Download Cash Conversion Cycle: Example

Lecture 9: 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.
19-1
Short-Term Planning
Short-term financing needs are tied to the
firm’s long-term decisions.
Total Capital Requirement
• The total cost of the assets that a firm needs to run
efficiently.
19-2
Short-Term Planning
As the business grows, it is likely to need additional fixed
assets and current assets.
19-3
Planning Strategies
Three approaches:
a) Relaxed Strategy
-permanent cash
surplus
b) Middle-of-the-road
Policy
c) Restrictive Policy
-permanent need for
short-term borrowing
19-4
Planning Strategies
Managers typically list three considerations when determining
the “best” mix of short-term and long-term financing:
Matching Maturities
Permanent Working Capital Requirements
The Advantages of Liquidity
19-5
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?
19-6
Working Capital
Much of short-term financial planning focuses on
variations in working capital.
 Components of Working Capital:
Current Assets
 Current Liabilities

19-7
Working Capital: Example
What will be the change in net working capital if current assets
increase by $170,000 and current liabilities decrease by
$60,000?
19-8
Current Assets
 Common current assets:

Accounts Receivable
• Trade Credit
• Consumer Credit
Inventory
 Cash & Marketable Securities

•
•
•
•
Demand Deposits
Time Deposits
Commercial Paper
Treasury Bills
19-9
Current Liabilities
 Common current liabilities:
Accounts Payable
 Short-term Borrowing

19-10
The Cash Conversion Cycle
Typically, most firms have positive net working
capital. But why do they need working capital at all?
Simple Cycle of Operations
19-11
The Cash Conversion Cycle
Cash Conversion
Inventory
Receivables
+
=
Cycle
Period
Period
-
Accounts
Payable Period
19-12
Useful Ratios
Why are these ratios useful?
19-13
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)
Inventory Receivables
+
Period
Period
-
Accounts
Payable Period
19-14
The Working Capital Trade-Off
Working capital can be actively managed; it is not set
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.
19-15
Changes in Working Capital:
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.
19-16
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.
19-17
Sources of Cash
Ending Accounts
Beginning Accounts
=
+
Receivable
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?
19-18
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
19-19
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
19-20
Short-term Financing Plan:
Example (with calculations)
19-21
Sources of Short-Term Financing
 Bank loans

Lines of Credit
 Secured Loans
 Commercial Paper
19-22
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.
19-23
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.
19-24
Commercial Paper
Large companies bypass the bank and issue
commercial paper directly to large investors.
Is commercial paper typically secured debt or
unsecured debt?
19-25