Chapter18 Short-TermFinanceandPlanningMcGraw-Hill/IrwinCopyright?2010byTheMcGraw-HillCompanies,Inc.Allrightsreserved.1KeyConceptsandSkillsUnderstandthecomponentsofthecashcycleandwhyitisimportantUnderstandtheprosandconsofthevariousshort-termfinancingpoliciesBeabletoprepareacashbudgetUnderstandthevariousoptionsforshort-termfinancing18-22ChapterOutlineTracingCashandNetWorkingCapitalTheOperatingCycleandtheCashCycleSomeAspectsofShort-TermFinancialPolicyTheCashBudgetShort-TermBorrowingAShort-TermFinancialPlan18-33SourcesandUsesofCashBalancesheetidentity(rearranged)NWC+fixedassets=long-termdebt+equityNWC=cash+otherCA–CLCash=long-termdebt+equity+CL–CAotherthancash–fixedassetsSourcesIncreasinglong-termdebt,equity,orcurrentliabilitiesDecreasingcurrentassetsotherthancash,orfixedassetsUsesDecreasinglong-termdebt,equity,orcurrentliabilitiesIncreasingcurrentassetsotherthancash,orfixedassets18-44TheOperatingCycleOperatingcycle–timebetweenpurchasingtheinventoryandcollectingthecashfromsaleoftheinventoryInventoryperiod–timerequiredtopurchaseandselltheinventoryAccountsreceivableperiod–timerequiredtocollectoncreditsalesOperatingcycle=inventoryperiod+accountsreceivableperiod18-55CashCycleCashcycleAmountoftimewefinanceourinventoryDifferencebetweenwhenwereceivecashfromthesaleandwhenwehavetopayfortheinventoryAccountspayableperiod–timebetweenpurchaseofinventoryandpaymentfortheinventoryCashcycle=Operatingcycle–accountspayableperiod18-66Figure18.118-77ExampleInformationInventory:Beginning=200,000Ending=300,000AccountsReceivable:Beginning=160,000Ending=200,000AccountsPayable:Beginning=75,000Ending=100,000Netsales=1,150,000CostofGoodssold=820,00018-88Example–OperatingCycleInventoryperiodAverageinventory=(200,000+300,000)/2=250,000Inventoryturnover=820,000/250,000=3.28timesInventoryperiod=365/3.28=111daysReceivablesperiodAveragereceivables=(160,000+200,000)/2=180,000Receivablesturnover=1,150,000/180,000=6.39timesReceivablesperiod=365/6.39=57daysOperatingcycle=111+57=168days18-99Example–CashCyclePayablesPeriodAveragepayables=(75,000+100,000)/2=87,500Payablesturnover=820,000/87,500=9.37timesPayablesperiod=365/9.37=39daysCashCycle=168–39=129daysWehavetofinanceourinventoryfor129daysIfwewanttoreduceourfinancingneeds,weneedtolookcarefullyatourreceivablesandinventoryperiods–theybothseemextensive.Acomparisontoindustryaverageswouldhelpsolidifythisassertion.18-1010Short-TermFinancialPolicySizeofinvestmentsincurrentassetsFlexible(conservative)policy–maintainahighratioofcurrentassetstosalesRestrictive(aggressive)policy–maintainalowratioofcurrentassetstosalesFinancingofcurrentassetsFlexible(conservative)policy–lessshort-termdebtandmorelong-termdebtRestrictive(aggressive)policy–moreshort-termdebtandlesslong-termdebt18-1111Carryingvs.ShortageCostsManagingshort-termassetsinvolvesatrade-offbetweencarryingcostsandshortagecostsCarryingcosts–increasewithincreasedlevelsofcurrentassets,thecoststostoreandfinancetheassetsShortagecosts–decreasewithincreasedlevelsofcurrentassetsTradingorordercostsCostsrelatedtosafetyreserves,i.e.,lostsalesandcustomers,andproductionstoppages18-1212Temporaryvs.PermanentAssetsTemporarycurrentassetsSalesorrequiredinventorybuild-upmaybeseasonalAdditionalcurrentassetsareneededduringthe“peak”timeThelevelofcurrentassetswilldecreaseassalesoccurPermanentcurrentassetsFirmsgenerallyneedtocarryaminimumlevelofcurrentassetsatalltimesTheseassetsareconsidered“permanent”becausethelevelisconstant,notbecausetheassetsaren’tsold18-1313Figure18.418-1414ChoosingtheBestPolicyCashreservesHighcashreservesmeanthatfirmswillbelesslikelytoexperiencefinancialdistressandarebetterabletohandleemergenciesortakeadvantageofunexpectedopportunitiesCashandmarketablesecuritiesearnalowerreturnandarezeroNPVinvestmentsMaturityhedgingTrytomatchfinancingmaturitieswithassetmaturitiesFinancetemporarycurrentassetswithshort-termdebtFinancepermanentcurrentassetsandfixedassetswithlong-termdebtandequityInterestRatesShort-termratesarenormallylowerthanlong-termrates,soitmaybecheapertofinancewithshort-termdebtFirmscangetintotroubleifratesincreasequicklyorifitbeginstohavedifficultymakingpayments–maynotbeabletorefinancetheshort-termloansHavetoconsiderallthesefactorsanddetermineacompromisepolicythatfitstheneedsofthefirm18-1515Figure18.618-1616CashBudgetForecastofcashinflowsandoutflowsoverthenextshort-termplanningperiodPrimarytoolinshort-termfinancialplanningHelpsdeterminewhenthefirmshouldexperiencecashsurplusesandwhenitwillneedtoborrowtocoverworking-capitalrequirementsAllowsacompanytoplanaheadandbeginthesearchforfinancingbeforethemoneyisactuallyneeded18-1717Example:CashBudgetInformationPetTreats,Inc.specializesingourmetpettreatsandreceivesallincomefromsalesSalesestimates(inmillions)Q1=500;Q2=600;Q3=650;Q4=800;Q1nextyear=550AccountsreceivableBeginningreceivables=$250Averagecollectionperiod=30daysAccountspayablePurchases=50%ofnextquarter’ssalesBeginningpayables=125Accountspayableperiodis45daysOtherexpensesWages,taxes,andotherexpenseare30%ofsalesInterestanddividendpaymentsare$50Amajorcapitalexpenditureof$200isexpectedinthesecondquarterTheinitialcashbalanceis$80,andthecompanymaintainsaminimumbalanceof$5018-1818Example:CashBudget–CashCollectionsACP=30days;thisimpliesthat2/3ofsalesarecollectedinthequartermadeandtheremaining1/3arecollectedthefollowingquarterBeginningreceivablesof$250willbecollectedinthefirstquarterQ1Q2Q3Q4BeginningReceivables250167200217Sales500600650800CashCollections583567633750EndingReceivables16720021726718-1919Example:CashBudget–

CashDisbursementsPayablesperiodis45days,sohalfofthepurchaseswillbepaidforeachquarterandtheremainingwillbepaidthefollowingquarterBeginningpayables=$125Q1Q2Q3Q4Paymentofaccounts275313362338Wages,taxesandotherexpenses150180195240Capitalexpenditures200Interestanddividendpayments50505050Totalcashdisbursements47574360762818-2020Example:CashBudget–NetCashFlowandCashBalanceQ1Q2Q3Q4Totalcashcollections583567633750Totalcashdisbursements475743607628Netcashinflow108-17626122BeginningCashBalance801881238Netcashinflow108-17626122Endingcashbalance1881238160Minimumcashbalance-50-50-50-50Cumulativesurplus(deficit)138-38-1211018-2121Short-TermBorrowingUnsecuredLoansLineofcreditCommittedvs.noncommittedRevolvingcreditarrangementLetterofcreditSecuredLoansAccountsreceivablefinancingAssigningFactoringInventoryloansBlanketinventorylienTrustreceiptFieldwarehousefinancingCommercialPaperTradeCredit18-2222Example:CompensatingBalanceWehavea$500,000lineofcreditwitha15%compensatingbalancerequirement.Thequotedinterestrateis9%.Weneedtoborrow$150,000forinventoryforoneyear.Howmuchdoweneedtoborrow?150,000/(1-.15)=176,471Whatinterestrateareweeffectivelypaying?Interestpaid=176,471(.09)=15,882Effectiverate=15,882/150,000=.1059or10.59%18-2323Example:FactoringLastyearyourcompanyhadaverageaccountsreceivableof$2million.Creditsaleswere$24million.Youfactorreceivablesbydiscountingthem2%.Whatistheeffectiverateofinterest?Receivablesturnover=24/2=12timesAPR=12(.02/.98)=.2449or24.49%EAR=(1+.02/.98)12–1=.2743or27.43%18-2424Short-TermFinancialPlanQ1Q2Q3Q4Beginningcashbalance801885050Netcashinflow108(176)26122Newshort-termborrowing38Interestonshort-terminvestment(loan)1(1)Short-termborrowingrepaid2513Endingcashbalance1885050159Minimumcashbalance(50)(50)(50)(50)Cumulativesurplus(deficit)13800109Beginningshort-termdebt003813Changeinshort-termdebt038(25)(13)Endingshort-termdebt03813018-2525QuickQuizHowdoyoucomputetheoperatingcycleandt