Principles of Corporate Finance_ 12th Edition

bre44380_ch30_787-812.indd 788 10/09/15 09:31 PM

788788 Part NinePart Nine Financial Planning and Working Capital ManagementFinancial Planning and Working Capital Management

Current Assets Current Liabilities

Cash $345 $231 Short-term loans

Other short-term financial investments 173 570 Accounts payable

Accounts receivable 735 37 Accrued income taxes

Inventories 790 143 Current payments due on long-term debt

Other current assets 429 834 Other current liabilities

Total $2,472 $1,815 Total

❱ TABLE 30.1^
Current assets and
liabilities for U.S.
manufacturing
corporations, 3rd
quarter, 2014 (figures
in $ billions).

Source: U.S. Census Bureau, Quarterly Financial Report for U.S. Manufacturing, Mining, and Trade Corporations, http://www.census.gov/

econ/qfr/index.html.

◗ FIGURE 30.1

Current assets as a percentage of

total assets in different industries.

Figures are the mean percentages

for companies in the S&P Composite

Index in 2013.

Source: Compustat.

0

10

20

30

40

50

60

% of total assets

Other

Inventory

Receivables

Cash and securities

Industry

TelecomsSoftware

Retail

Chemicals

Paper Utilities

Oil Rail

Pharma-ceutical

Food

● ● ● ● ●

Most firms keep inventories of raw materials, work in process, or finished goods awaiting

sale and shipment. But they are not obliged to do so. For example, they could buy materials

day by day, as needed. But then they would pay higher prices for ordering in small lots, and

they would risk production delays if the materials were not delivered on time. They can avoid

that risk by ordering more than the firm’s immediate needs. Similarly, firms could do away

with inventories of finished goods by producing only what they expect to sell tomorrow. But

this too could be a dangerous strategy. A small inventory of finished goods may mean shorter

and more costly production runs, and it may not be sufficient to meet an unexpected increase

in demand.

There are also costs to holding inventories that must be set against these benefits. Money

tied up in inventories does not earn interest, storage and insurance must be paid for, and there

may be risk of spillage or obsolescence. Firms need to strike a sensible balance between the

benefits of holding inventory and the costs.

30-1 Inventories

Akron Wire Products uses 255,000 tons a year of wire rod. Suppose that it orders Q tons

at a time from the manufacturer. Just before delivery, Akron has effectively no inventories.

EXAMPLE 30.1^ ●^ The Inventory Trade-Off