Chapter 16

Short-Term Financial PlanningFinal chapter!

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

Chapter Outline

Tracing Cash and Net Working Capital The Operating Cycle and the Cash

Cycle Some Aspects of Short-Term Financial

Policy The Cash Budget Short-Term Borrowing A Short-Term Financial Plan

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

The Operating Cycle

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

Operating cycle defined Inventory period Accounts receivable period

The Cash Cycle

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

Cash cycle defined Accounts payable period The cash cycle measures how long we

need to finance inventory and receivables

Table

Example InformationItem Beginnin

gEnding 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

Example - Operating Cycle Inventory Period

Inventory Turnover IT = ? Inventory Period = ?

Accounts Receivable Period Receivables Turnover

RT = ? Receivables Period = ?

Operating cycle

Example - Cash Cycle Accounts Payable Period Payables turnover

PT = Accounts payables period = Cash cycle =

So, we have to finance our inventory and receivables for ??? days

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

Carrying versus 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 Stock-out costs

Temporary versus Permanent Assets

Are current assets temporary or permanent? Both!

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

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

Figure 16.4

Choosing the Best Policy Best policy will be a combination of

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

Example

Cash Budget Primary tool in short-run financial planning

Identify short-term needs and potential opportunities

Identify when short-term financing may be required

How it works Identify sales, cash collections and cash

outflows Subtract outflows from inflows and

determine investing and financing needs

Example: Cash Budget Information

Expected Sales 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

Example: Cash Budget Information

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 m

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

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

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

Short-Term Borrowing Unsecured loans

Line of credit Committed Non-committed Revolving credit

Secured loans – loan secured by receivables or inventory or both

Example: Factoring Selling receivables to someone else 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? Period rate = .025/.975 = 2.564% APR = 12(2.564%) = 30.769%

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

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

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 are 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?

End of the Semester!

You made it!