Short Term Financial Planning Principles of Corporate Finance Brealey and Myers Sixth Edition Slides by Matthew Will Chapter 29 © The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill
© The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill Topics Covered Working Capital Links Between Long-Term and Short-Term Financing Tracing Changes in Cash and Working Capital Cash Budgeting A Short-Term Financing Plan
© The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill Working Capital Net Working Capital - Current assets minus current liabilities. Often called working capital. Cash Conversion Cycle - Period between firm’s payment for materials and collection on its sales. Carrying Costs - Costs of maintaining current assets, including opportunity cost of capital. Shortage Costs - Costs incurred from shortages in current assets.
© The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill Firm’s Cumulative Capital Requirement Lines A, B, and C show alternative amounts of long-term finance. Strategy A: A permanent cash surplus Strategy B: Short-term lender for part of year and borrower for remainder Strategy C: A permanent short-term borrower A B C Year 2Year 1 Dollars Cumulative capital requirement Time
© The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill Working Capital Simple Cycle of operations Cash
© The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill Working Capital Simple Cycle of operations Cash Raw materials inventory
© The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill Working Capital Simple Cycle of operations Cash Finished goods inventory Raw materials inventory
© The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill Working Capital Simple Cycle of operations Cash Finished goods inventory Receivables Raw materials inventory
© The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill Working Capital Simple Cycle of operations Cash Finished goods inventory Receivables Raw materials inventory
© The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill Changes in Cash & W.C. Example - Dynamic Mattress Company
© The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill Changes in Cash & W.C. Example - Dynamic Mattress Company Assume dividend = $1 mil R.E.=$11 mil
© The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill Changes in Cash & W.C. Example - Dynamic Mattress Company
© The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill Changes in Cash & W.C. Example - Dynamic Mattress Company Dynamic used cash as follows: Paid $1 mil dividend. Repaid $5 mil short term bank loan. Invested $14 mil. Purchased $5 mil of marketable securities. Accounts receivable expanded by $5 mil.
© The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill Cash Budgeting Steps to preparing a cash budget Step 1 - Forecast the sources of cash. Step 2 - Forecast uses of cash. Step 3 - Calculate whether the firm is facing a cash shortage or surplus.
© The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill Cash Budgeting Example - Dynamic Mattress Company Dynamic forecasted sources of cash AR ending balance = AR beginning balance + sales - collections
© The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill Cash Budgeting Example - Dynamic Mattress Company Dynamic collections on AR
© The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill Cash Budgeting Example - Dynamic Mattress Company Dynamic forecasted uses of cash Payment of accounts payable Labor, administration, and other expenses Capital expenditures Taxes, interest, and dividend payments
© The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill Cash Budgeting Example - Dynamic Mattress Company Dynamic cash budget
© The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill Cash Budgeting Example - Dynamic Mattress Company Dynamic short term financing requirements
© The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill A Short Term Financing Plan Example - Dynamic Mattress Company Dynamic forecasted deferrable expenses
© The McGraw-Hill Companies, Inc., 2000 Irwin/McGraw Hill A Short Term Financing Plan Example - Dynamic Mattress Company- Financing Plan