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WORKING CAPITAL MANAGEMENT
Current Assets & Current Liabilities
are collectively known as
WORKING CAPITAL
Components of Working Capital
Accounts Receivable:
arise because of companies do not usually expect
customers to pay for their purchases immediately.
These unpaid bills are a valuable asset that companies
expect to be able to turn into cash in the near future.
TRADE CREDIT : Unpaid bills from sales to other companies.
CONSUMER CREDIT : Sales of goods to the final customers.
Cash & Marketable Securities:
Cash: Dollar Bills & Bank Deposits.
DEMAND DEPOSITS: Money in checking accounts that the firm can pay out immediately.
TIME DEPOSITS: Money in saving accounts that the firm can pay out only with a delay.
Marketable Securities: Commercial Paper & Tresury Bills
Components of Working Capital
Accounts Payable: Unpaid Bills
Outstanding payments due to other companies
One firm’s credit is another firm’s debit
NET WORKING CAPITAL
CURRENT ASSETS – CURRENT LIABILITIES
Generally called as
WORKING CAPITAL
CASH CONVERSION CYCLE =
(Inventory Period + Receivables Period) – Accounts Payable Period
CASH CONVERSION CYCLE
CASH
FINISHED
GOODS
RECEIVABLES INVENTORY
CASH CONVERSION CYCLE =
(Inventory Period + Receivables Period) – Accounts Payable Period
CASH CONVERSION CYCLE :
Period between firm’s payment for materials and collection on its sales
Inventory Period = Average Inventory / [Cost of Goods Sold / 365]
Receivables Period = Average Accounts Receivables / [Sales / 365]
Payable Period = Average Payable / [Sales / 365]
Working Capital Trade-off
Carrying Costs:
Costs of maintaining Current Assets; including opportinity cost of capital.
Investment in CASH & RECEIVABLES may cause an interest loss and
Investment in INVENTORY has opportinity cost of capital; storage & insurance costs
Shortage Costs:
Costs incurred from shortages in Current Assets
Shortage in CASH may incur unnecassary transaction costs of selling marketable securities and
Shortage in RECEIVABLES may cause to lose customers because of credit sales’ restrictions
Shortage in INVENTORY may have shut down production & unable to to fill orders promptly
Carrying Costs encourage firm to hold current assets to a MINIMUM
Shortage Costs encourage firm to hold current assets to a MAXIMUM
It’s an art to find the LEVEL of CURRENT ASSETS
that minimizes the sum of
Carrying Costs & Shortage Costs
Links between
LONG-TERM & SHORT-TERM fınancıng
Short-Term financing
Time
Long -Term financing
Seasonal
component of
required assets
Total
Capital
Requirement
STRATEGIES:
1. Matching Maturities: Long-Lived assets with long-term debt & Current Assets with short-term debt
2. Permanent Working Capital Requirements: A positive amount of WORKING CAPITAL
3. The Comforts of Surplus Cash:The firm is always a short-term lender (Relaxed Strategy)
Firm’s Total Capital Requirement: The Cost of Assets
TRACING CHANGES IN CASH & NWC
Cash Budgeting:
Forecasting future sources and uses of cash
Alerts for future cash needs & provides a standart
Three Common Steps to preparing Cash Budget
1. Forecast the sources of cash
3. Calculate whether the firm is facing a
cash shortage or plus
2. Forecast the uses of cash
DETAILS:
The Steps of Calculating Sources of Cash
1. Receivables at the start of period
2. Forecast Sales
3. Forecast Collections
• Sales in current period (%?)
• Sales in last period (%?)
TOTAL COLLECTIONS
4. Receivables at the end of period
5. Other sources of cash (Dispose of land, machine, stock)
Ending Accounts Receivable = Beginning Acc. Rec. + Sales - Collections
DETAILS:
The Steps of Calculating Uses of Cash
1. Payments for Accounts Payable
2. Labor, Administrative and Other Expenses
(Regular Business Expenses)
3. Capital Expenditures (Pay for long-lived assets)
4. Taxes, Interest and Dividend Payments
Prepare SOURCES & USES CASH LIST each period
Determine Short-Term Financing Requirements
DYNAMIC MATTRESS'S FINANCING PLAN
1. Quarter 2. Quarter 3. Quarter 4. Quarter TOTAL
Cash Inputs 86,5 80,3 121,0 128,0 415,8
Cash Outputs 131,5 95,3 95,0 93,0 414,8
Cash Balance 45,0 15,0 26,0 35,0 1,0
Marketable Securities 5,0 5,0
Bank Loan 2% 40,0 8,6 31,4 40,0
Interest Payment 0,8 1,6 0,6 3,0
Stretch 5% 15,8 15,8 0
Cash Balance 45,0 15,0 26,0 32,0 2,0
Additions to Cash
Balance 3,0 3,0
QUESTIONS:
1. Cash or Marketable Securities enough or expand?
2. Does plan cahnge Current & Quick Ratios?
3. Hidden costs to stretching payables?
4. Does plan leave DYNAMIC in good financial shape for 2005?
5. What about log-term financing and capital expenditures?
6. Can the firm’s operating and investment plans be adjusted to
make the short-term financing problem easier?
SHORT-TERM FINANCING PLANS MUST BE DEVELOPED BY
TRIAL & ERROR !...
SOURCES OF SHORT-TERM FINANCING
Bank Loans:
Line of Credit: Aggrement by a bank that a company may borrow at
any time up to an established limit.
Revolving Credit Aggrement: If the firm wants to be sure it will able
to borrow; it can enter a RCA. ( RCA usually last for a few years and formally commit the
bank to an aggreed limit. A committment fee is required on any unused amount.)
Term Loans: Conditional Credit (Loans are paid when the goods are sold)
Syndicate Credit: Banks combined to provide cash
Commercial Paper:
Short-Term unsecured notes issued by firms
SOURCES OF SHORT-TERM FINANCING
Secured Loans:
Accounts Receivables Financing
1. Some companies solve their financing problem by borrowing on
the strength of their current assets!...
When a loan is secured by receivables, the firm assigns the receivables
to the bank.
The risk of default on the receivables is therefore borne by the firm
2. Others solve it by selling their current assets!...
An alternative procedure is to sell the receivables at a discount
to a financial institution known as FACTOR and let it collect the
money.
Once the firm has sold receivables, the factor bears all the
responsibility for collecting on the accounts!...
Inventory Financing
Bank also lend on the security of inventory; but they are choosy
about the inventory they will accept!...
THE COST OF BANK LOANS
Simple Interest
1. Simple Interest: The interest rate on bank loans frequently is
quoated on APR
2. Discount Interest : The interest rate on bank is often calculated on a
discount basis.
3. Interest with Compensating Balances: Occasionally, bank loans
require the firm to maintain some amount on balance at the bank,
which is called as Compensating Balance.
The reason is that borrower must pay interest on full amount borrowed
but has access only part of the funds.
In each case; the face value of the interest has to be
converted to effective interest rate in order to learn the actual
burden on the loan.
CASH & INVENTORY
MANAGEMENT
Cash Collection; Disbursement & Float
Cash & Inventory Management
Company’s Ledger Balance
800,000
Payment Float
200,000
Banks Ledger Balance
1,000,000
+
PAYMENT FLOAT: Checks written by a company that have not yet cleared.
Available Balance
1,000,000
Availability Float
120,000
Banks Ledger Balance
1,120,000
+
AVAILABILITY FLOAT: Checks already deposited that have been cleared
NET FLOAT: Difference between Payment & Availability Float
NET FLOAT = 200,000 - 120,000 = 80,000
Valuing Float:
Float results from delay between your writing a check and the reduction in your bank balance.
The amounf depends on the size of check & delay in collection.
Playing the float: To hold more funds in interest earning accounts!..
Delays that help the payer hurt the receipent.
Receipents try to speed up collections.
Payers try to slow down disbursements.
Both attempt to minimize NET FLOAT
Managing Float
Check Mailed
Mail Float
Check Received
Processing Float
Check Deposited
Check Available to receipent Check charged to payer’s account
Check clears Check clears
Receipents
see delays a
availability
float
Payers
see delays as
payment
float
Concentration Banking:
System whereby customers make payments to a regional collection center
which transfers funds to a principal bank.
SPEEDING UP COLLECTIONS
Lock-box system:
System whereby customers make send payments to a post office box and
a local bank collects and processes checks.
Controlling Disbursements
Speeding up collections is not only way to increase the net float.
You can also do this by slowing down disbursements.
•Increase Mail Time
•Remote Disbursement
•Zero Balance Account:
(Regional Bank Account to which just enough funds are transferred daily to pay each day’s bills)
•Electronic Fund Transfer
(About %14 of business to business payments, especially big companies use electronic payments)
•ACH (Automated Clearing House) :
(Bulk payments such as wages; dividends; payments to suppliers travel through ACH)
(ACH is easy, transaction costs are very low, float is drastically reduced.)
Cash Management involves a Trade-off
If the cash is invested in securities, it would earn interest.
On the other hand, you can’t use securities everytime to pay firm’s bills.
If you had to sell those securities everytime you needed to pay a bill,
you would incur heavy transaction costs.
The art of cash management is to balance these costs and benefits!..
INVENTORIES & CASH MANAGEMENT
Managing Inventories
Total Costs = Order Costs + Carrying Costs
When Orders increases; Order costs increases but Carrying costs decreases
0
10
20
30
40
50
60
70
80
1 2 3 4 5 6 7 8 9 10
Number of Orders
Total Costs
Carrying
Costs
Order Costs
Level Orders
Carrying
costs
3 TL
Order costs
3 TL Total
24 1 72 3 75
12 2 36 6 42
8 3 24 9 33
6 4 18 12 30
4,8 5 14,4 15 29,4
4 6 12 18 30
3,4 7 10,3 21 31,3
3 8 9 24 33
2,7 9 8 27 35
2,4 10 7,2 30 37,2
ECONOMIC ORDER QUANTIY = Order size that minimizes total inventory costs!...
= [ ( 2 * Annual Sales * Cost Per Order * ) / Carrying Costs ]^(1/2)
Cash Management involves a Trade-off
If the cash is invested in securities, it would earn interest.
On the other hand, you can’t use securities everytime to pay firm’s bills.
If you had to sell those securities everytime you needed to pay a bill,
you would incur heavy transaction costs.
The art of cash management is to balance these costs and benefits!..
INVENTORIES & CASH MANAGEMENT
Managing Inventories of Cash
Simple Inventory Models can tell us something about the management of Cash Balances
Total Costs = Cost of per sale of securities + Interest rates
INITIAL CASH BALANCE =
[ ( 2 * Annual Cash Outflows * Cost Per Sale of Securities ) / Interest Rates ]^(1/2)
Basic Trade-offs of Cash Management
•When the cost of selling securities is high, you should hold larger average cash balances
•When interest rates are high, you should hold smaller cash balances
•When annual cash outflows increase, the optimal level of cash incresases less than
proportionally
Uncertain Cash Flows
If cash flows are unpredictable, the cash balance should be allowed to meander
until it hits an upper or lower limit.
Upper Limit
Return Point
Lower Limit
At this point the firm buys or sells securities to restore the balance to the return point.
The lower limit plus one-third of the spread between the upper and lower limits.
Time
C
a
s
h
B
a
l
a
n
c
e
Money Market:
Market for short-term financial assets.
Only fixed income securities with maturities less than ONE year!...
These securities are highly marketable or liquid.
INVESTING IDLE CASH
Managing Inventories of Cash
Simple Inventory Models can tell us something about the management of Cash Balances
Total Costs = Cost of per sale of securities + Interest rates
MAIN TYPES OF MONEY MARKET SECURITIES
COMMERCIAL PAPER: Registrated by SEC with maturities of less than 2 months
CERTIFICATES OF DEPOSIT: CDs are time deposits at bank, usually in denominations
greater than $ 100,000
REPURCHASE AGGREEMENTS : Repos, repurchase aggreements are in effect
collateralized loans and are usually very short-term, with maturities of only a few days.
CREDIT MANAGEMENT &
BANKRUPTCY
TERMS OF SALE
Credıt, discount, and payment terms offered on a sale
In many cases payment is not made after delivery, so the buyer receives
CREDIT
To encourage the customer to pay before final date, a cash discount is
offered for prompt settlement!.. And this is expressed as
5 / 10; net 30
% discount for
early payment
Number of days that
discount is available
Number of days before
payment is due
Depending these conditions customer receives 5% discount for a
payment within 10 days, or else must pay in full within 30 days!
CREDIT MANAGEMENT & BANKRUPTCY
CREDIT MANAGEMENT & BANKRUPTCY
CREDIT AGGREEMENTS
Open account: Aggreement whereby sales are made with no formal debt contract!..
Commercial Draft: jargon for an order to pay
The seller prepares a draft ordering payment by the customer and sends this draft to customer’s bank.
For immediate payment it is called as “sight draft”
For delay payment it is called as “time draft”
The customer tells the bank to pay and acknowledges “accepted” and “signature”
When accepted a time draft is like postdated check and is called a “trade acceptance”
This trade acceptance is forwarded to the seller, who holds it until the payment becomes due!..
In case of suspicion seller ask the customer to organize the bank whether to accept the time draft.
If the bank guarantees then is called as “banker’s acceptance”
Banker’s acceptances are actively bought and sold in money market.
Conditional sale:
to avoid any unfortunate situations; the ownership of the goods
remains with the seller until full payment is made!...
CREDIT MANAGEMENT & BANKRUPTCY
CREDIT ANALYSIS
Procedure to determine the likelihood a customer will pay its bills !..
To carry out Credit Analysis:
•Promptly payments in the past (be aware of the high credit limit for small payments!)
•Rating Services (customer!s full credit report upon request)
•The other firms’ experience
•Your Bank
•For public companies cheque Moody’s or S&Poors
•Customer’s Stock Price
Financial Ratio Analysis
Numerical Credit Scoring (Analyzing credit risk is like a detective work)
•The Customer’s character
•The Customer’s capacity to pay
•The Customer’s capital
•The Collateral provided by customer
•The Condition of customer’s business
•Z Score: A discriminant analysis at distinguishing bankrupt and nonbankrupt firms.
If Z < 2,7 bankrupt possibility is 94%
If Z > 2,7 nonbankrupt possibility is 97%
CREDIT ANALYSIS IS WORTHWHİLE ONLY IF THE EXPECTED SAVINGS
EXCEED THE COST!...
CREDIT MANAGEMENT & BANKRUPTCY
CREDIT DECISION
The decision to offer credit depends on the probability of payment!..
You should grant credit
if the expected profit from doing so is greater than the profit from refusing!...
Credit Policy: Standarts set to determine the amount and nature of credit to extend to customers.
Offer Credit
Refuse Credit
Customer pays (p)
Customer defaults (1 - p)
REVENUES - COST
- COST
Refuse Credit : 0
Grant Credit : [p * PV(REVENUES – COST)] – [(1 - p) * PV ( COST)] if positive!...
If one sale may lead to profitable repeat sales, the firm should be inclined to grant credit on the initial purchase.
CREDIT MANAGEMENT & BANKRUPTCY
Some General Principles:
•Maximize Profit: Main job is not to minimize the bad accounts; it is to maximize PROFITS!
•Concentrate on the dangerous accounts: Set credit limits for each customer and WHEN THE
CUSTOMER EXCEEDS TAKE CARE!
•Look beyond the immediate order: Sometimes take care the growth in sales in the LONG-RUN.
Collection Policy:
•Procedures to collect and monitor receivables.
Account Receivable = Daily Sales X Average Collection Period
When customers stretch payables you end up a longer collection period!..
Never forget the formula and establish a COLLECTION POLICY:
Aging Schedule:
•Classification of accounts receivable by time outstanding!
Customer’s Name 1 month 1-2 months 2-3 months 3 months over TOTAL
A $10,000 $ 10,000
B $ 8,000 $3,000 $ 11,000
...
Z $ 15,000 $ 15,000
TOTAL $ 18,000 $ 3,000 $ 15,000 $ 36,000
Good collection policy balances conflicting goals. The company wants cordial relations with
customers and also wants them to pay the bills on time!...
CREDIT MANAGEMENT & BANKRUPTCY
BANKRUPTCY:
•The reorganization or liquidation of a firm that can not pay its debts.
WORKOUT:
• Agreement between a company and its creditors establishing the steps the
company must take to avoid bankruptcy.
• The advantage of a negotiated agreement is that the costs and delays of
formal bankruptcy are avoided.
• If the firm cannot get an agreement, then it may have no alternative but to
file for bankruptcy. Then the firm’s assets are liquidated - that is, sold –
and the proceeds are used to pay creditors.
LIQUIDATION: Sale of bankrupt firm’s assets.
• Priorities:
1. No firm in bankruptcy proceedings could not continue to operate
2. Wages and employee benefits
3. Taxes and other governmental debts
4. Unsecured bonds
CREDIT MANAGEMENT & BANKRUPTCY
REORGANIZATION
•Restructruring of financial claims on falling firm to allow it to keep operating. It is an
alternative for liquidation!...
THE REORGANIZATION PLAN
•To design a new capital structure for the firm to satisfy the creditors
•Allow the firm to solve the business problems
The reorganization plan goes into effect if it is accepted by creditors and confirmed by
the court!..
CLEARING
INFLATIONARY EFFECTS
ON FINANCIAL STATEMENTS
CLEARING INFLATIONARY EFFECTS
INFLATION
The continous increase in the general level of prices
Inflation distorts the historical data on financial statements
Inflation causes the asset values to be seen higher than they have in fact!...
For Example : Stocks; although the same quantity exists; monetary value seems higher
SO IT IS UNAVOIDABLE TO CLEAR UP INFLATIONARY EFFECTS.
There are two basic approach
•General Price Level (GPL)
•Current Replacement Cost (CRC)
•General Price Level (GPL):
•To correct the historical data by using an appropriate INDEX
Corrected Value = Historical Value X [
Index Value at the end
]
Index Value at the beginning
Before correction it is needed to determine the inflationary effect on each financial item!...
CLEARING INFLATIONARY EFFECTS
Items of Fin. Stat. Monetary Non -Monetary
Cash X
Bonds & Similiars X
Stocks & Similiars X
Recivables X
Inventory X
Fixed Assets & Accumulated Depreciation X
Short & Long-Term Debts X
Sales and all revenue accounts X
COGS and all expense accounts X
Retained Earnings X
Generally it can be said; Cash & Cash equivalents; receivables
and payables are monetary and the other s are non-monetary
The correction of inflationary effects on financial statements depends on the power of choosen
INDEX.
CLEARING INFLATIONARY EFFECTS
(EXAMPLE)
BALANCE SHEET FOR XYZ CORPORATION (31,12,2002) 2002 Type of Item Cleared Value
Current Assets 3.000
Cash 500,00 Monetary 500,00
Receivables 1000,00 Monetary 1.000,00
Inventories 1500,00 Non-monetary X 150/125 1.800,00
Net Fixed Assets 2700,00
Gross Machinery 3000,00 Non-monetary X 150/100 4.500,00
(-) Acc. Depreciation 300,00 Non-monetary X 150/100 450,00
TOTAL ASSETS 5700,00 7.350,00
Current Liabilities 1200,00
Acc. Payable 200,00 Monetary 200,00
Notes Payable 1000,00 Monetary 1.000,00
Long-term Debt 0,00
Shareholders' equity 4000,00 Non-monetary X 150/100 6.000,00
Retained Earnings 500,00 150,00
TOTAL LIABILITIES & SHAREHOLDER'S EQUITY 5700,00 7.350,00
CLEARING INFLATIONARY EFFECTS
(EXAMPLE)
INCOME STATEMENT FOR THE YEAR OF 2002
Net Sales 4500,00 Non-monetary X 150/125 5.400,00
Cost of Goods Sold 3000,00 Non-monetary X 150/125 3.600,00
Sales & Administrative Expenses 400,00 Non-monetary X 150/125 480,00
Depreciation 300,00 Non-monetary X 150/100 450,00
Taxable Income 800,00 Non-monetary X 150/125 870,00
Taxes 100,00 Non-monetary X 150/125 120,00
Inflationary Loss 360,00
Net Income 700,00 390,00
Dividends 200,00 Non-monetary X 150/125 240,00
To Retained Earnings 500,00 150,00
Inflation Index
31,12,2001 100
31,12,2002 150
Average for 2002 125
CLEARING INFLATIONARY EFFECTS
(EXAMPLE)
Calculation of Inflationary Loss
Historical Data Total Transaction
Corrected
Value Difference
Cash at the beginning 2200,00 X150/100 3300,00
Cash Inputs 3500,00 X150/125 4200,00
Sales 4500,00
Receivables 1000,00
Cash Outputs 5200,00 X150/125 6240,00
Cost of Goods Sold 3000,00
Inventory 1500,00
Sales & Adm. Expenses 400,00
Taxes 100,00
Dividends 200,00
Cash at the end 500,00 1260,00 760,00
Receivables 1000,00 X150/125 1200,00 200,00
Acc. Payable 200,00 X150/100 300,00 100,00
Notes Payable 1000,00 X150/100 1500,00 500,00
TOTAL (Inflation Loss) 360,00
WORKING CAPITAL MANAGEMENT TECHNIQUES

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WORKING CAPITAL MANAGEMENT TECHNIQUES

  • 2. Current Assets & Current Liabilities are collectively known as WORKING CAPITAL Components of Working Capital Accounts Receivable: arise because of companies do not usually expect customers to pay for their purchases immediately. These unpaid bills are a valuable asset that companies expect to be able to turn into cash in the near future. TRADE CREDIT : Unpaid bills from sales to other companies. CONSUMER CREDIT : Sales of goods to the final customers. Cash & Marketable Securities: Cash: Dollar Bills & Bank Deposits. DEMAND DEPOSITS: Money in checking accounts that the firm can pay out immediately. TIME DEPOSITS: Money in saving accounts that the firm can pay out only with a delay. Marketable Securities: Commercial Paper & Tresury Bills
  • 3. Components of Working Capital Accounts Payable: Unpaid Bills Outstanding payments due to other companies One firm’s credit is another firm’s debit NET WORKING CAPITAL CURRENT ASSETS – CURRENT LIABILITIES Generally called as WORKING CAPITAL
  • 4. CASH CONVERSION CYCLE = (Inventory Period + Receivables Period) – Accounts Payable Period CASH CONVERSION CYCLE CASH FINISHED GOODS RECEIVABLES INVENTORY
  • 5. CASH CONVERSION CYCLE = (Inventory Period + Receivables Period) – Accounts Payable Period CASH CONVERSION CYCLE : Period between firm’s payment for materials and collection on its sales Inventory Period = Average Inventory / [Cost of Goods Sold / 365] Receivables Period = Average Accounts Receivables / [Sales / 365] Payable Period = Average Payable / [Sales / 365]
  • 6. Working Capital Trade-off Carrying Costs: Costs of maintaining Current Assets; including opportinity cost of capital. Investment in CASH & RECEIVABLES may cause an interest loss and Investment in INVENTORY has opportinity cost of capital; storage & insurance costs Shortage Costs: Costs incurred from shortages in Current Assets Shortage in CASH may incur unnecassary transaction costs of selling marketable securities and Shortage in RECEIVABLES may cause to lose customers because of credit sales’ restrictions Shortage in INVENTORY may have shut down production & unable to to fill orders promptly Carrying Costs encourage firm to hold current assets to a MINIMUM Shortage Costs encourage firm to hold current assets to a MAXIMUM It’s an art to find the LEVEL of CURRENT ASSETS that minimizes the sum of Carrying Costs & Shortage Costs
  • 7. Links between LONG-TERM & SHORT-TERM fınancıng Short-Term financing Time Long -Term financing Seasonal component of required assets Total Capital Requirement STRATEGIES: 1. Matching Maturities: Long-Lived assets with long-term debt & Current Assets with short-term debt 2. Permanent Working Capital Requirements: A positive amount of WORKING CAPITAL 3. The Comforts of Surplus Cash:The firm is always a short-term lender (Relaxed Strategy) Firm’s Total Capital Requirement: The Cost of Assets
  • 8. TRACING CHANGES IN CASH & NWC Cash Budgeting: Forecasting future sources and uses of cash Alerts for future cash needs & provides a standart Three Common Steps to preparing Cash Budget 1. Forecast the sources of cash 3. Calculate whether the firm is facing a cash shortage or plus 2. Forecast the uses of cash
  • 9. DETAILS: The Steps of Calculating Sources of Cash 1. Receivables at the start of period 2. Forecast Sales 3. Forecast Collections • Sales in current period (%?) • Sales in last period (%?) TOTAL COLLECTIONS 4. Receivables at the end of period 5. Other sources of cash (Dispose of land, machine, stock) Ending Accounts Receivable = Beginning Acc. Rec. + Sales - Collections
  • 10. DETAILS: The Steps of Calculating Uses of Cash 1. Payments for Accounts Payable 2. Labor, Administrative and Other Expenses (Regular Business Expenses) 3. Capital Expenditures (Pay for long-lived assets) 4. Taxes, Interest and Dividend Payments Prepare SOURCES & USES CASH LIST each period Determine Short-Term Financing Requirements
  • 11. DYNAMIC MATTRESS'S FINANCING PLAN 1. Quarter 2. Quarter 3. Quarter 4. Quarter TOTAL Cash Inputs 86,5 80,3 121,0 128,0 415,8 Cash Outputs 131,5 95,3 95,0 93,0 414,8 Cash Balance 45,0 15,0 26,0 35,0 1,0 Marketable Securities 5,0 5,0 Bank Loan 2% 40,0 8,6 31,4 40,0 Interest Payment 0,8 1,6 0,6 3,0 Stretch 5% 15,8 15,8 0 Cash Balance 45,0 15,0 26,0 32,0 2,0 Additions to Cash Balance 3,0 3,0
  • 12. QUESTIONS: 1. Cash or Marketable Securities enough or expand? 2. Does plan cahnge Current & Quick Ratios? 3. Hidden costs to stretching payables? 4. Does plan leave DYNAMIC in good financial shape for 2005? 5. What about log-term financing and capital expenditures? 6. Can the firm’s operating and investment plans be adjusted to make the short-term financing problem easier? SHORT-TERM FINANCING PLANS MUST BE DEVELOPED BY TRIAL & ERROR !...
  • 13. SOURCES OF SHORT-TERM FINANCING Bank Loans: Line of Credit: Aggrement by a bank that a company may borrow at any time up to an established limit. Revolving Credit Aggrement: If the firm wants to be sure it will able to borrow; it can enter a RCA. ( RCA usually last for a few years and formally commit the bank to an aggreed limit. A committment fee is required on any unused amount.) Term Loans: Conditional Credit (Loans are paid when the goods are sold) Syndicate Credit: Banks combined to provide cash Commercial Paper: Short-Term unsecured notes issued by firms
  • 14. SOURCES OF SHORT-TERM FINANCING Secured Loans: Accounts Receivables Financing 1. Some companies solve their financing problem by borrowing on the strength of their current assets!... When a loan is secured by receivables, the firm assigns the receivables to the bank. The risk of default on the receivables is therefore borne by the firm 2. Others solve it by selling their current assets!... An alternative procedure is to sell the receivables at a discount to a financial institution known as FACTOR and let it collect the money. Once the firm has sold receivables, the factor bears all the responsibility for collecting on the accounts!... Inventory Financing Bank also lend on the security of inventory; but they are choosy about the inventory they will accept!...
  • 15. THE COST OF BANK LOANS Simple Interest 1. Simple Interest: The interest rate on bank loans frequently is quoated on APR 2. Discount Interest : The interest rate on bank is often calculated on a discount basis. 3. Interest with Compensating Balances: Occasionally, bank loans require the firm to maintain some amount on balance at the bank, which is called as Compensating Balance. The reason is that borrower must pay interest on full amount borrowed but has access only part of the funds. In each case; the face value of the interest has to be converted to effective interest rate in order to learn the actual burden on the loan.
  • 17. Cash Collection; Disbursement & Float Cash & Inventory Management Company’s Ledger Balance 800,000 Payment Float 200,000 Banks Ledger Balance 1,000,000 + PAYMENT FLOAT: Checks written by a company that have not yet cleared. Available Balance 1,000,000 Availability Float 120,000 Banks Ledger Balance 1,120,000 + AVAILABILITY FLOAT: Checks already deposited that have been cleared NET FLOAT: Difference between Payment & Availability Float NET FLOAT = 200,000 - 120,000 = 80,000 Valuing Float: Float results from delay between your writing a check and the reduction in your bank balance. The amounf depends on the size of check & delay in collection. Playing the float: To hold more funds in interest earning accounts!..
  • 18. Delays that help the payer hurt the receipent. Receipents try to speed up collections. Payers try to slow down disbursements. Both attempt to minimize NET FLOAT Managing Float Check Mailed Mail Float Check Received Processing Float Check Deposited Check Available to receipent Check charged to payer’s account Check clears Check clears Receipents see delays a availability float Payers see delays as payment float
  • 19. Concentration Banking: System whereby customers make payments to a regional collection center which transfers funds to a principal bank. SPEEDING UP COLLECTIONS Lock-box system: System whereby customers make send payments to a post office box and a local bank collects and processes checks. Controlling Disbursements Speeding up collections is not only way to increase the net float. You can also do this by slowing down disbursements. •Increase Mail Time •Remote Disbursement •Zero Balance Account: (Regional Bank Account to which just enough funds are transferred daily to pay each day’s bills) •Electronic Fund Transfer (About %14 of business to business payments, especially big companies use electronic payments) •ACH (Automated Clearing House) : (Bulk payments such as wages; dividends; payments to suppliers travel through ACH) (ACH is easy, transaction costs are very low, float is drastically reduced.)
  • 20. Cash Management involves a Trade-off If the cash is invested in securities, it would earn interest. On the other hand, you can’t use securities everytime to pay firm’s bills. If you had to sell those securities everytime you needed to pay a bill, you would incur heavy transaction costs. The art of cash management is to balance these costs and benefits!.. INVENTORIES & CASH MANAGEMENT Managing Inventories Total Costs = Order Costs + Carrying Costs When Orders increases; Order costs increases but Carrying costs decreases 0 10 20 30 40 50 60 70 80 1 2 3 4 5 6 7 8 9 10 Number of Orders Total Costs Carrying Costs Order Costs Level Orders Carrying costs 3 TL Order costs 3 TL Total 24 1 72 3 75 12 2 36 6 42 8 3 24 9 33 6 4 18 12 30 4,8 5 14,4 15 29,4 4 6 12 18 30 3,4 7 10,3 21 31,3 3 8 9 24 33 2,7 9 8 27 35 2,4 10 7,2 30 37,2 ECONOMIC ORDER QUANTIY = Order size that minimizes total inventory costs!... = [ ( 2 * Annual Sales * Cost Per Order * ) / Carrying Costs ]^(1/2)
  • 21. Cash Management involves a Trade-off If the cash is invested in securities, it would earn interest. On the other hand, you can’t use securities everytime to pay firm’s bills. If you had to sell those securities everytime you needed to pay a bill, you would incur heavy transaction costs. The art of cash management is to balance these costs and benefits!.. INVENTORIES & CASH MANAGEMENT Managing Inventories of Cash Simple Inventory Models can tell us something about the management of Cash Balances Total Costs = Cost of per sale of securities + Interest rates INITIAL CASH BALANCE = [ ( 2 * Annual Cash Outflows * Cost Per Sale of Securities ) / Interest Rates ]^(1/2) Basic Trade-offs of Cash Management •When the cost of selling securities is high, you should hold larger average cash balances •When interest rates are high, you should hold smaller cash balances •When annual cash outflows increase, the optimal level of cash incresases less than proportionally
  • 22. Uncertain Cash Flows If cash flows are unpredictable, the cash balance should be allowed to meander until it hits an upper or lower limit. Upper Limit Return Point Lower Limit At this point the firm buys or sells securities to restore the balance to the return point. The lower limit plus one-third of the spread between the upper and lower limits. Time C a s h B a l a n c e
  • 23. Money Market: Market for short-term financial assets. Only fixed income securities with maturities less than ONE year!... These securities are highly marketable or liquid. INVESTING IDLE CASH Managing Inventories of Cash Simple Inventory Models can tell us something about the management of Cash Balances Total Costs = Cost of per sale of securities + Interest rates MAIN TYPES OF MONEY MARKET SECURITIES COMMERCIAL PAPER: Registrated by SEC with maturities of less than 2 months CERTIFICATES OF DEPOSIT: CDs are time deposits at bank, usually in denominations greater than $ 100,000 REPURCHASE AGGREEMENTS : Repos, repurchase aggreements are in effect collateralized loans and are usually very short-term, with maturities of only a few days.
  • 25. TERMS OF SALE Credıt, discount, and payment terms offered on a sale In many cases payment is not made after delivery, so the buyer receives CREDIT To encourage the customer to pay before final date, a cash discount is offered for prompt settlement!.. And this is expressed as 5 / 10; net 30 % discount for early payment Number of days that discount is available Number of days before payment is due Depending these conditions customer receives 5% discount for a payment within 10 days, or else must pay in full within 30 days! CREDIT MANAGEMENT & BANKRUPTCY
  • 26. CREDIT MANAGEMENT & BANKRUPTCY CREDIT AGGREEMENTS Open account: Aggreement whereby sales are made with no formal debt contract!.. Commercial Draft: jargon for an order to pay The seller prepares a draft ordering payment by the customer and sends this draft to customer’s bank. For immediate payment it is called as “sight draft” For delay payment it is called as “time draft” The customer tells the bank to pay and acknowledges “accepted” and “signature” When accepted a time draft is like postdated check and is called a “trade acceptance” This trade acceptance is forwarded to the seller, who holds it until the payment becomes due!.. In case of suspicion seller ask the customer to organize the bank whether to accept the time draft. If the bank guarantees then is called as “banker’s acceptance” Banker’s acceptances are actively bought and sold in money market. Conditional sale: to avoid any unfortunate situations; the ownership of the goods remains with the seller until full payment is made!...
  • 27. CREDIT MANAGEMENT & BANKRUPTCY CREDIT ANALYSIS Procedure to determine the likelihood a customer will pay its bills !.. To carry out Credit Analysis: •Promptly payments in the past (be aware of the high credit limit for small payments!) •Rating Services (customer!s full credit report upon request) •The other firms’ experience •Your Bank •For public companies cheque Moody’s or S&Poors •Customer’s Stock Price Financial Ratio Analysis Numerical Credit Scoring (Analyzing credit risk is like a detective work) •The Customer’s character •The Customer’s capacity to pay •The Customer’s capital •The Collateral provided by customer •The Condition of customer’s business •Z Score: A discriminant analysis at distinguishing bankrupt and nonbankrupt firms. If Z < 2,7 bankrupt possibility is 94% If Z > 2,7 nonbankrupt possibility is 97% CREDIT ANALYSIS IS WORTHWHİLE ONLY IF THE EXPECTED SAVINGS EXCEED THE COST!...
  • 28. CREDIT MANAGEMENT & BANKRUPTCY CREDIT DECISION The decision to offer credit depends on the probability of payment!.. You should grant credit if the expected profit from doing so is greater than the profit from refusing!... Credit Policy: Standarts set to determine the amount and nature of credit to extend to customers. Offer Credit Refuse Credit Customer pays (p) Customer defaults (1 - p) REVENUES - COST - COST Refuse Credit : 0 Grant Credit : [p * PV(REVENUES – COST)] – [(1 - p) * PV ( COST)] if positive!... If one sale may lead to profitable repeat sales, the firm should be inclined to grant credit on the initial purchase.
  • 29. CREDIT MANAGEMENT & BANKRUPTCY Some General Principles: •Maximize Profit: Main job is not to minimize the bad accounts; it is to maximize PROFITS! •Concentrate on the dangerous accounts: Set credit limits for each customer and WHEN THE CUSTOMER EXCEEDS TAKE CARE! •Look beyond the immediate order: Sometimes take care the growth in sales in the LONG-RUN. Collection Policy: •Procedures to collect and monitor receivables. Account Receivable = Daily Sales X Average Collection Period When customers stretch payables you end up a longer collection period!.. Never forget the formula and establish a COLLECTION POLICY: Aging Schedule: •Classification of accounts receivable by time outstanding! Customer’s Name 1 month 1-2 months 2-3 months 3 months over TOTAL A $10,000 $ 10,000 B $ 8,000 $3,000 $ 11,000 ... Z $ 15,000 $ 15,000 TOTAL $ 18,000 $ 3,000 $ 15,000 $ 36,000 Good collection policy balances conflicting goals. The company wants cordial relations with customers and also wants them to pay the bills on time!...
  • 30. CREDIT MANAGEMENT & BANKRUPTCY BANKRUPTCY: •The reorganization or liquidation of a firm that can not pay its debts. WORKOUT: • Agreement between a company and its creditors establishing the steps the company must take to avoid bankruptcy. • The advantage of a negotiated agreement is that the costs and delays of formal bankruptcy are avoided. • If the firm cannot get an agreement, then it may have no alternative but to file for bankruptcy. Then the firm’s assets are liquidated - that is, sold – and the proceeds are used to pay creditors. LIQUIDATION: Sale of bankrupt firm’s assets. • Priorities: 1. No firm in bankruptcy proceedings could not continue to operate 2. Wages and employee benefits 3. Taxes and other governmental debts 4. Unsecured bonds
  • 31. CREDIT MANAGEMENT & BANKRUPTCY REORGANIZATION •Restructruring of financial claims on falling firm to allow it to keep operating. It is an alternative for liquidation!... THE REORGANIZATION PLAN •To design a new capital structure for the firm to satisfy the creditors •Allow the firm to solve the business problems The reorganization plan goes into effect if it is accepted by creditors and confirmed by the court!..
  • 33. CLEARING INFLATIONARY EFFECTS INFLATION The continous increase in the general level of prices Inflation distorts the historical data on financial statements Inflation causes the asset values to be seen higher than they have in fact!... For Example : Stocks; although the same quantity exists; monetary value seems higher SO IT IS UNAVOIDABLE TO CLEAR UP INFLATIONARY EFFECTS. There are two basic approach •General Price Level (GPL) •Current Replacement Cost (CRC) •General Price Level (GPL): •To correct the historical data by using an appropriate INDEX Corrected Value = Historical Value X [ Index Value at the end ] Index Value at the beginning Before correction it is needed to determine the inflationary effect on each financial item!...
  • 34. CLEARING INFLATIONARY EFFECTS Items of Fin. Stat. Monetary Non -Monetary Cash X Bonds & Similiars X Stocks & Similiars X Recivables X Inventory X Fixed Assets & Accumulated Depreciation X Short & Long-Term Debts X Sales and all revenue accounts X COGS and all expense accounts X Retained Earnings X Generally it can be said; Cash & Cash equivalents; receivables and payables are monetary and the other s are non-monetary The correction of inflationary effects on financial statements depends on the power of choosen INDEX.
  • 35. CLEARING INFLATIONARY EFFECTS (EXAMPLE) BALANCE SHEET FOR XYZ CORPORATION (31,12,2002) 2002 Type of Item Cleared Value Current Assets 3.000 Cash 500,00 Monetary 500,00 Receivables 1000,00 Monetary 1.000,00 Inventories 1500,00 Non-monetary X 150/125 1.800,00 Net Fixed Assets 2700,00 Gross Machinery 3000,00 Non-monetary X 150/100 4.500,00 (-) Acc. Depreciation 300,00 Non-monetary X 150/100 450,00 TOTAL ASSETS 5700,00 7.350,00 Current Liabilities 1200,00 Acc. Payable 200,00 Monetary 200,00 Notes Payable 1000,00 Monetary 1.000,00 Long-term Debt 0,00 Shareholders' equity 4000,00 Non-monetary X 150/100 6.000,00 Retained Earnings 500,00 150,00 TOTAL LIABILITIES & SHAREHOLDER'S EQUITY 5700,00 7.350,00
  • 36. CLEARING INFLATIONARY EFFECTS (EXAMPLE) INCOME STATEMENT FOR THE YEAR OF 2002 Net Sales 4500,00 Non-monetary X 150/125 5.400,00 Cost of Goods Sold 3000,00 Non-monetary X 150/125 3.600,00 Sales & Administrative Expenses 400,00 Non-monetary X 150/125 480,00 Depreciation 300,00 Non-monetary X 150/100 450,00 Taxable Income 800,00 Non-monetary X 150/125 870,00 Taxes 100,00 Non-monetary X 150/125 120,00 Inflationary Loss 360,00 Net Income 700,00 390,00 Dividends 200,00 Non-monetary X 150/125 240,00 To Retained Earnings 500,00 150,00 Inflation Index 31,12,2001 100 31,12,2002 150 Average for 2002 125
  • 37. CLEARING INFLATIONARY EFFECTS (EXAMPLE) Calculation of Inflationary Loss Historical Data Total Transaction Corrected Value Difference Cash at the beginning 2200,00 X150/100 3300,00 Cash Inputs 3500,00 X150/125 4200,00 Sales 4500,00 Receivables 1000,00 Cash Outputs 5200,00 X150/125 6240,00 Cost of Goods Sold 3000,00 Inventory 1500,00 Sales & Adm. Expenses 400,00 Taxes 100,00 Dividends 200,00 Cash at the end 500,00 1260,00 760,00 Receivables 1000,00 X150/125 1200,00 200,00 Acc. Payable 200,00 X150/100 300,00 100,00 Notes Payable 1000,00 X150/100 1500,00 500,00 TOTAL (Inflation Loss) 360,00