1. Short-Term Finance and Planning13
Short-Term Finance
and Planning

2. 13.1
Working Capital Management

3. Working Capital
Current, or short-term, assets and liabilities are collectively known as working capital.
Net working capital = Current assets – Current liabilities

4. Working Capital Management
Short-term financial Management
= Working capital management
Managing working capital is a daily activity that ensures that the firm has sufficient resources to continue its operations and avoid costly interruptions.
Working capital management involves the administration, within policy guidelines, of current assets and current liabilities.

5. Cash and Net Working Capital
Rearrange balance sheet identity
Net working capital + Fixed assets = Long-term debt + Equity
Net working capital = Cash + Other current assets – Current liabilities
Cash = Long-term debt + Equity + Current liabilities
– Current assets other than cash – Fixed assets
Sources of cash
Increasing long-term debt, equity, or current liabilities
Decreasing current assets other than cash, or fixed assets
Uses of cash
Decreasing long-term debt, equity, or current liabilities
Increasing current assets other than cash, or fixed assets

6. The Operating Cycle and the Cash Cycle

7. The Operating Cycle
Operating cycle – the period from inventory purchase to the receipt of cash
Inventory period – the period required to purchase and sell the inventory
Accounts receivable period – the period required to collect on credit sales
Operating cycle = Inventory period + Accounts receivable period

8. The Cash Cycle
Cash cycle – the period from when cash is paid out to when is received.
Accounts payable period – the period from inventory purchase to payment for the inventory
Cash cycle = Operating cycle – Accounts payable period

9. Operating Cycle and Cash Cycle: Example
Item
Beginning
Ending
Inventory
$2546
$2802
Accounts receivable
7564
6736
Accounts payable
3590
4050
Net sales
$29500
Cost of goods sold
22750

10. Operating Cycle and Cash Cycle: Example
Inventory turnover=$22750/[( )/2]=8.51 times
Inventory period=365 days/8.51times=42.89 days
Receivable turnover=$29500/[( )/2]=4.13 times
Receivables period=365 days/4.13times = days
Payables turnover=$22750/[( )/2]=5.96 times
Payables period=365 days/5.96times = days
Operating cycle=42.89 days days=131 days
Cash cycle=131 days-61.24days=70 days
Inventory has to be financed for 70 days.

11. Cash Flows and Working Capital Management
The need for short-term financial management is suggested by the gap between cash inflows and cash outflows.
The gap between cash inflows and cash outflows can be filled either by borrowing or by holding a liquidity reserve in the form of cash or marketable securities.
The gap between cash inflows and cash outflows can be shortened by changing the inventory, receivable and payable periods.

12. 13.2
Short-Term Financial Policy

13. Short-Term Financial Policy
The size of investments in current assets
Flexible policy – maintain a high ratio of current assets to sales
Restrictive policy – maintain a low ratio of current assets to sales
The financing of current assets
Flexible policy – a low proportion of short-term debt relative to long-term financing.
Restrictive policy – a high proportion of short-term debt relative to long-term financing.

14. The size of investments in current assets
A flexible short-term financial policy
Keeping large balances of cash and marketable securities.
Making large investments in inventory.
Granting liberal credit terms.
A restrictive short-term finance policy
Keeping low cash balances and making little investment in marketable securities.
Making small investments in inventory.
Allowing few or no credit sales.

15. Carrying Costs and Shortage Costs
Increase with the level of investment in current assets
Costs of maintaining economic value and opportunity costs
Shortage costs
Decrease with the level of investment in current assets
Trading, or order, costs and costs related to lack of safety reserves
Managing short-term assets involves a trade-off between carrying costs and shortage costs.
A flexible policy is most appropriate when carrying costs are low relative to shortage costs.
A restrictive policy is most appropriate when carrying costs are high relative to shortage costs.

16. The Optimal Investment in Current Assets

17. The Financing of Current Assets
A flexible short-term financing policy
A low proportion of short-term debt relative to long-term financing.
A restrictive short-term financing policy
A high proportion of short-term debt relative to long-term financing.

18. The Financing of Current Assets
In an ideal economy, short-term assets can always be financed with short-term debt and long-term assets can always be financed with long-term debt. The net working capital is always zero.
In a real economy, it is not likely that current assets will ever drop to zero. Firms generally need to carry a minimum level of “permanent” current assets at all times.
A growing firm usually has a total asset requirement of current assets and current liabilities. The total asset may change because of (1) a general growth trend, (2) seasonal variation around the trend and (3) unpredictable day-to-day and month-to-month fluctuations.

19. The Financing of Current Assets
A flexible policy has a short-term cash surplus and a large investment in cash and marketable securities.
A restrictive policy uses long-term financing for permanent assets requirements only and short-term borrowing for seasonal variations.
A compromise policy means the firm keeps a reserve of liquidity that it uses to initially finance seasonal variations in current asset needs. Short-term borrowing is used when the reserve is exhausted.

20. The Best Financing Policy
There is no definitive answer.
Several considerations must be included in a proper analysis.
Cash reserves
Maturity hedging
Relative interest Rates

21. 13.3
Cash Budgeting

22. Cash Budgeting
Cash Budgeting records estimates of cash inflows and outflows over a specified period.
The result of cash budgeting is an estimate of the cash surplus or deficit.
It is a primary tool in short-term financial planning
It helps determine what borrowing is required or what lending will be possible in the short run.

23. Cash Budgeting: Example
April
May
June
Credit sales
$390,000
$364,000
$438,000
Credit purchases
147,800
176,300
208,500
Cash disbursements
Wages, taxes and expenses
53,800
51,000
78,300
Interest
13,100
Equipment purchases
87,000
147,000
Above are some important figures for the second quarter of the year.
The company predicts that 5% of its credit sales will never be collected, 35% of its sales will be collected in the month of the sale, and the remaining 60% will be collected in the following month. Credit purchases will be paid in the month following the purchase.
In march, credit sales were $245,000 and credit purchases were $168,000.

24. Cash Budgeting: Example
April
May
June
Beginning cash balance
$140,000
$101,600
$104,100
Cash receipts
Cash collections from credit sales
283,500
361,400
371,700
Total cash available
$423,500
$463,000
$475,800
Cash disbursements
Purchases
$168,000
$147,800
$176,300
Wages, taxes and expenses
53,800
51,000
78,300
Interest
13,100
Equipment purchases
87,000
147,000
Total cash disbursements
$321,900
$358,900
$267,700
Ending cash balance
$208,100

25. 13.4
Short-Term Borrowing

26. Short-Term Borrowing
The most common way to finance a temporary cash deficit to arrange a short-term loan.
Loans
Unsecured loans
Secured loans
Other sources
Commercial paper
Trade Credit

27. Compensating Balance
The company has a $100,000 line of credit with a 10% compensating balance requirement. The quoted interest rate is 16%. The company needs to borrow $54,000 for one year. How much do the company need to borrow?
$54,000 / ( ) = $60,000
$60,000*16%=$9,600
$9,600/54,000=17.78%