copyright 1998 by harcourt brace &company short-term financial management terry s. maness and...

Copyright Copyright 1998 by Harcourt Brace &Company 1998 by Harcourt Brace &Company

SHORT-TERM FINANCIAL MANAGEMENTSHORT-TERM FINANCIAL MANAGEMENT Terry S. Maness and John T. Zietlow Terry S. Maness and John T. Zietlow

Copyright Copyright 1998 by Harcourt Brace & Company 1998 by Harcourt Brace & Company

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Requests for permission to make copies of any part of the work should be mailedRequests for permission to make copies of any part of the work should be mailedto: Permissions Department, Harcourt Brace & Company, 6277 Sea Harbor Drive,to: Permissions Department, Harcourt Brace & Company, 6277 Sea Harbor Drive,Orlando, Florida 32887-6777.Orlando, Florida 32887-6777.

Produced in the United States of AmericaProduced in the United States of America

ISBN: 0-03-019127-0ISBN: 0-03-019127-0


Chapter 1Chapter 1The Role of Working CapitalThe Role of Working Capital

SalesSales

A /RA /R

CashCash

InvInv


ObjectivesObjectives

View firm as a system of cash flowsView firm as a system of cash flows

How WC and depreciation create How WC and depreciation create disparities between profit and cash flowdisparities between profit and cash flow

Management aspects of various WC Management aspects of various WC accountsaccounts

Discussion of appropriate level of WCDiscussion of appropriate level of WC


The Cash Flow TimelineThe Cash Flow Timeline

OrderOrder Order Order Sale Sale CashCash PlacedPlaced Received Received ReceivedReceived Accounts CollectionAccounts Collection < Inventory > < Receivable > < Float >< Inventory > < Receivable > < Float >

Time ==>Time ==> Accounts Disbursement Accounts Disbursement

< Payable > < Float >< Payable > < Float > Invoice Invoice Payment Payment CashCash Received Sent Received Sent PaidPaid

OrderOrder Order Order Sale Sale CashCash PlacedPlaced Received Received ReceivedReceived Accounts CollectionAccounts Collection < Inventory > < Receivable > < Float >< Inventory > < Receivable > < Float >

Time ==>Time ==> Accounts Disbursement Accounts Disbursement

< Payable > < Float >< Payable > < Float > Invoice Invoice Payment Payment CashCash Received Sent Received Sent PaidPaid


...in the beginning...in the beginning

Balance Sheet - June 1Balance Sheet - June 1

CashCash $1,000$1,000 DebtDebt $$ 500500 Common Stock 500Common Stock 500

TotalTotal $1,000$1,000 Total Total $1,000$1,000


CashCash $1,000$1,000 DebtDebt $$ 500500 Common Stock 500Common Stock 500

TotalTotal $1,000$1,000 Total Total $1,000$1,000


The Next Day, June 2The Next Day, June 2

Balance Sheet - June 2Balance Sheet - June 2Purchase Fixed Assets and InventoryPurchase Fixed Assets and Inventory

CashCash $ $ 400400 A/PA/P $ $ 300300InventoryInventory 300300 Debt Debt 500 500Fixed AssetsFixed Assets 600600 Common Stock Common Stock 500500

TotalTotal $1,300$1,300 TotalTotal $1,300$1,300

Balance Sheet - June 2Balance Sheet - June 2Purchase Fixed Assets and InventoryPurchase Fixed Assets and Inventory

CashCash $ $ 400400 A/PA/P $ $ 300300InventoryInventory 300300 Debt Debt 500 500Fixed AssetsFixed Assets 600600 Common Stock Common Stock 500500

TotalTotal $1,300$1,300 TotalTotal $1,300$1,300


End of JuneEnd of June


Sale of product, incur operating expenses,Sale of product, incur operating expenses, incur depreciation, and generate profitincur depreciation, and generate profit

CashCash $ $ 325325 A/PA/P $ 300$ 300A/RA/R 700700 AccrualsAccruals 200200InventoryInventory 0 0 Debt Debt 500 500Fixed AssetsFixed Assets 600 600 Common Stock Common Stock 500 500(Accum Depr) (Accum Depr) (100)(100) Retained Earnings Retained Earnings 2525TotalTotal $1,525$1,525 TotalTotal $1,525$1,525


Sale of product, incur operating expenses,Sale of product, incur operating expenses, incur depreciation, and generate profitincur depreciation, and generate profit

CashCash $ $ 325325 A/PA/P $ 300$ 300A/RA/R 700700 AccrualsAccruals 200200InventoryInventory 0 0 Debt Debt 500 500Fixed AssetsFixed Assets 600 600 Common Stock Common Stock 500 500(Accum Depr) (Accum Depr) (100)(100) Retained Earnings Retained Earnings 2525TotalTotal $1,525$1,525 TotalTotal $1,525$1,525


July 1July 1

Balance Sheet - July 1Balance Sheet - July 1

Pay operating accruals with cashPay operating accruals with cash

CashCash $ $ 125125 A/PA/P $ 300$ 300A/RA/R 700 700 AccrualsAccruals 0 0InventoryInventory 0 0 Debt Debt 500 500Fixed AssetsFixed Assets 600 600 Common Stock Common Stock 500 500(Accum Depr) (Accum Depr) (100)(100) Retained Earnings Retained Earnings 2525TotalTotal $1,325$1,325 TotalTotal $1,325$1,325


Pay operating accruals with cashPay operating accruals with cash

CashCash $ $ 125125 A/PA/P $ 300$ 300A/RA/R 700 700 AccrualsAccruals 0 0InventoryInventory 0 0 Debt Debt 500 500Fixed AssetsFixed Assets 600 600 Common Stock Common Stock 500 500(Accum Depr) (Accum Depr) (100)(100) Retained Earnings Retained Earnings 2525TotalTotal $1,325$1,325 TotalTotal $1,325$1,325


July 15July 15


Pay payables with cashPay payables with cash

CashCash $ $ ( 175)( 175) A/PA/P $ $ 0 0A/RA/R 700 700 AccrualsAccruals 0 0InventoryInventory 0 0 Debt Debt 500 500Fixed AssetsFixed Assets 600 600 Common Stock Common Stock 500 500(Accum Depr) (Accum Depr) (100)(100) Retained Earnings Retained Earnings 2525TotalTotal $1,025$1,025 TotalTotal $1,025$1,025


Pay payables with cashPay payables with cash

CashCash $ $ ( 175)( 175) A/PA/P $ $ 0 0A/RA/R 700 700 AccrualsAccruals 0 0InventoryInventory 0 0 Debt Debt 500 500Fixed AssetsFixed Assets 600 600 Common Stock Common Stock 500 500(Accum Depr) (Accum Depr) (100)(100) Retained Earnings Retained Earnings 2525TotalTotal $1,025$1,025 TotalTotal $1,025$1,025


July 31July 31


Collect accounts receivableCollect accounts receivable

CashCash $ $ 525 525 A/PA/P $ $ 00A/RA/R 00 AccrualsAccruals 0 0InventoryInventory 0 0 Debt Debt 500 500Fixed AssetsFixed Assets 600 600 Common Stock Common Stock 500 500(Accum Depr) (Accum Depr) (100)(100) Retained Earnings Retained Earnings 2525TotalTotal $1,025$1,025 TotalTotal $1,025$1,025


Collect accounts receivableCollect accounts receivable

CashCash $ $ 525 525 A/PA/P $ $ 00A/RA/R 00 AccrualsAccruals 0 0InventoryInventory 0 0 Debt Debt 500 500Fixed AssetsFixed Assets 600 600 Common Stock Common Stock 500 500(Accum Depr) (Accum Depr) (100)(100) Retained Earnings Retained Earnings 2525TotalTotal $1,025$1,025 TotalTotal $1,025$1,025


Profit versus Cash FlowProfit versus Cash Flow

QuestionQuestion: Why did the firm end up with : Why did the firm end up with $125 in additional cash while earning a $125 in additional cash while earning a profit of $25?profit of $25?

AnswerAnswer: Some expenses are not cash : Some expenses are not cash expenses.expenses.QuestionQuestion: Why did the firm run out of cash : Why did the firm run out of cash during its operating cycle?during its operating cycle?

AnswerAnswer: The cash deficit was due to the : The cash deficit was due to the differences between the timing of cash differences between the timing of cash disbursements and cash receipts.disbursements and cash receipts.


Important PointsImportant Points

The firm must manage its cost The firm must manage its cost structure to generate a profit.structure to generate a profit.

WC accounts must be managed so WC accounts must be managed so that liquidity is maintained.that liquidity is maintained.


Relationship Between Accrual Relationship Between Accrual Income and Cash FlowIncome and Cash Flow

Income StatementIncome Statement Adjustment AccountAdjustment Account Cash Flow Account Cash Flow Account

SalesSales - Change in accounts receivable- Change in accounts receivable = Cash collected= Cash collected

Cost of goods soldCost of goods sold - Change in accounts payable- Change in accounts payable+ Change in inventory+ Change in inventory = Cash paid to suppliers= Cash paid to suppliers

Operating expensesOperating expenses - Change in operating accruals- Change in operating accruals- Depreciation- Depreciation = Cash paid for = Cash paid for

operating expensesoperating expenses

InterestInterest - Change in accrued interest- Change in accrued interest = Cash paid to creditors= Cash paid to creditors

TaxesTaxes - Change in accrued taxes- Change in accrued taxes- Change in deferred taxes- Change in deferred taxes = Cash paid for taxes= Cash paid for taxes

__________________________________ ______________________________________Net ProfitNet Profit Operating Cash FlowOperating Cash Flow


Managing the Cash CycleManaging the Cash Cycle

Managing InventoryManaging Inventory

Managing ReceivablesManaging Receivables

Managing PayablesManaging Payables

Electronic CommerceElectronic Commerce


Managing InventoryManaging Inventory

JITJIT

Trade-offs between:Trade-offs between:

– stock out costsstock out costs

– cost of excess inventorycost of excess inventory

– ordering costsordering costs


Managing ReceivablesManaging Receivables

Who should receive credit and how Who should receive credit and how much? (5 C’s)much? (5 C’s)

Credit termsCredit terms

Monitoring the outstanding balanceMonitoring the outstanding balance

Speeding up the receipt of payments Speeding up the receipt of payments through lockboxesthrough lockboxes


Managing PayablesManaging Payables

Search for terms that match with cash Search for terms that match with cash receiptsreceipts

Timing of paymentTiming of payment

Controlled disbursementControlled disbursement


Electronic CommerceElectronic Commerce

Revolutionizing management of cash Revolutionizing management of cash cyclecycle

Proprietary systemsProprietary systems

Impact of InternetImpact of Internet


How Much WC is EnoughHow Much WC is Enough

One viewOne view– optimal level is zerooptimal level is zero

– WC is an idle resourceWC is an idle resource

– Provides little valueProvides little value

How much in resources to commit?How much in resources to commit?– Why inventory?Why inventory?

– Why receivables and payables?Why receivables and payables?

– Why short-term investments?Why short-term investments? Chrysler’s $5 billion cushion of investmentsChrysler’s $5 billion cushion of investments


SummarySummary

Firm must operate at a profitable levelFirm must operate at a profitable level A profitable firm may still struggle A profitable firm may still struggle

financiallyfinancially Working capital soaks up cash flow and Working capital soaks up cash flow and

may cause an otherwise profitable firm may cause an otherwise profitable firm to failto fail

A successful firm’s operation is A successful firm’s operation is managed from a profit and a cash flow managed from a profit and a cash flow perspectiveperspective

copyright 1998 by harcourt brace &company short-term financial management terry s. maness and...

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