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Chap019
- 1. McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
- 2. Short-Term Financial Planning Short-term financial planning focuses on managing a firm’s current assets and liabilities. This chapter examines a number of short-term planning strategies and provides a greater understanding of how firms develop short-term financial plans. 19-2
- 3. Short-Term Planning Short-term financing needs are tied to the 19-3 firm’s long-term decisions. Total Capital Requirement • The total cost of the assets that a firm needs to run efficiently.
- 4. Short-Term Planning As the business grows, it is likely to need additional 19-4 fixed assets and current assets.
- 5. Planning Strategies Three approaches: a)Relaxed Strategy -permanent cash surplus a)Middle-of-the-road Policy a)Restrictive Policy -permanent need for short-term borrowing 19-5
- 6. Planning Strategies Managers typically list three considerations when determining the “best” mix of short-term and long-term financing: 19-6 Matching Maturities Permanent Working Capital Requirements The Advantages of Liquidity
- 7. 19-7 Liquidity Some firms choose to hold more liquidity than others. Why do many high-tech companies hold huge amounts of short-term securities while many manufacturers (ex. steel) hold much smaller reserves? What are the costs associated with holding excess cash?
- 8. 19-8 Working Capital Much of short-term financial planning focuses on variations in working capital. Components of Working Capital: Current Assets Current Liabilities
- 9. Working Capital: Example What will be the change in net working capital if current assets increase by $170,000 and current liabilities decrease by 19-9 $60,000?
- 10. 19-10 Current Assets Common current assets: Accounts Receivable • Trade Credit • Consumer Credit Inventory Cash & Marketable Securities • Demand Deposits • Time Deposits • Commercial Paper • Treasury Bills
- 11. Current Liabilities 19-11 Common current liabilities: Accounts Payable Short-term Borrowing
- 12. The Cash Conversion Cycle Typically, most firms have positive net working capital. But why do they need working capital at all? 19-12 Simple Cycle of Operations
- 13. The Cash Conversion Cycle 19-13
- 14. 19-14 Useful Ratios Why are these ratios useful?
- 15. Cash Conversion Cycle: Example What is the cash conversion cycle for a firm with $3 million average inventories, $1.5 million average accounts payable, a receivables period of 40 days, and an annual cost of goods sold of $18 million? Cash Conversion Cycle (CCC) 19-15 Inventory Period Receivables Period Accounts = + - Payable Period
- 16. The Working Capital Trade-Off Working capital can be actively managed; it is not set 19-16 in stone. Carrying Costs Costs of maintaining current assets, including opportunity cost of capital. What are some carrying costs associated with holding inventory? Shortage Costs Costs incurred from shortages in current assets.
- 17. Changes in Working Capital: 19-17 Example How would the following affect cash and net working capital? The firm repurchases outstanding shares of stock. Both cash and net working capital will decrease. The firm uses cash on hand to buy raw materials. Cash will decrease; net working capital will be unaffected. The firm sells long-term bonds and puts the proceeds in its bank account. Both cash and net working capital will increase.
- 18. 19-18 Cash Budgeting 3 Steps to preparing a cash budget: 1. Forecast the sources of cash. 2. Forecast the uses of cash. 3. Calculate whether the firm is facing a cash shortage or surplus. The financial plan gives the strategy for investing cash surpluses or financing any deficit.
- 19. 19-19 Sources of Cash Ending Accounts Receivable = Beginning Accounts Receivable + Sales - Collections Example: What was the sales volume in the current quarter if beginning accounts receivable, at $5,000, was $1,000 higher than ending, and $20,000 was collected?
- 20. 19-20 Uses of Cash Uses of cash can be split into four broad categories: Payments of Accounts Payable Labor, Administrative, and Other Expenses Capital Expenditures Taxes, Interest, and Dividend Payments
- 21. The Cash Balance Are large cash outflows in early periods generally a sign of trouble for a firm? Our calculations only give us a best guess about future cash flows. Undertake scenario analysis for better planning 19-21
- 22. Short-term Financing Plan: Example (with calculations) 19-22
- 23. Sources of Short-Term Financing 19-23 Bank loans Lines of Credit Secured Loans Commercial Paper
- 24. 19-24 Bank Loans The simplest and most common form of short-term finance is a bank loan. Line of Credit • Agreement by a bank that a company may borrow at any time up to an established limit. Term Loans • A loan that lasts for an extended period of time. Self-liquidating Loans • A loan that provides the cash to repay itself with the sale of goods.
- 25. 19-25 Secured Loans If a bank is concerned about credit risk, it will demand that a firm provide collateral for the loan. Accounts Receivable Financing • The firm assigns its receivables to the bank. Inventory Financing • The bank accepts the firm’s inventory as collateral.
- 26. Commercial Paper Large companies bypass the bank and issue commercial paper directly to large investors. Is commercial paper typically secured debt or 19-26 unsecured debt?
Editor's Notes
- Chapter 19 Learning Objectives Understand why the firm needs to invest in net working capital. Show how long-term financing policy affects short-term financing requirements. Trace a firm’s sources and uses of cash and evaluate its need for short-term borrowing. Develop a short-term financing plan that meets the firm’s need for cash. Identify several major sources of short-term financing.
- Chapter 19 Outline Short Term Planning 3 Strategies 3 Considerations The Importance of Liquidity Net Working Capital Current Assets Current Liabilities The Cash Conversion Cycle The Working Capital Trade-off Cash Budgeting Sources of Cash Uses of Cash The Cash Balance Sources of Short-Term Financing
- Total capital requirement – The total cost of the assets that a firm needs to run efficiently. Example: money invested in plant, machinery, inventories, accounts receivable, etc.
- Note: The graph above illustrates the growth in the firm’s capital requirements. The line is upward-sloping, showing that as the business grows it is likely to need additional fixed assets and current assets.
- Relaxed Strategy – The firm has a permanent short-term cash surplus. This surplus will likely be invested in marketable securities. Middle-of-the-road Policy – The firm has spare cash that it can lend out during the part of the year when capital requirements are low; the firm can borrow during the rest of the year when capital requirements are higher. Restrictive Policy – The firm has a permanent need for short-term borrowing.
- There are often costs to holding surplus cash. Holdings of marketable securities are at best a zero-NPV investment for taxpaying firms. Managers of firms with large cash surpluses may be careless with funds.
- Remember: Net working capital = (current assets – current liabilities)
- Accounts receivable - Arise because customers don’t usually pay for their purchases immediately. Trade credit – Arise due to unpaid bills from sales to other companies. Consumer credit – Arise due to unpaid bills from sales to the final consumer. Inventory – Raw materials, works-in-process, or finished goods awaiting sale and shipment. Cash and marketable securities: Demand deposits – money in checking accounts that the firm can pay out immediately. Time deposits – money in savings accounts that can be paid out only with a delay. Commercial paper – short-term unsecured debt sold by other firms. Treasury bills – short-term debts sold by the U.S. government.
- Net Working Capital – Current assets minus current liabilities. Often called working capital.
- Cash Conversion Cycle – Period between firm’s payment for materials and collection on its sales. The longer the production process, the more cash the firm must keep tied up in inventories. The longer it takes customers to pay their bills, the higher the value of accounts receivable. If a firm can delay paying for its own materials, it may reduce the amount of cash it needs. i.e. Accounts payable reduce net working capital.
- Working capital can be managed; it is not set in stone. Example: accounts receivable are affected by the terms of credit the firm offers to its customers. Example: The cost of the firm’s investment in receivables is the interest that could have been earned if customers paid their bills earlier. Carrying Costs – Costs of maintaining current assets, including opportunity cost of capital. Shortage Costs – Costs incurred from shortages in current assets.
- Line of credit – Agreement by a bank that a company may borrow at any time up to an established limit. Commercial Paper – Short-term unsecured notes issued by firms. Secured Debt – Debt that has first claim on specified collateral in the event of default.
- Line of credit – Agreement by a bank that a company may borrow at any time up to an established limit. Term loan – A loan that lasts for an extended period of time; typically a number of years. Self-liquidating Loans – A loan that provides the cash to repay itself with the sale of goods.
- Note: When borrowing short-term, the required collateral is generally restricted to liquid assets such as receivables, inventories, or securities. Accounts Receivable Financing: The firm assigns its receivables to the bank. If the firm fails to repay the loan, the bank can collect on the receivables and use the cash to repay the debt. Inventory Financing: Banks often use inventory as collateral, but they will only choose collateral inventories that can be easily resold. Field Warehousing: An independent warehouse company hired by the bank supervises the inventory pledged as collateral for the loan.
- Commercial Paper – Short-term unsecured notes issued by firms.