Ch. 16: Short-Term Financial Planning

1. Ch. 16: Short-Term Financial Planning • Cash and Net Working Capital • The Operating Cycle and the Cash Cycle • Short-Term Financial Policy • The Cash Budget • A Short-Term Financial Plan • Short-Term Borrowing • Factoring

2. Sources and Uses of Cash • Sources of Cash • From financing: • Increase in long-term debt • Increase in equity • Increase in current liabilities • From selling assets • Decrease in current assets • Decrease in fixed assets

3. 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 period • Inventory period = time inventory sits on the shelf • Accounts receivable period = time it takes to collect on receivables

4. The Cash Cycle • The time between payment for inventory and receipt from the sale of inventory • Cash cycle = operating cycle – accounts payable period • Accounts payable period = time between receipt of inventory and payment for it • The cash cycle measures how long we need to finance inventory and receivables

5. Table 16.1

6. Example • Given the following averages: • Inventory = $2,500, • Accounts Receivable = $1,800, • Accounts Payable = $875, • and given Net Sales (all on credit) = $11,500 and Cost of Goods Sold (all on credit) = $8,200, • find Operating Cycle and Cash Cycle (in days)

7. Short-Term Financial Policy • Flexible (Conservative) Policy • Large amounts of cash & 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 & marketable security balances • Low inventory levels • Little or no credit sales (low accounts receivable) • Relatively high levels of short-term liabilities • Low liquidity

8. Policies Graphed • See Fig. 16.4, p. 458 • Permanent vs. temporary current assets • Best policy will be in between flexible and restrictive policies • Things to consider • Cash reserves • Maturity hedging • Relative interest rates • Compromise policy: borrow short-term to meet peak needs, maintain a cash reserve for emergencies

9. Carrying vs. Shortage Costs • Carrying costs • Opportunity cost of owning current assets versus long-term assets that pay higher returns • Cost of storing larger amounts of inventory • Shortage costs • Order costs – the cost of ordering additional inventory or transferring cash • Stock-out costs – the cost of lost sales due to lack of inventory, including lost customers

10. Cash Budget Example • 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 • Minimum cash balance = $2 million

11. Cash Budget

12. Short-Term Financial Plan

13. 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

14. Factoring Selling receivables at a discount Example: 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? Periodic rate = APR = What is the effective annual rate? EAR =

15. Recommended Practice • Self-Test Problems 16.1 & 16.2, pp. 467-8 • Problems on pp. 470-4: 5, 7, 9, 11, 13 (most answers are on p. 549)