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Short-Term Financial Planning
Chapter 16
McGraw-Hill
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© 2004 The McGraw-Hill Companies, Inc. All rights reserved.
Chapter Outline
1.
2.
3.
4.
5.
6.
7.
Sources and Uses of Cash
The Operating Cycle and Cash Cycle
Calculate Operating Cycle and Cash Cycle
Managers in Short-term Financing
Short-Term Financial Policy
Cash Budget
Short-Term Borrowing
16.1
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1.Sources and Uses of Cash

Sources of Cash

Obtaining financing:





Uses of Cash

Increase in long-term debt
Increase in equity
Increase in current liabilities


Selling assets


Decrease in current assets
Decrease in fixed assets
Paying creditors or
stockholders


Decrease in long-term debt
Decrease in equity
Decrease in current liabilities
Buying assets


Increase in current assets
Increase in fixed assets
Cash + Current Asset other than cash + Fixed Assets
= Current Liabilities + Long-term debt + Equity
16.2
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Sources and Uses of Cash
Illustration
Cash + Current Asset other than cash + Fixed Assets
= Current Liabilities + Long-term debt + Equity
16.3
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2.The Operating Cycle
 The
time it takes to receive inventory, sell it and
collect on the receivables generated from the sale
 Operating cycle = inventory period + accounts
receivable period
Inventory period = time inventory sits on the shelf
 Accounts receivable period = time it takes to collect
on receivables

16.4
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The Cash Cycle
 The
time between payment for inventory and
receipt from the sale of inventory
 Cash cycle = operating cycle – accounts payable
period

Accounts payable period = time between receipt of
inventory and payment for it
 The
cash cycle measures how long we need to
finance inventory and receivables
16.5
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Operating and Cash Cycle
Illustration
Inventory
purchased
Inventory sold
Inventory period
Accounts receivable period
Accounts payable period
Cash cycle
Cash
received
Cash paid for
inventory
30%
16.6
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3.Example Information
Item
Beginning
Ending
Average
Inventory
200,000
300,000
250,000
Accounts
Receivable
160,000
200,000
180,000
75,000
100,000
87,500
Accounts
Payable
Net Sales = $1,150,000
Cost of Goods Sold = $820,000
16.7
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Example - Operating Cycle

Inventory Period = 365 / Inventory Turnover

Inventory Turnover = COGS / Average inventory
 IT


= 820,000 / 250,000 = 3.28 times
Inventory Period = 365 / 3.28 = 111 days
Accounts Receivable Period = 365 / Receivables
Turnover

Receivables Turnover = Credit Sales / Average AR
 RT


= 1,150,000 / 180,000 = 6.4 times
Receivables Period = 365 / 6.4 = 57 days
Operating cycle = 111 + 57 = 168 days
16.8
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Example - Cash Cycle
Accounts Payables Period = 365 / payables turnover
 Payables turnover = COGS / Average AP
 PT = 820,000 / 87,500 = 9.4 times
 Accounts payables period = 365 / 9.4 = 39 days
 Cash cycle = 168 – 39 = 129 days
 So, we have to finance our inventory and receivables for 129
days

16.9
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4.Managers in Short-term Financing
16.10
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5.Short-Term Financial Policy



Flexible (Conservative) Policy
 Large amounts of cash and
marketable securities
 Large amounts of inventory
 Liberal credit policies (large
accounts receivable)
 Relatively low levels of
short-term liabilities
High liquidity
Wants to avoid losing
business because of shortage
of resources



Restrictive (Aggressive)
Policy
 Low cash and marketable
security balances
 Low inventory levels
 Little or no credit sales (low
accounts receivable)
 Relatively high levels of
short-term liabilities
Low liquidity
Wants to avoid wasting
resources
16.11
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Carrying versus Shortage Costs
Shortage costs (increase when current assets decrease)
 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
 Carrying costs (increase when current assets increase)
 Opportunity cost of owning current assets versus longterm assets that pay higher returns
 Cost of storing larger amounts of inventory

16.12
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Choosing the Best Policy
 Best
policy will be a combination of flexible and
restrictive policies
 Compromise policy – borrow short-term to meet
peak needs, maintain a cash reserve for
emergencies
50%
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16.13
© 2004 The McGraw-Hill Companies, Inc. All rights reserved.
6.Cash Budget
 Primary

tool in short-run financial planning
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

16.14
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Example: Cash Budget Information

Expected Sales for 2005 by quarter (millions)










Q1: $57; Q2: $66; Q3: $66; Q4: $90
Beginning Accounts Receivable = $30
Average collection period = 30 days
Purchases from suppliers = 50% of current quarter’s estimated
sales, at the beginning of each quarter
Accounts payable period = 45 days
Wages, taxes and other expenses = 25% of sales
Interest and dividends = $5 million per quarter
Major expansion planned for quarter 2 costing $35 million
Beginning cash balance = $5 million
Minimum cash balance requirement = $2 million
16.15
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Example: Cash Budget Step 1:
Cash Collections
Q1
Q2
Q3
Q4
Beginning Receivables
30
19
22
22
Sales
57
66
66
90
Cash Collections = Beg.
Receivables + 2/3(Sales)
68
63
66
82
Ending Receivables =
1/3(Sales)
19
22
22
30
16.16
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Example: Cash Budget Step 2:
Cash Disbursements
Payment of A/P = 50% of
sales
Wages, taxes, other
expenses
Capital Expenditures
Long-term financing
(interest and dividends)
Total Disbursements
Q1
28.50
Q2
33.00
Q3
33.00
Q4
45.00
14.25
16.50
16.50
22.50
35.00
5.00
5.00
5.00
5.00
47.75
89.50
54.50
72.50
75%
16.17
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Example: Cash Budget Step 3:
Net Cash Flow and Cash Balance
Q1
Q2
Q3
Q4
Total Cash Collections
68.00
63.00
66.00
82.00
Total Cash Disbursements
47.75
89.50
54.50
72.50
Net Cash Flow
20.25
(26.50)
11.50
9.5
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 (deficit)
23.25
(3.25)
8.25
17.75
Beginning Cash Balance
16.18
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Things to Consider in Cash Budgeting
 Cash

reserve
more important for firms with unexpected opportunities on a
regular basis, less important for firms in stable business
 Maturity

Avoid financing long-term assets with short-term securities
 Relative

hedging
interest rates
Long-term rates are normally higher, you don’t want to rely on
higher interest debt to finance temporary short-term assets
16.19
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7. Short-Term Borrowing

Unsecured loans



Line of credit – prearranged agreement with a bank that
allows the firm to 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
16.20
inventory or both
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Short-Term Financial Plan
Q1
Q2
Q3
Q4
Beginning Cash
5.00
25.25
2.00
10.05
Net Cash Inflow
20.25
(26.50)
11.50
9.50
New Short-Term Debt
0.00
3.25
0.00
0.00
Interest on Short-Term Debt
0.00
0.00
0.20
0.00
Short-Term Debt Repayment
0.00
0.00
3.25
0.00
Ending Cash Balance
25.25
2.00
10.05
19.55
Minimum Cash Balance
-2.00
-2.00
-2.00
-2.00
Cumulative Surplus (Deficit)
23.25
0.00
8.05
17.55
Beginning Short-Term Debt
0.00
0.00
3.25
0.00
Change in Short-Term Debt
0.00
3.25
-3.25
0.00
Ending Short-Term Debt
0.00
3.25
0.00
0.00
16.21
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Review Questions
1. What kind of activity is a source of cash and what kind
of activity is a use of cash?
2. What is operating cycle? What is cash cycle? How
cash cycle will be affected by changes in inventory
period/turnover, accounts receivable period/turnover,
and accounts payable period/turnover?
3. Know how to calculate operating cycle and cash cycle
given information on sales, COGS, inventory, account
receivable, and account payable.
16.22
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Review Questions (cont ..)
5. What are the differences between flexible and
restrictive short-term financial policies? What are
carrying costs and shortage costs?
7. What are the short-term borrowing options?
16.23
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