mcgraw-hill/irwin ©2001 the mcgraw-hill companies all rights reserved 16.0 chapter 16 short-term...

McGraw-Hill/Irwin ©2001 The McGraw-Hill Companies All Rights Reserved

16.1

Chapter

16Short-TermFinancialPlanning


16.2

Key Concepts and Skills

Be able to compute the operating and cash cycles and understand why they are important

Understand the different types of short-term financial policy

Understand the essentials of short-term financial planning


16.3

Chapter Outline

Tracing Cash and Net Working CapitalThe Operating Cycle and the Cash CycleSome Aspects of Short-Term Financial PolicyThe Cash BudgetShort-Term BorrowingA Short-Term Financial Plan


16.4

Sources and Uses of Cash

Sources of Cash Obtaining financing:

Increase in long-term debt Increase in equity Increase in current

liabilities Selling assets

Decrease in current assets Decrease in fixed assets

Uses of Cash Paying creditors or

stockholders Decrease in long-term debt Decrease in equity Decrease in current

liabilities Buying assets

Increase in current assets Increase in fixed assets


16.5

The Operating Cycle

The time it takes to receive inventory, sell it and collect on the receivables generated from the sale

Operating cycle = inventory period + accounts receivable periodInventory period = time inventory sits on the shelfAccounts receivable period = time it takes to collect

on receivables


16.6

The Cash Cycle

The time between payment for inventory and receipt from the sale of inventory

Cash cycle = operating cycle – accounts payable periodAccounts payable period = time between receipt of

inventory and payment for it

The cash cycle measures how long we need to finance inventory and receivables


16.7

Table 16.1

Accounts receivableaccounts payable

Accounting information on cash flows;reconciliation of accounts payable; applicationof payments to accounts receivable

Controller

Accounts payableDecisions on payment policies and onwhether to take discounts

Payables manager

Inventory, accounts payableSetting of production schedules andmaterials requirements

Productions manager

Inventory, accounts payableDecisions on purchases, suppliers; maynegotiate payment terms

Purchasing manager

Accounts receivableCredit policy decisionsMarketing manager

Accounts receivableMonitoring and control of accountsreceivable; credit policy decisions

Credit manager

Cash, marketable securities,short-term loans

Collection, concentration, disbursement;short-term investments; short-term borrowing;banking relations

Cash manager

Assets/Liabilities InfluencedDuties Related to Short-TermFinancial ManagementTitle of Manager


16.8

Example Information

Item Beginning Ending Average

Inventory 200,000 300,000 250,000

Accounts Receivable

160,000 200,000 180,000

Accounts Payable

75,000 100,000 87,500

Net Sales = $1,150,000 Cost of Goods Sold = $820,000


16.9

Example - Operating Cycle

Inventory Period = 365 / Inventory Turnover Inventory Turnover = COGS / Average inventory

IT = 820,000 / 250,000 = 3.28 times Inventory Period = 365 / 3.28 = 111 days

Accounts Receivable Period = 365 / Receivables Turnover Receivables Turnover = Credit Sales / Average AR

RT = 1,150,000 / 180,000 = 6.4 times Receivables Period = 365 / 6.4 = 57 days

Operating cycle = 111 + 57 = 168 days


16.10

Example - Cash Cycle

Accounts Payables Period = 365 / payables turnoverPayables turnover = COGS / Average AP

PT = 820,000 / 87,500 = 9.4 timesAccounts payables period = 365 / 9.4 = 39 days

Cash cycle = 168 – 39 = 129 daysSo, we have to finance our inventory and

receivables for 129 days


16.11

Short-Term Financial Policy

Flexible (Conservative) Policy Large amounts of cash and

marketable securities Large amounts of

inventory Liberal credit policies

(large accounts receivable) Relatively low levels of

short-term liabilities

High liquidity

Restrictive (Aggressive) Policy Low cash and marketable

security balances Low inventory levels Little or no credit sales

(low accounts receivable) Relatively high levels of

short-term liabilities

Low liquidity


16.12

Carrying versus Shortage Costs

Carrying costsOpportunity cost of owning current assets versus

long-term assets that pay higher returnsCost of storing larger amounts of inventory

Shortage costsOrder costs – the cost of ordering additional

inventory or transferring cashStock-out costs – the cost of lost sales due to lack of

inventory, including lost customers


16.13

Temporary versus Permanent Assets

Are current assets temporary or permanent?Both!

Permanent current assets refer to the level of current assets that the company retains regardless of any seasonality in sales

Temporary current assets refer to the additional current assets that are added when sales are expected to increase on a seasonal basis


16.14

Figure 16.4

Policy F always implies a short-termcash surplus and a large investmentin cash and marketable securities.

Dollars Dollars

Policy F Policy R

Long-termfinancing

Total assetrequirement

Marketablesecurities

Time

Long-termfinancing

Time

Total assetrequirement

Short-termfinancing

Policy R uses long-term financing forpermanent asset requirements only andshort-term borrowing for seasonalvariations.


16.15

Choosing the Best Policy

Best policy will be a combination of flexible and restrictive policies

Things to considerCash reservesMaturity hedgingRelative interest rates

Compromise policy – borrow short-term to meet peak needs, maintain a cash reserve for emergencies


16.16

Figure 16.5

Dollars

Time

Flexible policy (F)

Compromise policy (C)

Restrictive policy (R)

Short-termfinancing

Total seasonalvariation

Marketablesecurities

General growth infixed assetsand permanentcurrent assets

With a compromise policy, the firm keeps a reserve of liquidity that it usesto initially finance seasonal variations in current asset needs. Short-termborrowing is used when the reserve is exhausted.


16.17

Cash Budget

Primary tool in short-run financial planningIdentify short-term needs and potential opportunitiesIdentify when short-term financing may be required

How it worksIdentify sales and cash collectionsIdentify various cash outflowsSubtract outflows from inflows and determine

investing and financing needs


16.18

Example: Cash Budget Information Expected Sales for 2000 by quarter (millions)

Q1: $57; Q2: $66; Q3: $66; Q4: $90 Beginning Accounts Receivable = $30 Average collection period = 30 days Purchases from suppliers = 50% of next quarter’s estimated

sales Accounts payable period = 45 days Wages, taxes and other expenses = 25% of sales Interest and dividends = $5 million per quarter Major expansion planned for quarter 2 costing $35 million Beginning cash balance = $5 million with minimum cash

balance of $2 million


16.19

Example: Cash Budget – Cash Collections

Q1 Q2 Q3 Q4

Beginning Receivables 30 19 22 22

Sales 57 66 66 90

Cash Collections = Beg. Receivables + 2/3(Sales)

68 63 66 82

Ending Receivables = 1/3(Sales)

19 22 22 30


16.20

Example: Cash Budget – Cash Disbursements

Q1 Q2 Q3 Q4

Payment of A/P = 50% of sales

28.50 33.00 33.00 45.00

Wages, taxes, other expenses

14.25 16.50 16.50 22.50

Capital Expenditures 35.00

Long-term financing (interest and dividends)

5.00 5.00 5.00 5.00

Total Disbursements 47.75 89.50 54.50 72.50


16.21

Example: Cash Budget – NetCash Flow and Cash Balance

Q1 Q2 Q3 Q4

Total Cash Collections 68.00 63.00 66.00 82.00

Total Cash Disbursements 47.75 89.50 54.50 72.50

Net Cash Flow 20.25 (26.50) 11.50 9.5

Beginning Cash Balance 5.00 25.25 (1.25) 10.25

Net Cash Inflow 20.25 (26.50) 11.50 9.50

Ending Cash Balance 25.25 (1.25) 10.25 19.75

Minimum Cash Balance -2.00 -2.00 -2.00 -2.00

Cumulative surplus (deficit) 23.25 (3.25) 8.25 17.75


16.22

Short-Term Borrowing Unsecured loans

Line of credit – prearranged agreement with a bank that allows the firm to borrow up to a certain amount on a short-term basis

Committed – formal legal arrangement that may require a commitment fee and generally has a floating interest rate

Non-committed – informal agreement with a bank that is similar to credit card debt for individuals

Revolving credit – non-committed agreement with a longer time between evaluations

Secured loans – loan secured by receivables or inventory or both


16.23

Example: Factoring

Selling receivables to someone else at a discountExample: You have an average of $1 million in

receivables and you borrow money by factoring receivables with a discount of 2.5%. The receivables turnover is 12 times per year.

What is the APR? Period rate = .025/.975 = 2.564% APR = 12(2.564%) = 30.769%

What is the effective rate? EAR = 1.0256412 – 1 = 35.502%


16.24

Short-Term Financial PlanQ1 Q2 Q3 Q4

Beginning Cash 5.00 25.25 2.00 10.05

Net Cash Inflow 20.25 (26.50) 11.50 9.50

New Short-Term Debt 0.00 3.25 0.00 0.00

Interest on Short-Term Debt 0.00 0.00 0.20 0.00

Short-Term Debt Repayment 0.00 0.00 3.25 0.00

Ending Cash Balance 25.25 2.00 10.05 19.55

Minimum Cash Balance -2.00 -2.00 -2.00 -2.00

Cumulative Surplus (Deficit) 23.25 0.00 8.05 17.55

Beginning Short-Term Debt 0.00 000 3.25 0.00

Change in Short-Term Debt 0.00 3.25 -3.25 0.00

Ending Short-Term Debt 0.00 3.25 0.00 0.00


16.25

Chapter 16 Quick Quiz

Suppose your average inventory is $10,000, your average receivables is $9,000 and your average payables is $4,000. Net sales are $100,000 and cost of goods sold is $50,000. What is the operating cycle and the cash cycle?

What are the differences between flexible and restrictive short-term financial policies?

What factors do we need to consider when choosing a financial policy?

What factors go into determining a cash budget and why is it valuable?

mcgraw-hill/irwin ©2001 the mcgraw-hill companies all rights reserved 16.0 chapter 16 short-term...

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