1. Supply Chains and Working Capital Management
CHAPTER 21
Supply Chains and Working Capital Management

2. Definitions Working capital management:
day-to-day control of cash, inventories, receivables, accruals, and accounts payable.
Net operating working capital (NOWC):
Operating CA – Operating CL =
(Cash + Inventory + A/R) – (Accruals + A/P) 2

3. Basic Definitions Net operating working capital (NOWC):
Operating CA – Operating CL =
(Cash + Inv. + A/R) – (Accruals + A/P)
Working capital:
Total current assets used in operations.
Net working capital:
Current assets – Current liabilities. 2

4. Working capital management affects ROE
ROE = Profit margin x Total assets turnover x Equity multiplier
High current assets, low assets turnover results in low ROE
Low current assets, high assets turnover results in high ROE

5. Cash Conversion Cycle (CCC)
The cash conversion cycle focuses on the time between payments made for materials and labor and payments received from sales:
Cash
Conversion =
Cycle
Inventory
Conversion +
Period
Average
Collection −
Payables
Deferral

6. CCC
Inventory conversion period: the length of time from receiving material to finished product to selling to customer.
Average collection period (days sales outstanding): the length of time from sale to receiving the payment from customer.
Payable deferral period: the length of time from purchase to payment.

8. Cash Conversion Cycle (GBM on p.813)
Annual sales = $1,216.7
COGS = 1,013.9
Inventory = 140.0
A/R= 445.0
A/P=115.0
Inv+A/R-A/P=( )=470; financed by loans at 10%. So interest is 47 /y.

9. Cash Conversion Cycle (Cont.)
CCC = –
CCC = 140/(1013.9/365) + 445/(1216.7/365) - 115/(1013.9/265)
CCC = – 41.4
CCC = days
Inventory conversion period
Payables
deferral
period
Days sales
outstanding

10. Target CCC vs. realized CCC

11. Problems
Average collection period is much higher than the target, indicating customers are not paying on time.
This late payment increased GBM’s investment in working capital, which is financed by bank loans.
This lowers the firm’s profits and thus stock price.

12. Benefit of reducing CCC
Now, CCC is days, resulting in $470 mil being tied up in net operating working capital and 47 million interest
If working capital decreases, then…

13. Comparison

14. What’s the goal of cash management?
Minimize the cash amount the firm must hold for conducting its normal business activities, yet, at the same time, have a sufficient cash reserve to:
Take trade discounts.
Pay promptly and maintain its credit rating.
Meet any unexpected cash needs. 7

15. Ways to Minimize Cash Holdings
Synchronize inflows and outflows.
Using wire transfers to speeding up check-clearing process
Use lockboxes (post office box).
(More…) 8

16. Inventory management
Produce components only after receiving an order and then send the parts directly to the final assembly line.
Decrease money and time invested in this stage.

17. Receivable management
Provide trade credit : 2/10, net 30
Cash discounts: Lower price. Attracts new customers and reduces DSO.
Credit standards: tighter standards reduce bad debt losses, but may reduce sales
Collection policy: tougher policy will reduce DSO, but may damage customer relationships.

18. Is there a cost to accruals? Can firms control accruals?
Accruals are free in that no explicit interest is charged.
Firms have little control over the level of accruals. Levels are influenced more by industry custom, economic factors, and tax laws.

19. Homework Assignment
Chapter 21 problems: 1, 2, 5, 6, 11, 12.