Assignment ReviewLecture 7 Current Asset Mgmnt & Financing Analyzing Financial Performance (Gapenski Chapters 16 & 17)
The “costs” of assets • All assets have costs… • Assets are financed by equity and liability: the fundamental accounting equation • The concept of an opportunity cost • Fixed assets… • Acquisition funded by loans or equity • But also incur a “carrying cost”… time value effect – also funded by loans or equity
Current asset (CA) costs • CA are also financed by equity/ liability: • Cash and marketable securities • Accounts receivable • Inventories • Difference between earning (marketable securities) and unearning (A/R, inventories) CA. • A/R can be factored • Inventories can be sold at discount…
Optimizing CA • Rule is to keep CA to minimum possible without incurring > costs • A/R depends on trade credit offered – affected by customer demands and industry practice. • Inventory levels affected by: • Operating levels (e.g. process industries vs. hospitals) are “permanent” CA • “Safety stocks” and seasonal stock are “temporary” current assets
Financing CA policies • Maturity matching – “moderate” • Permanent assets with equity and LT debt • Seasonal assets with ST debt • Conservative – equity and LT debt funds permanent assets and part of seasonal assets • Aggressive – ST borrowings fund seasonal and part of permanent assets Why would you select each?
Cash management • Collect quickly/ disburse (pay) slowly • Collection: variety of methods get collections into cash, thence into earning assets: lockbox services, concentration banks, electronic funds transfer and automated clearinghouses • Disbursement: payables management, ZBAs at concentration banks, remote disbursement
Receivables management • Cost of carrying A/R is a function of: • average collection period (ACP) aka Days Sales Outsanding (DSO) • average $sales/day • cost of financing • ACP depends on credit terms offered/ nature of the business • Reducing ACP generates a reduction in carrying cost and a one-time infusion of cash • “Aging schedules” can point to problems • HC providers face complexities other sectors do not
Sources of short term financing • Accrued expenses: • “free money” • Spontaneous • Accounts payable: • Free trade credit – pay w/in discount period • Costly trade credit – pay outside time Ethical issues with: paying late and taking discount; or with “stretching” • Bank financing: short term loans, revolving credits, etc.
Analyzing financial performance(Chapter 17) Statement of cash flows – How was cash generated? • Operating activities – core to business • Investing activities – generally, purchases/ sales of fixed assets • Financing – ST / LT securities as investments and as liabilities
Ratio analysis • Common approaches, but values are industry-specific • Net income as numerator: • Total margin -- NI/ revenues • ROA -- NI/ total assets • ROE -- NI/ equity Would you expect the ROA to be higher/ lower than the ROE? Why?
Liquidity ratios • Current ratio – CA/ CL • “Acid test” – remove inventories from CA • Some industries function with relatively high inventories • Days cash on hand: can a business meet its payments…an operational view
Debt Management Ratios • Capitalization ratios – balance sheet data focusing on debt leverage • Debt/ equity • Debt/ assets • Coverage ratios – income statement data indicating whether net income can “cover” debt requirements • TIE ratio (times interest earned) = EBIT/ Interest exp Complementary, but capitalization ratios are point in time…
DuPont Analysis ROE = Total margin x Total asset turnover x Equity multiplier NI/ Equity = NI/ Rev x Rev/ assets x Assets/ equity Total margin: expense control Total asset turnover: asset utilizationEquity multiplier: debt utilization