This is “The Bigger Picture”, section 17.4 from the book Finance for Managers (v. 0.1).
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Through efficient current asset management, necessary working capital can be reduced. By freeing up cash from working capital, we can employ it in more productive, and higher returning, endeavors. Particularly in service industries, where there is less dependency upon fixed captial, effective collections from customers can be the difference between success and failure. A company can have a large net income, but if they can’t finance current assets (as can happen when a company grows too quickly), they can be driven to default. In a sense, they can be very profitably going bankrupt!
When considering cash management, its tempting to try to decrease our cash conversion cycle at all costs. Some strategies may hurt our relationship with our customers: overly aggressive collections can alienate customers, or we might deny credit to customers when they need our support most.
Unscrupulous managers might also manipulate reporting of current assets to falsely represent the state of the company. They might not properly account for bad debts; net income will consequently be higher, but only as accounts receivable swells into a “ticking time-bomb”. If the manager is rewarded for raising revenue, he or she might relax credit standards and sell to customers who have no capacity to pay. Even if the customer can “scrape together” the payments, perhaps the burden would be too much (for example, a low-income customer leasing a luxury automobile).
Another possibility is overstating the value of inventory. Obsolescence or spoilage can cause the value of inventory to be less than what is represented on the balance sheet.