1. Current Asset Management
Chapter 16
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Introduction
Investment and financing policies
Manage cash and marketable securities
Manage receivables and inventory
Short-term financing
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3. Short Term Financial Management
Current Assets and Liabilities
Found in Financial Statements
Support operational requirements
Goal is to minimize financial costs
Maintain liquidity
Manage fluctuations in business environment
Receive payment
Pay bills
Have services ready to meet demand
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Uncertainty
If flows were certain, easy job to plan for known fluctuations in business.
If flows uncertain, unexpected needs require additional cash and inventories to meet needs of business.
A low policy provides for minimum cash and inventories stocks. Minimizes cost
A high policy provides the converse.
Opportunity cost is profit penalty.
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Policy Choices
Aggressive – highest return and risk
Use higher proportion short-term debt and credit
Conservative – lowest return and risk
Use higher proportion of marketable securities and cash, long term debt and equity capital
Moderate – falls in the middle somewhere.
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Financing Policies
Conservative- use no to very little short-term financing
Moderate- use some short-term financing
Aggressive – use much more short-term financing (highest risk and return)
Long-term debt and equity are adjusted up and down depending on strategy selected.
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Policy Choices
If a firm has low business risk, may choose to follow a higher risk financial strategy.
Higher debt ratio in target capital structure
More aggressive short-term financing
If a firm has high business risk, may choose to follow a low risk financial strategy
Lower debt ratio
More conservative short term financing.
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Cash Management
The goal of cash management is to hold the minimum amount necessary to meet liquidity requirements. Opportunity costs?
The primary cash management technique is float management:
Acceleration of receipts
Disbursement control
The cost of cash management initiatives must be balanced by corresponding benefits.
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Cash Management
Liquidity Ratios – financial analysis
Cash Budget
Calculation of alternative financing arrangements
Managing receivables
Managing payments
negotiating with vendors
Negotiating bank loans and lines of credit.
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Using Float
Net float is the difference between the cash amount on the firm’s books and the amount on the bank’s books.
Suppose Colonial 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.
Colonial 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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11. Accelerating Receipts
Net float is maximized by accelerating receipts and slowing disbursements.
Deposit checks received daily
Lockboxes (perhaps multiple banks and locations)
Concentration banking (single bank)
Automated clearinghouses (electronic banking)
Federal Reserve wire system
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Disbursement Control
Disbursement control for outflows
Payables centralization
Prompt payment?
Master and zero-balance accounts
Controlled (remote) disbursement
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13. Economic Decision Making
Efficiency in Cash Operations
Make the policy decision on the criteria
The marginal benefit of policy should exceed the marginal benefit
In finance, one can often calculate the benefit and costs in dollar terms
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14. Marketable Securities
Two primary reasons to hold:
As an interest earning substitute for cash.
Opportunity costs of cash balances is foregone interest
As a temporary repository for cash being accumulated to meet a specific need.
Cash management of obligations
Managers do cash and marketable securities management simultaneously.
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15. Marketable Securities
Examples are short-term treasury securities, money market funds,
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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16. Receivables management
If a service is provided for cash, the revenue is immediately received.
If the service is provided on credit, the revenue is not received until the receivable is collected.
Receivables management is fundamental to healthcare providers.
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17. Accumulation of Receivables
Suppose Colonial contracts with an insurer whose patients use $2,000 in services daily and who pays in 20 days.
Average daily billings ADB of $2,000
Average collection period ACP of 20 days
The clinic will accumulate receivables at a rate of $2,000 per day.
However, after 20 days, the receivables balance will stabilize at $40,000:
Receivables balance = ADB x ACP
$2,000 x = $40,000
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18. Receivables Financing
Suppose Colonial uses bank financing that has an interest rate of 10% to finance its receivables.
The annual cost of carrying the receivables is $4,000:
$40,000 x 0.10 = $4,000.
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19. Monitoring Receivables
Healthcare managers must continuously monitor the firm’s receivables.
Monitoring methods include:
Average collection period (ACP), often called days in patient accounts receivable (DPAR)
Aging schedules
Receivables are monitored both in the aggregate and by specific payer.
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20. Supply Chain Management
Supply chain management is clinically important for healthcare providers, but not as financially motivated as it is for manufacturers, wholesalers, or retailers.
Inventories consist of base stocks plus safety stocks.
The goal of inventory management is to meet operational needs at the lowest cost.
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Inventory Management
Management techniques used are:
Just-in-time (or stockless) systems
Point of distribution systems
In addition, some providers have contracts with suppliers that are priced on the basis of the amount of medical services provided or amount may be even capitated.
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Revenue Cycle
Those recurrent activities associated with billing and collecting for services.
For example:
Preinsurance verification
Patient precertification
Preservice patient financial counseling
Time of service recertification
Third-party claim submission
Claim follow-up
Payment receipt and posting
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Revenue Cycle
In revenue cycle management, each of the identified activities is closely monitored to ensure that:
The correct amount of reimbursement is collected on each patient.
Reimbursements are collected as quickly as possible.
The costs associated with the revenue cycle are minimized consistent with rapid and correct collections.
An important key to good revenue cycle management is electronic claims processing.
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Short-term Financing
Three primary advantages over long-term.
Lower issuance costs
Fewer restrictive covenants
Generally lower interest rate
Major sources for providers
Accruals
Accounts payable (trade credit)
Bank loans (notes payable)
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25. ST Financing Disadvantage
Interest expense can fluctuate much more than LT debt
Recently short term rates rather low because of the Federal Reserve Policy
ST comes due on a regular basis.
If deterioration in business, may have difficulty meeting payments
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Accruals
Accruals consist primarily of wages owed to employees and taxes owed to governments.
Even not-for-profits have accrued taxes
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.
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Accounts Payable
Trade credit is credit furnished by a business’s suppliers.
Trade credit often is the largest source of short-term credit, especially for small businesses.
Both accruals and trade credit are spontaneous liabilities in the sense that their levels change spontaneously as patient volume rises and falls.
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Colonial Healthcare buys $3,000,000 (invoice price) of medical supplies from one of its vendors on terms of 2/10, net How much trade credit is available from this vendor and how much does it cost?
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Gross/Net Breakdown
Colonial buys supplies worth $3,000,000 x 0.98 = $2,940,000 because that is the net, or cash, (true) price.
If Northwest does not take the discount, it must pay $3,000,000 for the supplies. This is the gross, or invoice, price.
The difference, $60,000, is a financing cost similar to the dollar amount of interest paid on a loan.
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Net Daily Purchases (NDP)
NDP = ($3,000,000 x 0.98) /360 = $8,167
Payables level with discount
Payables = $8,167 x 10 = $81,670
Payables level without discount
Payables = $8,167 x 30 = $245,010
Credit breakdown
Total trade Credit = $245,010
Free Trade Credit = ,670
Costly Trade Credit = $163,340
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31. Approximate Cost Rate of Costly Trade Credit
Colonial Health Care must pay $60,000 (.02 x $3 mil) to obtain $163,340 in extra trade credit
Cost Rate = $60,000/$163,340 = = 36.7%
The $60,000 in financing charges is paid through the year rather than at year end, so the Expected Annual Rate (EAR) is higher
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32. Approximate Cost Formula
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Effective Annual Rate
Periodic rate = 2 / 98 =
Periods / year = 360 / (30-10) = 18
EAR = (1+ Periodic rate)M
= (1.0204) = = 43.8%
Higher than the nominal cost previously calculated.
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Decision
Colonial should take $81,670 in free trade credit
Costly trade credit should not be taken if it can be beaten by a less costly alternative
If one can obtain a bank loan in the 8 to 12% range, no need to take the $163,340 in costly trade credit.
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Bank Loans
Commercial banks provide short-term credit to healthcare providers.
Where do these appear on the balance sheet?
Notes payable
Bank loan features
Promissory note
Compensating balances kept in bank
Line of credit
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36. Secured Short-term Loans
Borrower pledges an asset as collateral.
Receivables and inventories are commonly pledged as assets
Also possible to pledge marketable securities.
Use fixed assets for long term matching
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37. Receivables Financing
Receivables may be pledged, gives the lender recourse.
Receivables may also be factored. This is selling the accounts receivables.
There is no recourse to the selling business. The lender has purchased the receivables.
Purchaser needs to check credit of receivables.
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Inventory Financing
Not really used by healthcare providers
Equipment/devices firms and Pharmaceuticals may use it.
Inventory secured by
Blanket lean
Trust receipt against specific items
Warehouse receipt
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Final Comments
Borrowing on an unsecured basis is generally cheaper and simpler than a secured loan
Businesses must often provide collateral in order to borrow.
In some cases, security will lower the interest rate.
Accounts receivables may be used as collateral.
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