1. Managing the Firm’s Assets
part 7
Financial Management in the Entrepreneurial Firm 23
Managing the Firm’s Assets
PowerPoint Presentation by Charlie Cook
12e
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All rights reserved.

2. Looking Ahead After studying this chapter, you should be able to:
Describe the working capital cycle of a small business.
Identify the important issues in managing a firm’s cash flows.
Explain the key issues in managing accounts receivable, inventory, and accounts payable.
Discuss the techniques commonly used in making capital budgeting decisions.
Determine the appropriate cost of capital to be used in discounted cash flow techniques.
Describe the capital budgeting practices of small firms.
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3. Working-Capital Working Capital Management Net Working Capital
The management of current assets and current liabilities
Net Working Capital
The sum of a firm’s current assets (cash, account receivable, and inventories) less current liabilities (short-term notes, accounts payable, and accruals).
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4. The Working-Capital Cycle (cont’d)
Purchase or produce inventory for sale, which increases accounts payable.
a. Sell inventory for cash. b. Sell inventory for credit (accounts receivable).
Pay the accounts payable (decreases cash and accounts payable).
Collect the accounts receivable (decreases accounts payable and increases cash).
Begin cycle again
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5. The Working Capital Cycle
Increases
accounts payable
Increases inventory
Decreases inventory 2a
for cash 3b
Pay
operating
expenses
and taxes 1
Purchase
or produce
inventory 2
Sell the 2b
on credit
accounts
receivable
Decreases
payable 3a 4
Collect 5
Begin cycle
again
Cash
decreases
increases
The Working Capital Cycle
Fig. 23.1
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6. Working-Capital Time Line
Order
Placed
Inventory
Received
Cash Payment
for Inventory
Sale
Cash Collection
of Receivables
Days in Inventory
Days in Accounts Receivable
Days in Accounts Payable
Cash Conversion Period a b c d
Cash conversion period— the time required to convert paid-for inventories and accounts receivable into cash.
Source: Adapted from Terry W. Maness and John T. Zeitlow, Short-Term Financial Management (New York: Dryden Press/Harcourt Brace, 1998), p. 4.
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Fig. 23.2

7. Pokey, Inc.’s Beginning Balance Sheet
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8. Pokey, Inc.’s Monthly Balance Sheets
July
Aug.
Sept.
Cash
400
(100)
Accounts receivable
Inventory
500
Fixed assets
600
Accumulated depreciation
TOTAL ASSETS
1,000
1,500
Accounts payable
Accrued operating expenses
Income tax payable
Long-term debt
300
Common debt
700
Retained earnings
TOTAL DEBT AND EQUITY
Changes: August to September
–500
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9. Pokey, Inc.’s Monthly Balance Sheets
July
Aug.
Sept.
Oct.
Cash
400
(100)
Accounts receivable
900
Inventory
500
Fixed assets
600
Accumulated depreciation
(50)
TOTAL ASSETS
1,000
1,500
1,350
Accounts payable
Accrued operating expenses
250
Income tax payable 25
Long-term debt
300
Common debt
700
Retained earnings 75
TOTAL DEBT AND EQUITY
Changes: September to October
+900
–500
–50
+250
+25
+75
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10. Pokey, Inc.’s Monthly Balance Sheets
Changes: October to November
+650
–900
–250
July
Aug.
Sept.
Oct.
Nov.
Cash
400
(100)
550
Accounts receivable
900
Inventory
500
Fixed assets
600
Accumulated depreciation
(50)
TOTAL ASSETS
1,000
1,500
1,350
1,100
Accounts payable
Accrued operating expenses
250
Income tax payable 25
Long-term debt
300
Common debt
700
Retained earnings 75
TOTAL DEBT AND EQUITY
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11. Changes in Pokey’s Balance Sheet
Change in the Balance Sheet Effect on Income Statement
Increase accounts receivable of $900 Sales $900
Decrease inventories of $500 Cost of goods sold $500
Increase in accrued operating Operating expenses $250 expenses of $250
Increase accumulated depreciation of $50 Depreciation expense $50
Increase accrued taxes of $25 Tax expense $25
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12. Pokey’s November Income Statement
Sales revenue
900
Cost of goods sold
500
Gross Profit
400
Operating expenses:
Cash
250
Depreciation 50
Total operating expenses
300
Operating income
100
Income tax (25%) 25
Net income 75
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13. Working Capital Time Line for Pokey, Inc
Order
Placed
Inventory
Received
Cash Payment for Inventory
Sale
Cash Collection
of Receivables
Days in Inventory
Days in Accounts Receivable
Days in Accounts Payable
Cash Conversion Period
Pokey, Inc.
Oct. 15
Nov. 30
Aug. 31
Aug. 15
Sept. 30
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Fig. 23.3

14. Working Capital Time Line for Quick-turn Company
Order
Placed
Inventory
Received
Cash Payment for Inventory
Sale
Cash Collection
of Receivables
Days in Inventory
Days in Accounts Receivable
Days in Accounts Payable
Quick-turn Company
Aug. 31
Aug. 15
Sept. 30
Oct. 31
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Fig. 23.3b

15. Managing Cash Flows The Nature of Cash Flows Net Cash Flow Net Profit
The flow of actual cash through a firm.
Net Cash Flow
The difference between inflow and outflows
Net Profit
The difference between revenue and expenses
The Growth Trap
A cash shortage resulting from rapid growth
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16. Flow of Cash Through A Business
Borrowed
Funds
Collection of
Accounts
Receivable
Owner's
Investment
Sale of
Fixed Assets
Payment of
Expenses
Payment for
Inventory
Dividends
Cash
Sales
Purchase of
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Fig. 23.4

17. Chai Corporation: Cash Budget (July -September)
May June July August September Monthly Sales $100,000 $120,000 $130,000 $130,000 $120,000
Cash receipts
Cash sales for month (40%) $ 52,000 $ 52,000 $ 48,000
1 month after sale (30%) 36, , ,000
2 months after sale (30%) 30, ,000 39,000
Step 1 Total collections $118,000 $127,000 $126,000
Purchases (80% of sales) $104,000 $104,000 $ 96,000 $ 80,000
Cash disbursements Step 2a Payments on purchases $104,000 $104,000 $ 96,000 Rent 3,000 3,000 3,000
Wages and salaries 18,000 18,000 16,000
Step 2b Tax prepayment 1,000 Utilities (2% of sales) 2,600 2,600 2,400
Interest on long-term note
Step 2c Short-term interest (1% of short-term debt)
Total cash disbursements $128,600 $127,706 $118,313
Step 3 Net change in cash $ 10,600 $ $ 7,687
Step 4 Beginning cash balance 5,000 5,000 5,000
Step 5 Cash balance before borrowing $ 5,600 $ 4,294 $ 12,687
Step 6 Short-term borrowing (payments) 10, ,687 Ending cash balance $ 5,000 $ 5,000 $ 5,000
Step 7 Cumulative short-term debt outstanding $ 10,600 $ 11,306 $ 3,619
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18. Managing Accounts Receivable
How Accounts Receivable Affect Cash
Accounts receivable represent the firm’s decision to delay the inflow of cash from customers who have been extended credit.
Life Cycle of Accounts Receivable
Firm makes credit sale to customer.
Invoice is prepared and sent to customer.
Customer pays firm.
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19. Managing Accounts Receivable
Accounts Receivable Financing
Financing speeds up immediate cash flow
Pledged accounts receivable
Accounts receivable used as collateral for a loan.
Factoring
Obtaining cash by selling accounts receivable at a discount to another firm.
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20. Managing Inventory Inventory is a “necessary evil.”
Product supply and consumer demand don’t always match up.
Reducing Inventory to Free Cash
Monitoring current inventory
Determine age and suitability for sale.
Controlling stockpiles
Match on-hand inventory with demand.
Avoid personalizing the business-customer relationship.
Avoid forward purchasing of inventory; the carrying cost for excess inventory may exceed any savings.
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21. Managing Accounts Payable
Negotiation
Asks creditors for adjustments or additional time.
Timing
Creditors’ funds can supply short-term cash needs until payment is demanded.
Accounts with cash discounts for early payment should be examined for their savings potential.
“Buy now, pay later”—pay early enough to get cash discounts and timely enough to avoid late-payment fees.
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22. An Accounts Payable for Terms 3/10, Net 30
Annualized interest rate
discount%
Cash -
100 %
discount x
period
Net
year in
Days =
56.4% or
0.564, x
18.25 =
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Table 23.2

23. Capital Budgeting Capital Budgeting Analysis
An analytical method that helps managers make decisions about long-term investments such as:
Developing new products Replacing equipment
Construct new facilities Expand sales territories
Seeks to answer the question:
“Do future benefits from the investment exceed the cost of making the investment?”
Good decisions can add value to the firm; bad decisions can put the firm out of business.
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24. Three Rules of Capital Budgeting
Investors judging the attractiveness of an investment prefer:
More cash rather than less cash.
Cash sooner rather than later.
Less risk rather than more risk.
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25. Capital Budgeting Techniques
Capital Budgeting Decisions Involve:
Accounting return on investment
How many dollars in average profits are generated per dollar of average investment?
Payback period
How long will it take to recover the original profit outlay?
Discounted cash flows (net present value or internal rate of return)
How does the present value of future benefits from the investment compare to the investment outlay?
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26. Capital Budgeting Techniques
Accounting return on investment
Evaluation of a capital expenditure based on the average annual after- tax profits relative to the average book value of an investment.
Initial investment = $10,000
Year After-Tax Profits 1 1, , , ,000 2
000 10 4 3
500 1 + = ,
Accounting return on investment
42.5% or
0.425,
5,000
2,125 =
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27. Capital Budgeting Techniques
Payback period
Measuring the amount of time it will take to recover the cash outlay of an investment.
Original Investment = $15,000
Annual Depreciation = $1,500
Acceptable payback period= 5 years
Payback period = 4.86 years
After-Tax Year Profits 1–2 1,000 3–6 2,000 7–10 2,500
After-Tax Cash Flows 2,500 3,500 4,000
Investment Recovery Year 1-2 Year , ,500
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28. Discounted Cash Flows Discounted Cash Flows (DCF)
An analysis comparing the present value of future cash flows with the cost of the initial investment.
Considers that cash received today is more valuable than cash to be received in the future—the time value of money.
Net present value (NPV)
The current value of cash that will flow from a project over time less the initial investment outlay.
Internal rate of return (IRR)
The rate of return that a firm expects to earn on a project; return rate must exceed cost of capital.
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29. A Firm’s Cost of Capital
The rate of return required to satisfy a firm’s debt holders and investors.
Opportunity Cost
The rate of return that could be earned on another investment of similar risk.
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30. Measuring the Cost of Capital
Weighted Cost of Capital
The cost of capital adjusted to reflect the relative costs of debt and equity financing.
Weighted Weight Cost Cost Debt 40% 7.5% 3.0 % Equity 60% 18.0% 10.8% Total 100% 13.8%
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31. Using the Cost of Debt as an Investment Criterion
Favorable Financial Leverage
A benefit gained by investing at a rate of return that is greater than the interest rate on a loan.
Debt Capacity
The limit at which a firm cannot assume more debt without additional equity investment by its owners.
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32. Capital Budgeting Practices of Small Firms
Factors Affecting the Capital Budgeting Analysis Process:
Nonfinancial (personal) variables
Undercapitalization and liquidity problems
Uncertainty of cash flows within the firm
Lack of established market value for the firm
Small size, scope, and length of firm’s projects
Lack of managerial experience and talent in firm
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