Working Capital Management Founded in 1807, John Wiley & Sons is the oldest independent publishing com- pany in the United States. With offices in North America, Europe, Asia, and Australia, Wiley is globally committed to developing and marketing print and electronic products and services for our customers’ professional and personal knowledge and understanding. The Wiley Corporate F&A series provides information, tools, and insights to corporate professionals responsible for issues affecting the profitability of their company, from accounting and finance to internal controls and performance management. Working Capital Management Applications and Cases JAMES S. SAGNER Cover design: Wiley Copyright © 2014 John Wiley & Sons, Inc. All rights reserved. Published by John Wiley & Sons, Inc., Hoboken, New Jersey. Parts of this publication are taken from Essentials of Working Capital Management, published in 2011 by John Wiley & Sons, Inc. All rights reserved. Published simultaneously in Canada. No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise, except as permitted under Section 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher, or authorization through payment of the appropriate per-copy fee to the Copyright Clearance Center, Inc., 222 Rose- wood Drive, Danvers, MA 01923, (978) 750-8400, fax (978) 646-8600, or on the Web at www.copyright.com. Requests to the Publisher for permission should be addressed to the Permissions Department, John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030, (201) 748-6011, fax (201) 748-6008, or online at http://www.wiley.com/go/permissions. Limit of Liability/Disclaimer of Warranty: While the publisher and author have used their best efforts in preparing this book, they make no representations or warranties with respect to the accuracy or completeness of the contents of this book and specifically disclaim any implied warranties of merchantability or fitness for a particular purpose. No warranty may be created or extended by sales representatives or written sales materials. The advice and strategies contained herein may not be suitable for your situation. You should consult with a professional where appropriate. Neither the publisher nor author shall be liable for any loss of profit or any other commercial damages, including but not limited to special, incidental, consequential, or other damages. For general information on our other products and services or for technical support, please contact our Customer Care Department within the United States at (800) 762-2974, outside the United States at (317) 572-3993 or fax (317) 572-4002. Wiley publishes in a variety of print and electronic formats and by print-on-demand. Some material included with standard print versions of this book may not be included in e-books or in print-on-demand. If this book refers to media such as a CD or DVD that is not included in the version you purchased, you may download this material at http://booksupport.wiley. com. For more information about Wiley products, visit www.wiley.com. Library of Congress Cataloging-in-Publication Data: Sagner, James S. Working capital management : applications and cases / James S. Sagner. p. cm. — (Wiley corporate f&a series) Includes bibliographical references and index. ISBN 978-1-118-93383-1 (cloth); ISBN 978-1-118-93384-8 (epub); 978-1-118-93385-5 (epdf) 1. Working capital. 2. Corporations—Finance. 3. Cash management. 4. Working capital—Case studies. 5. Corporations—Finance—Case studies. 6. Cash management— Case studies. I. Title. HG4028.W65S243 2014 658.15′224—dc23 2014012277 Printed in the United States of America 10 9 8 7 6 5 4 3 2 1 This book is for my colleagues and friends in banking, in the corporate world, and in the universities with which I have been associated. As any author can attest, I have learned far more from them than they have from me. Contents Preface xiii Acknowledgments xv Chapter 1: Concepts in Working Capital Management 1 Working Capital Concepts 2 Improving Working Capital Management 5 The Signifi cance of Working Capital 8 Cost as the Working Capital Issue 9 Applying These Ideas to a Real Business: Best Buy 12 Summary 15 Notes 16 Chapter 2: Working Capital Ratios and Other Metrics 17 Ratio Analysis 18 Other Ratios and Their Application 22 Other Metrics 23 Benchmarking 27 General Problems in the Use of Ratios and Metrics 29 Summary 32 Notes 32 Chapter 3: Cash—Management and Fraud Prevention 35 Forms of Cash 36 Paper Transactions: Lockboxing 38 Paper Transactions: Depository Accounts 40 Paper Transactions: Controlled Disbursement 41 Electronic Transactions 43 Float and Cost Issues 46 Summary 49 Notes 49 vii viii ◾ Contents Chapter 4: Cash—Credit and Short‐Term Financial Instruments 51 Developing a Short‐Term Forecast 52 Cash Budgeting 53 Credit Financing 55 Short‐Term Investments 58 Summary 63 Notes 63 Chapter 5: Managing Bank Relationships 65 The Changing Financial Landscape 66 Bank Relationship Management 66 Cash Mobilization in a Multibank Network 68 General Terms of Credit Facilities 71 Specific Terms in Credit Facilities 72 Ongoing Bank Relationship Concerns 75 Summary 77 Notes 78 Appendix to Chapter 5: Selecting Noncredit Banking Services 81 The Request for Proposal 82 RFP Evaluation 85 Chapter 6: Accounts Receivable and Working Capital Issues 89 Elements of Receivables Management 90 Float Opportunities in Managing Receivables 91 Receivables Cycle Monitoring: Ratios 93 Receivables Cycle Monitoring: The Aging Schedule 94 Sales Financing 96 Credit Reporting 97 Terms of Sale 99 Invoice Generation 100 Asset‐Based Financing 102 Debt Collection Agencies 103 Summary 104 Notes 104 Chapter 7: Inventory and Working Capital Issues 107 Elements of Inventory Management 108 Inventory Cycle Monitoring: Ratios 109