1. FINANCIAL PLANNING & FORECASTING Chapter 16 The Sales Forecast Additional Funds Needed Pro Forma Financial Statements

2. Short-Term Financial Planning A.Two Important “Cycles” 1.Operating Cycle = Inventory Conversion Period + Accounts Receivable Period 2.Cash Cycle = OC – Payables Deferral Period Dr. David P EchevarriaAll Rights Reserved2

3. Dr. David P EchevarriaAll Rights Reserved3 CASH FLOW CYCLE (Cash Conversion Cycle) A.The Cash Cycle (CC) = ICP + RCP - PDP 1.The Inventory Conversion Period (ICP)  ICP = Average Inventory / (COGS / 365) 2.Receivables Collection Period (RCP)  RCP = Average Receivables / (Cr. Sales / 365) 3.Payables Deferral Period (PDP)  PDP = Payables / (COGS / 365)

4. Dr. David P EchevarriaAll Rights Reserved4 CASH [FLOW] CYCLE 4.CC are shortened by a.Reducing the ICP. b.Reducing the RCP. c.Lengthening the PDP. d.The CC Equation (using a 360-day year) CC =

5. Dr. David P EchevarriaAll Rights Reserved5 OPERATING CYCLE CASH FLOW CYCLE H.Working Capital Requirements. 1.Cash {WC} must be sufficient to cover the CC. 2.Cash {WC} provided by Profits, Borrowing, and/or Trade Credit. I. The Liquidity Paradox. 1.Cash and equivalents are the least profitable assets. 2.Returns on other asset investments much greater. 3.Consider investment returns on; a.inventory. b.receivables. c.fixed assets.

6. Working Capital Management A.How do we finance seasonal variations? 1.Conservative a.High Current Ratios: > 3.0x b.Draw on excess cash 2.Moderate a.Industry Average CR’s: ~ 2.0x b.Use some cash and some trade credit 3.Aggressive a.Low Current Ratios: ~ 1.0 – 1.3x b.Rely on trade credit and borrowing S-T c.Zero WC strategy Dr. David P EchevarriaAll Rights Reserved6

7. Dr. David P EchevarriaAll Rights Reserved7 FINANCING SEASONAL VARIATIONS C.Major Sources of Short Term Capital 1. Spontaneous Sources; a.Accruals. b.Trade credit from suppliers. c.Trade credit is not free when offered with discount terms. 2.Cost of Trade Credit, A/B Net C = 3.Commercial Banks, Money Markets Short-term loans, notes, revolving lines of credit (RLOC) agreements a.Simple interest = rate b.Discount interest = rate / (1 - rate)

8. Dr. David P EchevarriaAll Rights Reserved8 FINANCING SEASONAL VARIATIONS 4.Commercial Paper. a. S-T IOU's issued by most creditworthy corporations (AAA). b. Maturities less than 270 days. c. Average Maturities; 120-150 Days. d. Rates typically at 50 To 150 basis points < prime. 5.Bankers Acceptances; finance import activity. 6.Factors, Commercial Credit Corporations. a. Factoring receivables. b. Inventory-pledged loans.

9. Dr. David P EchevarriaAll Rights Reserved9 FINANCING SEASONAL VARIATIONS 7.Receivables / Inventory Secured Loans. a. Factoring; selling A/R to factors (expensive). b. Pledging A/R: using A/R as collateral for bank loans. c. Blanket liens (UCC). d. Trust receipts: field warehouse financing (expensive). 8.Term Loans. a.Amortized [typically] in less than 15 years. b. Private placements; amortized over 15 years or longer. c.Term loans usually carry restrictive covenants: 9.Installment Loans a. Regular payments of principal and interest. b. Effective cost of these funds a function of terms.

10. Dr. David P EchevarriaAll Rights Reserved10 THE CASH BUDGET and control A.Budgets are planning (and control) tools. B.Estimate receipts and disbursements 1.Timing 2.Magnitude C.Cash budgets identify the flow of cash into and out of the firm.

11. Dr. David P EchevarriaAll Rights Reserved11 THE CASH BUDGET D.Cash budgets identify when the firm will need short-term sources of finance. 1.Bank borrowing (notes payable) 2.Floating commercial paper (notes payable) E.Cash budgets identify when firm will have excess cash. 1.Excess cash may be invested to earn interest. 2.2. Excess cash may be used to retire debt (usually short-term debt).

12. Dr. David P EchevarriaAll Rights Reserved12 HOMEWORK ASSIGNMENT A.Self-Test: 16-1, c, d, f B.Questions: 16-1, 16-4 C.Problems: 16-1, 16-4, 16-6 7 th Ed same problems, values different from 6 th Ed