Presentation By: Edith Muinde Kathy Kibowen Olivia Otieno SHORT TERM FINANCING Presentation By: Edith Muinde Kathy Kibowen Olivia Otieno

INTRODUCTION

Whereas long term financing decisions concern how the firm finances its assets over several years, short-term financing decisions concern how the firm can get the money it needs for daily, weekly and monthly needs. Cash management is paramount, either budgeting the amount on hand, buying supplies on credit, or borrowing it for short periods of time. Short term funds are also often used for investments in accounts receivable and inventory (Gallagher and Andrew, 2007).

COMPONENTS OF WORKING CAPITAL

CURRENT ASSETS This includes: Current receivables - Arise because companies do not expect customers to pay for their purchases immediately. These unpaid bills are a valuable asset that companies expect to be able to turn into cash in the near future. Inventory – This consists of raw materials, work in process or finished goods awaiting sale and shipment.

Cash securities – This consists partly of currency bills but most common is in form of bank deposits. Market Securities - The principal market security is commercial paper (short-term unsecured debt sold by other firms). Other securities include Treasury bills (short-term debts sold by government and state and local government securities.

CURRENT LIABILITIES As earlier noted, a company’s principlal current asset consists of unpaid bills. One firm’s credit must be another’s debit. Accounts payable – outstanding payments due to other companies. Short-term borrowing – This is another major current liability.

WORKING CAPITAL AND CASH CONVERSION CYCLE

NET WORKING CAPITAL Net working capital is the difference between current assets and current liabilities. The components of working capital constantly change with the cycle of operations, but the amount of working capital is fixed. This is one reason why net working capital is a useful summary measure of current assets and current liabilities.

CASH CONVERSION CYCLE A firm starts the cycle by purchasing raw materials, but it does not pay for them immediately. This delay is the accounts payable period. The firm processes the raw materials and then sells the finished goods. The delay between the initial investment in inventories and the sale date is the inventory period Sometime after the firm has sold the goods, its customers pay their bills. The delay between the date of sale and the date at which the firm is paid is the accounts receivable period.

Cash conversion cycle = (inventory period + receivable period) – accounts payable period Inventory period = average inventory annual cost of goods sold/365 Accounts receivable period = average accounts receivable annual sales/365 Accounts payable period = average accounts payable annual cost of goods sold/365

WORKING CAPITAL MANAGEMENT

Cash conversion cycle is not cast in stone Cash conversion cycle is not cast in stone. To a large extent, it is within the management control. Working capital can be managed. For instance: Accounts receivable are effected by the terms of credit the firm offers to its customers. Reduce the amount of money tied up in receivables by getting tough on customers who delay in paying debts. –(risk of customers taking their business elsewhere) Reduce investment in inventories of raw materials.-(risk of one day running out of inventories and production stall)

A financial manager must always strike a balance between the costs and benefits of current assets i.e find level of current assets that minimize the sum of carrying costs and shortage costs.

TOOLS OF SHORT TERM FINANCIAL PERFORMANCE

CASH BUDGET This is a statement of the firms planned inflows and outflows of cash. Firms use the cash budget to ensure they will have enough cash available to meet short term financial obligations. Any surplus cash resources can be invested quickly and efficiently. It usually spans a one year period, with more frequent breakdowns provided as components of the budget.

CASH RECEIPTS Include all the firm’s cash inflows in a given period. The most common components of cash receipts are cash sales, collections of accounts receivable, and other cash receipts.

CASH DISBURSEMENTS Include all outlays of cash by the firm in the period. The most common cash disbursements are cash purchases, fixed-asset outlays, payments of accounts payable, wages, interest payments, taxes and rent and lease payments. Cash disbursements may also include items such as dividends and share repurchases.

CASH AND LIQUIDITY MANAGEMENT

This explains how firms manage cash This explains how firms manage cash. However, it is important to know the difference between cash management and liquidity management.

REASONS FOR LIQUIDITY Speculative motive – this is the need to hold cash to take advantage of additional investment opportunities, such as bargain purchase that might arise attractive interest rates, and favourable exchange rate fluctuations in case of international firms. Precautionary motive – the need to hold cash as a safety margin to act as a financial reserve.

Transaction motive- the need to have cash on hand to satisfy normal disbursement and collection activities associated with a firm’s ongoing operations. Compensating balances – cash balances are kept at commercial banks to compensate for banking services the firm receives. A minimum compensating balance requirement may impose a lower limit on the level o cash a firm holds.

Understanding float Most of the time money that a firm has may be different from that which the bank thinks it has. This is because some of the written checks may not have been presented for payment.

We look at two types of float and they include; Disbursement float; which is created when firms write checks to decrease the book balance but no change in its available balance. Collection float; are created when firm’s receive checks and it increases book balance but does not immediately change available balance.

Float management This involves controlling the collection and disbursement of cash. The objective in cash collection is to speed up collections and reduce the lag between the time customers pay bills and the time the cash becomes available.

CASH COLLECTION & CONCENTRATION The primary objective of the collections process is to quickly and efficiently collect funds from customers and others. This process includes gathering and disseminating information related to the collections. Collection delays usually work against the firm

CREDIT AND INVENTORY MANAGEMENT

SHORT-TERM BORROWING There are four short-term borrowing options: unsecured borrowing, secured borrowing, commercial paper, and trade credit.

Unsecured Loans The most common way to finance a temporary cash deficit is to arrange a short-term unsecured bank loan . This kind of loan is recommended if the company has an excellent credit rating. It is usually used to finance projects having quick cash flows and is appropriate if the company has immediate cash and can either repay the loan in the near future or quickly obtain longer term financing

Secured Loans Banks and other finance companies often require security for a short-term loan just as they do for a long-term loan. Security for short-term loans usually consists of accounts receivable, inventories, or both.

accounts receivable financing This involves either assigning receivables or factoring receivables. Under assignment, the lender has the receivables as security, but the borrower is still responsible if a receivable can't be collected. With conventional factoring, the receivable is discounted and sold to the lender (the factor). Once it is sold, collection is the factor's problem, and the factor assumes the full risk of default on bad accounts. With maturity factoring, the factor forwards the money on an agreed-upon future date.

inventory loans These are short-term loans to purchase inventory, come in three basic forms: blanket inventory liens, trust receipts, and field warehouse financing:

Blanket Inventory Lien Blanket Inventory Lien. A blanket lien gives the lender a lien against all the borrower's inventories (the blanket "covers" everything). Trust Receipt. A trust receipt is a device by which the borrower holds specific inventory in "trust" for the lender. Automobile dealer financing, for example, is done by use of trust receipts. This type of secured financing is also called floor planning; in reference to inventory on the showroom floor. However, it is somewhat cumbersome to use trust receipts for, say, wheat grain. Field Warehouse Financing. In field warehouse financing, a public warehouse company (an independent company that specializes in inventory management) acts as a control agent to supervise the inventory for the lender.

Commercial Paper There are a variety of other sources of short-term funds employed by corporations. One of the most important, especially for certain very large corporations is commercial paper. Commercial paper consists of short-term notes issued by large and highly rated firms. Typically, these notes are of short maturity, ranging up to 270 days (book 1). Commercial paper can be issued only if the company possesses a high credit rating; therefore, the interest rate is less than that of a bank loan (Shim & Siegel, 2000). This is because the firm issues these directly and because it usually backs the issue with a special bank line of credit.

Trade Credit Another very important source of short-term financing for firms of all sizes is trade credit, meaning accounts payable. Such payables amount to money borrowed from suppliers, and small firms in particular rely heavily on suppliers for short-term credit. Trade credit is important for large firms as well; retailing giant Wal-Mart uses more trade credit than it does money borrowed from banks.

Cash Discounts As we have seen, cash discounts are often part of the terms of sale. The practice of granting discounts for cash purchases in the United States dates to the Civil war and is widespread today. One reason discounts are offered is to speed up the collection of receivables and reduce the amount of credit being offered (and the potential losses from defaults).