1. Ch. 16: Short-Term Financial Planning
Cash and Net Working Capital
The Operating Cycle and the Cash Cycle
Short-Term Financial Policy
The Cash Budget
A Short-Term Financial Plan
Short-Term Borrowing
Factoring

2. Sources and Uses of Cash
Sources of Cash
From financing:
Increase in long-term debt
Increase in equity
Increase in current liabilities
From selling assets
Decrease in current assets
Decrease in fixed assets

3. The Operating Cycle
The time it takes to receive inventory, sell it and collect on the receivables generated from the sale
Operating cycle = inventory period + accounts receivable period
Inventory period = time inventory sits on the shelf
Accounts receivable period = time it takes to collect on receivables

4. The Cash Cycle
The time between payment for inventory and receipt from the sale of inventory
Cash cycle = operating cycle – accounts payable period
Accounts payable period = time between receipt of inventory and payment for it
The cash cycle measures how long we need to finance inventory and receivables

5. Table 16.1
Use this table as motivation for why non-finance majors need to understand short-term financial management

6. Example Given the following averages: Inventory = $2,500,
Accounts Receivable = $1,800,
Accounts Payable = $875,
and given Net Sales (all on credit) = $11,500 and Cost of Goods Sold (all on credit) = $8,200,
find Operating Cycle and Cash Cycle (in days)

7. Short-Term Financial Policy
Flexible (Conservative) Policy
Large amounts of cash & 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 & marketable security balances
Low inventory levels
Little or no credit sales (low accounts receivable)
Relatively high levels of short-term liabilities
Low liquidity

8. Policies Graphed See Fig. 16.4, p. 458
Permanent vs. temporary current assets
Best policy will be in between 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

9. Carrying vs. 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 – the cost of ordering additional inventory or transferring cash
Stock-out costs – the cost of lost sales due to lack of inventory, including lost customers

10. Cash Budget Example Expected Sales for 2000 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
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
Minimum cash balance = $2 million

11. Cash Budget

12. Short-Term Financial Plan

13. Short-Term Borrowing Unsecured loans
Line of credit: prearranged agreement with a bank that allows the firm to borrow up to a certain amount on a short-term basis
Committed: formal legal arrangement that may require a commitment fee and generally has a floating interest rate
Non-committed: informal agreement with a bank that is similar to credit card debt for individuals
Revolving credit: non-committed agreement with a longer time between evaluations
Secured loans: loan secured by receivables or inventory or both

14. Factoring Selling receivables 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?
Periodic rate =
APR =
What is the effective annual rate?
EAR =

15. Recommended Practice Self-Test Problems 16.1 & 16.2, pp. 467-8
Problems on pp : 5, 7, 9, 11, 13 (most answers are on p. 549)