foundation of the American College of Healthcare Executives
Gross/Net Breakdown
Northwest buys supplies worth $3,000,000 because that is the net, or cash, price.
If Northwest does not take the discount, it must pay $3M / 0.98 = $3,061,224 for the supplies. This is the gross, or invoice, price.
The difference, $61,224, is a financing cost similar to the interest on a loan.
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Copyright © 1999 by the Foundation of the American College of Healthcare Executives
Total trade credit = $249,990 Free trade credit = 83,333 Costly trade credit = $166,657
Payables = $8,333 x 10 = $83,333.
Payables = $8,333 x 30 = $249,990.
Payables level with discount
Payables level without discount
Credit breakdown
Gross/Net Breakdown
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Copyright © 1999 by the Foundation of the American College of Healthcare Executives
Approximate Cost ofCostly Trade Credit
Northwest loses $61,224 to obtain $166,657 in extra trade credit, so
Cost = = 0.367 = 36.7%.$61,224
$166,657
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Copyright © 1999 by the Foundation of the American College of Healthcare Executives
Approximate Cost Formula
Cost = x Discount % 1 - Discount %
360 Days
taken
Discount period
-
= x = 0.0204 x 18 2 98
360 30 - 10
= 0.367 = 36.7%.
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Copyright © 1999 by the Foundation of the American College of Healthcare Executives
What Should Northwest Do?
Northwest should take the $83,333 in free trade credit--it should take all the free trade credit that it can get.
However, it should take the costly trade credit only if the implied cost is less than the cost of alternative financing sources.
Because Northwest can obtain bank loans at a 10% rate, it should not take the $166,657 in costly trade credit.