Financial Management in Working Capital | Đại Học Hoa Sen

1. ĐẠI HỌC HOA SENKhoa Kinh tế Thương mại

2. KHOA KINH TẾ THƯƠNG MẠI FINANCIAL MANAGEMENT ThS. Nguyễn Tường Minh Email: minh.nguyentuong@yahoo.com.vn

3. References • Foundation of Financial Management, Block & Hirt, McGraw Hill, 13th edition,USA, 2009. • Fundamentals of Corporate Finance, Brealey et al., McGraw Hill, 5th edition, USA, 2007. • Other relevant materials.

4. Chapter 6: Working Capital and the Financing Decision • Chapter Opening • Rapidly expanding sales may cause intense pressure for inventory and receivables • buildup – draining the cash resources of the firm • Some of the increased current assets can be financed through the firm’s retained • earnings, and some external sources of funds must be found • Seasonal demand for products makes forecasting cash flows and receivables and • inventory management difficult • Working capital management involves the financing and management of the current • assets of the firm

5. Chapter 6: Working Capital and the Financing Decision • Main Contents: • The nature of Asset growth • Controlling Assets – matching Sales and Production • Patterns of financing • The financing decision • A decision process • Toward an optimal policy

6. I. The Nature of Asset Growth • The key to current assets planning is the ability of management to forecast sales • accurately and then to match the production schedules with the sales forecast

7. I. The Nature of Asset Growth • Failure to realize the firm’s permanent • current assetscauses the problems of • inadequate financing

8. II. Controlling Assets – Matching Sales and Production • An example of Seasonal sales • The smallest sales are in the first and second quarters of the year • In the first and second quarters of the year, the heavy fixed costs of publishing • cause very low EPS

9. II. Controlling Assets – Matching Sales and Production (cont’d) • An example of Seasonal sales (cont’d) • If management has not planned inventory correctly, lost sales due to stock outs could • be a serious problem

10. II. Controlling Assets – Matching Sales and Production (cont’d) • An example of Seasonal sales (cont’d) • Two retails companies do not stock a year or more of inventory at one time • Most retail stores are not involved in deciding on level versus seasonal production, • but rather in matching sales and inventory as the products are either manufactured for • them by either others or their subsidiaries • The forth quarter for retailers is their biggest quarter and accounts for as much as • one-half of their earning

11. II. Controlling Assets – Matching Sales and Production (cont’d) • An example of Seasonal sales (cont’d) • Both companies show seasonal peaks and troughs in sales that will also be reflected • in their cash balance, account receivables, and inventory • Target is growing much faster than Limited Brands, but its EPS is almost as high as • Target’s at the forth quarter as Limited Brands use higher leverage • The financial manager must avoid getting caught short of cash or be unprepared to • borrow in relation to the seasonal sales

12. II. Controlling Assets – Matching Sales and Production (cont’d) • Temporary Assets under Level Production: an example of Yawakuzi • Yawakuzi sales forecast (in unit): • Yawakuzi decides to produce 800 motorcycles per month

13. II. Controlling Assets – Matching Sales and Production (cont’d) • Temporary Assets under Level Production: an example of Yawakuzi (cont’d) • Yawakuzi’s production schedule and inventory:

14. II. Controlling Assets – Matching Sales and Production (cont’d) • Temporary Assets under Level Production: an example of Yawakuzi (cont’d) • Sales forecast, cash receipts and payments, and cash budgets:

15. II. Controlling Assets – Matching Sales and Production (cont’d) • Temporary Assets under Level Production: an example of Yawakuzi (cont’d) • Total current assets first year ($ million)

16. II. Controlling Assets – Matching Sales and Production (cont’d) • Temporary Assets under Level Production: an example of Yawakuzi (cont’d) • Cash budget and assets for second year with no growth in sales ($ million) • Assumptions in second year: • No-growth • The monthly cash flow is the same as that of the first year

17. II. Controlling Assets – Matching Sales and Production (cont’d) • Temporary Assets under Level Production: an example of Yawakuzi (cont’d) • The nature of asset growth

18. III. Patterns of Financing • Is it always the axiom that all current assets should be financed by current liabilities ? • The most appropriate financing pattern is that asset buildup and length of financing terms • are perfectly matched • The difficulty is in determining precisely what part of current asset is temporary and what • part is permanent • The exact timing of asset liquidation is a difficult matter

19. III. Patterns of Financing (cont’d) Long-term financing • To protect against the danger of not being able to provide adequate short-term financing • in tight money periods, the financial manager may rely on long-term funds to cover some • short-term needs

20. III. Patterns of Financing (cont’d) Short-term financing • Many small businesses find it hard to access to long-term capital, what should they do ? • What are the advantages of the short-term financing ?

21. IV. The Financing Decision • In making the financing decision, the financial manager have to solve a timing problem, • as well as select the right type of financing

22. IV. The Financing Decision (cont’d) • Corporations are more flexible than others in finding the sources of funds and minimize • their cost of funds • From the forecasted asset needs, the firms often minimize their financing cost by raising • funds in advance

23. IV. The Financing Decision (cont’d) • Term structure of interest rates (Yield curve): • Yield curve – is the relative level of short-term and long-term interest rates at a point in time • Yield curve is valuable for decision of how to time and structure the borrowing between • short- and long-term

24. IV. The Financing Decision (cont’d) • Term structure of interest rates (Yield curve): • Yield curves are constructed by the US government securities • Yield on corporate debt securities move in the same direction as government securities, • but have higher interest rate • Yield curves change daily to reflect the macroeconomic conditions or the competitive • environment of the money and capital markets • Long-term rates should be higher than short-term rates • Long-term rates reflect the average of short-term expected rates over the time period

25. IV. The Financing Decision (cont’d) • Term structure of interest rates (Yield curve): • Yield curves help the financial manager to expect the cost of financing over time: • The higher interest rate in the long term reflects the higher anticipated one-year • rate in the future • As long-term rates are much higher than short-term rates, the short-term rates are • expected to rise • As long-term rates are lower than short-term rates, the short-term rates are expected • to fall • As interest rates are high and expected to decline, the financial manager will try • to borrow short term • As the interest rates decline, the CFO will try to lock in the lower rates with heavy • long-term borrowing

26. IV. The Financing Decision (cont’d) • Term structure of interest rates (Yield curve): The financial manager try to forecast the inflation to trace out the expected interest rate

27. V. A Decision Process

28. V. A Decision Process (cont’d)

29. VI. Toward an Optimal Working Capital Policy 1 Most aggressive asset – financing mix plan 4 Most conservative asset – financing mix plan 2, 3 Moderate approach

30. Chapter 6: Working Capital and the Financing Decision • Chapter concepts • Working capital management involves financing and controlling the current assets of • the firm • Management must distinguish between those current assets that are easily converted • to cash and those that are more permanent • The financing of an asset should be tied to how long the asset is likely to be on the • balance sheet • Long-term financing is usually more expensive than short-term financing based on the • theory of the term structure of interest rate • Risk, as well as profitability, determines the financing plan for current assets

31. Thank you for your attention !