Chapter 16

Short-Term
Financial Planning

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McGraw-Hill/Irwin Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
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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: Factoring

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Short-Term Financial Planning

• Working Capital Management
• Current assets and current liabilities: within
one year.
• Example:
•cash level
•inventory level
•credit term
•short term borrowing

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Net Working Capital

• Net working capital + Fixed assets = long-term debt +
equity
• [current assets - current liabilities] + Fixed assets =
long-term debt + equity
• [(Cash + other current assets) - current liabilities] +
Fixed assets = long-term debt + equity
• Cash = Long-term debt + Equity + Current liabilities
- Other current assets - Fixed assets

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Sources and Uses of Cash

• Sources of Cash • Uses of Cash
– Obtaining financing: – Paying creditors or
• Increase in long-term stockholders
debt • Decrease in long-term
• Increase in equity debt
• Increase in current • Decrease in equity
liabilities • Decrease in current
– Selling assets liabilities
• Decrease in current – Buying assets
assets • Increase in current
• Decrease in fixed assets
assets • Increase in fixed assets

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The Operating Cycle

• The time period between the acquisition of inventory
and collection of cash from receivable/customer
• Operating cycle
= average inventory period + average receivable
period
= Days Sales in Inventory + DS in Receivable
• Inventory period = how long inventory sits on the
shelf =365/Inventory turnover
=365/(COGS/average inventory)
• Receivable period = how long it takes to collect cash
from receivables = 365/Receivable turnover
= 365/(Sales/average accounts receivable)
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The Cash Cycle

• The time between cash disbursement and cash
collection
• The cash cycle measures how long we need to
finance inventory and receivables
• Cash cycle = operating cycle – average payable
period
Accounts payable period
= time between receipt of inventory and payment for it
= 365/Payable turnover
= 365/(COGS/average accounts payable)

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Example Information
Item Beginning Ending Average

Inventory 200,000 300,000 250,000

Accounts 160,000 200,000 180,000

Receivable
Accounts 75,000 100,000 87,500
Payable
Net Sales = $1,150,000 Cost of Goods Sold = $820,000

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Example - Operating Cycle

• Inventory Period = 365 / Inventory Turnover

• Acct Receivable Period = 365 / Receivables t/o

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Example - Cash Cycle

• Accounts Payables Period = 365/payables t/o

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Carrying versus Shortage Costs

• Carrying costs
– Incurred when investment in current assets is high
– Opportunity cost of owning current assets versus
long-term assets that pay higher returns
– Cost of storing larger amounts of inventory
• Shortage costs
– Incurred when investment in current assets is low
– 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
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Short-Term Financial Policy

• Flexible • Restrictive
(Conservative) Policy (Aggressive) Policy
– Large amounts of cash – Low cash and
and marketable marketable security
securities balances
– Large amounts of – Low inventory levels
inventory – Little or no credit sales
– Liberal credit policies (low accounts
(large accounts receivable)
receivable) – Relatively high levels of
– Relatively low levels of short-term liabilities
short-term liabilities
• Low liquidity (CR )
• High liquidity (CR )
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Figure 16.4

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Figure 16.5

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Cash Budget
• A forecast of cash receipts and disbursements for the
next planning period
• Primary tool in short-run financial planning
– Identify potential opportunities
– Identify when short-term financing may be required
• How it works
– Identify sales and cash collections
– Identify various cash outflows
– Subtract outflows from inflows and determine
investing and financing needs

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Example: Cash Budget

• Expected Sales for 2000 by quarter (millions)
– Q1: $57; Q2: $66; Q3: $66; Q4: $90
• Beginning Accounts Receivable = $30m
• Average collection period = 30 days
• Purchases from suppliers = 50% of next quarter’s
estimated sales
• Accounts payable period = 90 days
• Wages, taxes and other expenses = 25% of sales
• Major expansion planned for quarter 2 costing $35
million
• Interest and dividends = $5 million per quarter
• Beginning cash balance = $5 million with minimum cash
balance of $2 million
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Example: Cash Budget – Cash

Collections
Q1 Q2 Q3 Q4

Sales 57 66 66 90

Cash Collections(30days)

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Example: Cash Budget – Cash

Payments to suppliers
Q1 Q2 Q3 Q4

Sales 57 66 66 90

Purchases
(50% of next Q sales)

Cash payments (90

days)

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Example: Cash Budget – Cash

Disbursements
Q1 Q2 Q3 Q4
Payment of A/P 28.50 33.00 33.00 45.00

(25% * 57) (25%*66) (25%*66) (25%*90)

Wages, taxes, other
expenses (25% sales) =14.25 =16.50 =16.5 = 22.50

Capital Expenditures 35.00

Long-term financing 5.00 5.00 5.00 5.00

(interest and dividends)
Total Disbursements 47.75 89.50 54.50 72.50

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Example: Cash Budget

Q1 Q2 Q3 Q4

Total Cash Collections 68.00 63.00 66.00 82.00

Total Cash 47.75 89.50 54.50 72.50

Disbursements
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 20.25 (26.50) 11.50 9.50

Ending Cash Balance 25.25 (1.25) 10.25 19.75

Minimum Cash Balance -2.00 -2.00 -2.00 -2.00

Cumulative surplus 23.25 (3.25) 8.25 17.75

(deficit)
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Short-Term Borrowing
• Unsecured loans
– Line of credit – 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

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Factoring

• Account Receivable Financing

• Selling receivables to someone (lender) at a
discount
• Formula:
– Period rate = discount interest/funds financing
– APR = receivable t/o*(period rate)
– EAR = (1+period rate)receivable t/o – 1

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Example: Factoring
• Example: You have an average of $1 million in
receivables and you borrow money by factoring
receivables with a discount of 2.5%. Average
Receivable period = 30.41days
• What is the Receivables turnover

• What is the APR?

• What is the effective rate?

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Tutorial

• Problem 6, 7, 8 & 10 from page 513

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