chap006 ppt
TRANSCRIPT
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Chapter
McGraw-Hill/IrwinCopyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
Working Capital
and the Financing
Decision6
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Chapter Outline
Working capital management
Current asset management
Asset financing Long-term versus short-term financing
Risk and profitability vis--vis asset financing
Expected value analysis may sometimes beemployed
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Working Capital Management
The financing and management of the
current assets of a firm
Crucial to achieving long-term objectives of thefirm or its failure
Requires immediate action
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The Nature of Asset Growth
Effective current assets managementrequires matching of the forecasted salesand production schedules
Differences in actual sales and forecastedsales can result in: Unexpected buildup.
Reduction in inventory, affecting receivables and
cash flow Firms current assets could be:
Self-liquidating
Permanent current assets.
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The Nature of Asset Growth (contd)
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Controlling Assets Matching Sales
and Production Fixed assets grow slowly with:
Increase in productive capacity
Replacement ofold equipment Current assets fluctuate in the short run,
depending on:
Level of production versus the level of sales
When production is higher than sales the inventory
rises
When sales are higher than production, inventory
declines and receivables increase
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Controlling Assets Matching Sales
and Production (contd) Cash budgeting process
Level production method
Smooth production schedules
Use of manpower and equipment efficiently to lower
cost
Match sales and production as closely as
possible in the short run Allows current assets to increase or decrease with
the level of sales
Eliminates the large seasonal bulges or sharp
reductions in current assets
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Matching Sales and Production-
McGraw-Hill Companies, Inc.
A good example of seasonal sale
Has significant share of sales and earnings
in the third and fourth quarters Due to seasonal nature of textbook
publishing
Lenders and financial managers need to planinventory
Lack of correct inventory planning can lead to
lost sales
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Quarterly Sales and Earnings Per
Share for McGraw Hill
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Seasonal Sales Pattern in Target and
Limited Brands Like publishers, retail companies do not
stock inventory for more then a year
Fourth quarter is the biggest quarter forretailers
As per the figure, the Target is growing
much faster than the Limited Brands
Even then, in the fourth quarter, peak
earnings are almost equal for both the
companies
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Quarterly Sales and Earnings Per
Share, Target and Limited Brands
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Point-of-Sales Terminals
Retail-oriented firms use new, computerized
inventory control systems linked online
Digital inputs oroptical scanners Helps adjust orders or production schedules
RadioFrequency Identification (RFID)
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Temporary Assets under Level
Production An Example Yawakuzi Motorcycle Company
Sales fluctuations: High sales demand during
early spring and summer; sales drop during
October through March
Decision: Apply level production method - 12-
month sales forecast is issued
Result: Level production and seasonal salescombine to produce fluctuating inventory
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Yawakuzi Sales Forecast (in units)
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Yawakuzis Production Schedule
and Inventory
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Sales Forecasts, Cash Receipts, and
Payments, and Cash Budget
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Sales Forecasts, Cash Receipts, and
Payments, and Cash Budget (contd) Table 6-3 is created to examine the buildup
in accounts receivable and cash
Sales forecast: Based on assumptions takenearlier (table 6-1)
Cash receipts: 50% cash collected during the
month of sale and 50% pertains to the prior
month Cash budget: a comparison of cash receipt and
payment schedules to determine cash flow
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Total Current Assets, First Year
($millions)
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Yawakuzis Nature of Asset Growth
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Cash Budget and Assets for II Year
With No Growth in Sales ($millions) Graphic presentation of the current asset
cycle.
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Patterns of Financing
Selection of external sources to fund
financial assets is an important decision
The appropriate financing pattern: Matching of asset buildup and length of
financing pattern
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Matching Long-Term and Short-
Term Needs
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Alternative Plans
It is important to considerother alternatives
The challenge of constructing a financial plan is
to prioritize the current assets into temporary
and permanent
The exact timing of asset liquidation, even in the
light of ascertaining dollar amounts is onerous
It is also difficult to judge the amount of short-term and long-term financing available
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Long-Term Financing
Firms can be assured of having adequate
capital at all times:
Use long-term capital to cover part of the short-
term needs
Long-term capital can be used to finance:
Fixed assets
Permanent current assets Part of the temporary current assets
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Using Long-Term Financing for Part
of Short-T
erm Needs
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Short- Term Financing
Small businesses do not have total access
to long-term financing
They rely on short-term bank and trade credit
Advantage: interest rates are lower
Short-term finances are used finance:
Temporary current assets
Part of the permanent working capital needs
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Using Short-Term Financing for Part
of Long-T
erm Needs
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Term Structure of Interest Rates
A yield curve that shows the relative levelof short-term and long-term interest rates
U.S. government securities are popular as they
are free of default risks Corporate debt securities entail a higher interest
rate due to more financial risks
Yield curves for both securities change daily to
reflect: Current competitive conditions
Expected inflation
Changes in economic conditions
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Basic Theories - Yield Curve
Liquidity premium theory
Long-term rates should be higher than short-term rates
Market segmentation theory Treasury securities are divided into market
segments by the various financial institutionsinvesting in the market
Expectations hypothesis
Yields on long-term securities is a function ofshort-term rates
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Long- and Short-Term Annual
Interest Rates
Relative volatility and the historical level of
short-term and long-term rates
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Alternative Financing Plans
ADecision Process: Comparing alternative
financing plans forworking capital
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Impact of Financing Plans on
Earnings
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Varying Condition and its Impact
Tight money periods
Capital is scarce making short-term financing
difficult to find or may ensue very high rates
Inadequate financing may mean loss of sales or
financial embarrassment
Expected value
Represents the sum of the expected outcomesunder both conditions
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Expected Returns under Different
Economic Conditions
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Expected Returns for High Risk
Firms
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Toward an Optimal Policy
A firm should:
Attempt to relate asset liquidity to financing
patterns, and vice versa
Decide how it wishes to combine asset liquidity
and financing needs
Risk-oriented firm - short-term borrowings and low
degree of liquidity
Conservative firm - long-term financing and high
degree of liquidity
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Net working capital as a percentage of
salesS&P Industrials
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Asset Liquidity and Financing
Assets