1. Short-Term Financial Planning Final chapter!

2. 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

3. 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

4. Sources and 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
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

5. 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

6. 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

7. Table

8. Example Information Item Beginning Ending Average Inventory 200,000
300,000
250,000
Accounts Receivable
160,000
180,000
Accounts Payable
75,000
100,000
87,500
Net Sales = $1,150,000 Cost of Goods Sold = $820,000

9. Example - Operating Cycle
Inventory Period
Inventory Turnover
IT = ?
Inventory Period = ?
Accounts Receivable Period
Receivables Turnover
RT = ?
Receivables Period = ?
Operating cycle

10. 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

11. 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

12. 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

13. 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

14. Figure 16.4

15. 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

16. Example

17. 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

18. 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

19. 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

20. Example: Cash Budget – Cash CollectionsQ1 Q2 Q3 Q4
Beginning Receivables 30 19 22
Sales 57 66 90
Cash Collections = Beg. Receivables + 2/3(Sales) 68 63 82
Ending Receivables = 1/3(Sales)

21. Example: Cash Budget – Cash DisbursementsQ1 Q2 Q3 Q4
Payment of A/P = 50% of sales
28.50
33.00
45.00
Wages, taxes, other expenses
14.25
16.50
22.50
Capital Expenditures
35.00
Long-term financing (interest and dividends)
5.00
Total Disbursements
47.75
89.50
54.50
72.50

22. Example: Cash Budget – Net Cash Flow and Cash BalanceQ1 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
9.50
Ending Cash Balance
19.75
Minimum Cash Balance
-2.00
Cumulative surplus (deficit)
23.25
(3.25)
8.25
17.75

23. Short-Term Borrowing Unsecured loans
Line of credit
Committed
Non-committed
Revolving credit
Secured loans – loan secured by receivables or inventory or both

24. 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%) = %
What is the effective rate?
EAR = – 1 = %

25. 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
Interest on Short-Term Debt
0.20
Short-Term Debt Repayment
Ending Cash Balance
19.55
Minimum Cash Balance
-2.00
Cumulative Surplus (Deficit)
23.25
8.05
17.55
Beginning Short-Term Debt
000
Change in Short-Term Debt
-3.25
Ending Short-Term Debt

26. 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?

27. End of the Semester!
You made it!