Short-Term Financial Management: Cash and Collections

1. chapter12 Short-Term Financial Management Lonni Steven Wilson, Medaille College

2. Key Chapter Objectives • Understand the definition of net working capital and see how it is calculated. • Discuss cash management by sport businesses, including how much cash to hold. • Understand what is involved in the efficient collection and disbursement of cash. • Identify issues that arise as businesses engage in collections management, the conversion of accounts receivable to cash.

3. Key Terms net working capital—As discussed earlier, net working capital equals current assets minus current liabilities. short-term financial management—Centers on current assets and current liabilities, which generate inflows or outflows of cash to or from a business within one year or less. accounts receivable—Unpaid bills for goods and services that have been sold to customers. current assets—Cash and other assets that are expected to be converted to cash within one year.

4. Accounts Receivable • As shown in table 12.1 (see next slide), accounts receivable are an extremely important current asset. • Typically, accounts receivable have the largest value relative to other current assets.

5. Table 12.1 from the Text All numbers are in billions From U.S. Department of Commerce, Bureau of the Census, Quarterly Financial Report for Manufacturing, Mining and Trade Corporations: 2006: Quarter 2.

6. Types of Current Assets • Cash • Marketable securities • Accounts receivable • Inventories • Prepaid expenses • Other types of current assets

7. Types of Current Liabilities • Short-term debt • Accounts payable • Accrued income taxes • Current payments on long-term debt • Accrued liabilities • Unearned or deferred credits • Other types of current liabilities

8. Cash Management Decisions • How much cash to hold • How best to replenish cash (marketable securities versus borrowing) • How to achieve efficient collection and disbursement of cash Why hold cash? The reason for holding cash (despite the fact that it doesn’t earn interest) is the need for liquidity (i.e., having an asset on hand for immediate transactions).

9. Key Terms payment float—Checks written by the firm and not yet cleared. availability float—Checks received by the firm and deposited but not yet cleared. net float—The net effect of checks in the process of collection (payment-availability float).

10. The Benefit of Float Interest is earned on available balance from the bank while payment float occurs (assuming the business has an interest-earning account with the bank). The financial manager’s true concern is with available balance rather than ledger balance.

11. Methods of Reducing Float • Concentration banking: Making payments to a local office as opposed to corporate headquarters. Reduces mail time; local checks reduce processing time. • Lockbox system: Sending payments to a post office box (regional collection point); a bank collects and deposits the payments on behalf of the company. (continued)

12. Methods of Reducing Float (continued) Disbursements: Having regional banking accounts whereby suppliers in that region have disbursement checks written to them from a relatively close bank. Note: This system can also be used to increase float if, for example, companies use banks in remote locations such as Helena, Montana, or Pierre, South Dakota, which would then mean it would take suppliers extra days to receive and cash checks. Electronic funds transfers: Reducing the use of paper checks, thereby speeding up collections and reducing availability float.

13. Credit Management The terms of credit become important in determining the amount of accounts receivable appearing on the balance sheet. • 1/10/30: Customers receive a 1% discount for paying within 10 days. • 2/10/30: Customers receive a 2% discount for paying within 10 days. If customers have a poor credit record • COD (cash on delivery) • CBD (cash before delivery)

14. Average Daily Sales Outstanding • SMC’s annual sales are $4 million. • Therefore, its average daily sales = $4,000,000 / 365 days = $10,959 per day. • The average daily sales outstanding is equal to the average daily sales divided by current accounts receivable. • Assume that accounts receivable equal $186,300. • The average daily sales outstanding therefore equals $186,300 / $10,959 = 17 days. • This means that when making a purchase, the average SMC customer pays in 17 days.

15. Aging Report An aging report tabulates receivables by accounts’ ages. Table 12.2 Sample Aging Report (continued)

16. Aging Report (continued) • An aging report can provide more detailed information. • Note that in table 12.1, a significant number of customers are past due (40% of accounts are outstanding more than 30 days). • Any company that displays a report like the one shown in table 12.2 has serious collections problems and should be reviewing its collections policies.

17. Questions for In-Class Discussion • How should a business monitor collections activity? • How has the advent of greater volumes of electronic funds transfers affected the accumulation of float by a business?