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Part 7
Short-Term Financial Decisions
Chapters in This Part
Chapter 14 Working Capital and Current Assets Management
Chapter 15 Current Liabilities Management
Chapter 14
Working Capital and Current Assets Management
Instructor’s Resources
Overview
This chapter introduces the fundamentals and describes the interrelationship of net working capital, profitability,
and risk in managing a firm’s current asset accounts. The chapter then focuses on the management of three major
current asset accounts⎯cash, accounts receivable, and inventory. Also discussed are general inventory
management policies, international inventory management, and several specific inventory management techniques:
ABC, economic order quantity (EOQ), reorder point, materials requirement planning (MRP), and just-in-time
(JIT). The key aspects of accounts receivable management are discussed: credit policy, credit terms, and collection
policy. The chapter also discusses the additional risk factors involved in managing international accounts
receivable. Examples demonstrate the effect of changes in credit policy. Also discussed are the impacts of changes
in cash discounts. The chapter describes how managers and individuals often have to make choices that involve
tradeoffs between quantity and price.
Answers to Review Questions
1. Working capital management, the management of a firm’s current assets and liabilities, is one of the most
important functions of a financial manager. Managing these accounts wisely results in a balance between
profitability and risk that has a positive impact on the firm’s value. Therefore, managing these current balance
sheet accounts to achieve an appropriate balance between profitability and risk takes a large amount of a
2. The more predictable a firm’s cash inflows, the lower the level of net working capital with which it can safely
operate. This is true since the more predictable or certain the receipt of cash inflow, the less the cushion (i.e.,
net working capital) that is needed to absorb unexpected funds requirements. The higher a firm’s net working
304 Zutter/Smart • Principles of Managerial Finance Brief, Eighth Edition
The EOQ looks at all of the various costs of inventory and determines what order size minimizes total
inventory cost. The model analyzes the tradeoff between order costs and carrying costs and determines the
order quantity that minimizes the total inventory cost.
With modern technology, a number of techniques have been developed for controlling inventory using
computers. As a group, these systems are referred to as computerized systems for resource control.
MRP is a computerized system that breaks down the bill of materials for each product in order to determine what to
order, when to order it, and what priorities to assign to ordering. MRP relies on EOQ and reorder point
concepts to determine how much to order. This system simulates each product’s bill of materials, inventory
status, and manufacturing process. By monitoring the production process, order and delivery process, and
inventory levels the system determines when orders should be placed for each inventory part.
Enterprise resource planning (ERP) expands on both MRP systems by extending the information in the
model to include data concerning suppliers and customers. By including both internal and external
information, this system is designed to eliminate production delays.
10. The need to ship materials and products to foreign countries creates challenges for international inventory
11. A firm uses a credit selection process to determine if credit should be extended to a customer and if so, how
much. The credit manager may use the five Cs of credit to focus the analysis of a customer’s creditworthiness:
a. Character—the applicant’s past record of meeting financial, contractual, and moral obligations.
12. Credit scoring is the ranking of an applicant’s overall credit strength. It is derived as a weighted average of
13. The tradeoffs in tightening credit standards are that while investment in accounts receivable and bad debt
© 2019 Pearson Education, Inc.
E14-5. Cash discount plan
0.15 $22,000 $27,187.50 $23,680 $25,507.50
$170,050
X
X
=+ −=
=
© 2019 Pearson Education, Inc.
T = 6.31 turnovers per year
ACP = 365 ÷ 6.31 = 57.84 days
P14-1. CCC
LG 2; Basic
a. OC = Average age of inventories + Average collection period
= 80 days + 40 days
P14-2. Changing CCC
LG 2; Intermediate
a. AAI = 365 days ÷ 5 times inventory = 73 days
OC = AAI + ACP
© 2019 Pearson Education, Inc.
P14-3. Multiple changes in CCC
LG 2; Intermediate
a. AAI = 365 ÷ 6 times inventory = 61 days
OC = AAI + ACP
= 61 days + 45 days
© 2019 Pearson Education, Inc.
P14-5. EOQ analysis
LG 3: Intermediate
(2 ×S×O)
C = (2 ×1,400,000 ×$55)
$2.70 = 7,552
(3) EOQ = √ [(2 × 1,400,000 × $55) / $0.01] = 124,097
P14-6. EOQ, reorder point, and safety stock
LG 3; Intermediate
S×× × ×
×
(2) carrying costs (1) ordering costs—unaffected by how soon one orders
(4) reorder point
312 Zutter/Smart • Principles of Managerial Finance Brief, Eighth Edition
P14-7. Personal finance: Marginal costs
LG 3; Challenge
V-6 V-8
MSRP
Engine (liters)
Ownership period in years
Depreciation over 5 years
$30,260
3.7
5
17,337
44,320
5.7
5
25,531
$11,889 more than the cost of the smaller V-6 SUV
over the 5 year period. Additionally, Jimmy will spend
$4,441 more on fuel for the V-8 SUV. The total
marginal costs over the 5-year period, associated with
purchasing the V-8 over the V-6, are $16,330.
Marginal fuel cost
Total marginal costs
4,441
$16,330
© 2019 Pearson Education, Inc.
P14-10. Relaxation of credit standards
LG 4; Challenge
Additional profit contribution from sales = 1,000 additional units × ($40 − $31) $9,000
Cost of marginal investment in AR:
× $56,055
× 38,219
P14-11. Initiating a cash discount
LG 5; Challenge
Additional profit contribution from sales = 2,000 additional units × ($45 − $36) $18,000
Cost of marginal investment in AR:
× $124,274
© 2019 Pearson Education, Inc.
P14-14. Float
LG 6; Basic
a. Collection float = 3 + 2 + 2.5 = 7.5 days
P14-15. Lockbox system
LG 6; Basic
P14-16. Zero-balance account
LG 6; Basic
Current average balance in disbursement account $420,000
Opportunity cost (12%) × 0.12
318 Zutter/Smart • Principles of Managerial Finance Brief, Eighth Edition
© 2019 Pearson Education, Inc.
Case
Case studies are available on www.myfinancelab.com.
Assessing Roche Publishing Company’s Cash Management Efficiency
Chapter 14’s case involves the evaluation of a furniture manufacturer’s cash management by its treasurer. The student
must calculate the OC, CCC, and resources needed and compare them to industry standards. The cost of the firm’s
current operating inefficiencies is determined and the case also looks at the decision to relax its credit standards.
Finally, all the variables are consolidated and a recommendation made. To determine the net profit or loss from the
change in credit standards we must evaluate the four factors that are impacted:
– Change in contribution margin
– Change in sales discounts
– Investment in accounts receivable
– Bad-debt expenses
Change in sales volume:
Total contribution margin of annual sales:
Under proposed plan = ($15,000,000 × 0.20) = $ 3,000,000
Cost of marginal investment in accounts receivable:
Average investment under proposed plan $1,380,898
− Average investment under present plan 1,809,211
Marginal investment in accounts receivable − 428,313
× Required return on investment 0.12
Marginal investment in AR $428,313
Gain from lower marginal investment in AR
0.12 × 428,313 + 51,398
Net impact from change in credit standards $ 76,398
