Slide 1

Short-Term Finance and Planning

Chapter 18

Copyright 2013 by The McGraw-Hill Companies, Inc. All rights reserved.

McGraw-Hill/Irwin

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Chapter Outline

Tracing Cash and Net Working Capital

The Operating Cycle and the Cash Cycle

The Cash Budget

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Overarching Principles

Much of this chapter is about timing:

Keep the money you have as long as you can;

Get the money owed you as soon as you can.

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Sources and Uses of Cash

Balance sheet identity (rearranged):

NWC + fixed assets = long-term debt + equity

NWC = cash + other CA CL

Cash = long-term debt + equity + CL

CA other than cash fixed assets

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Sources and Uses of Cash

Sources of Cash:

Increasing long-term debt, equity, or current liabilities

Decreasing current assets other than cash, or fixed assets

Uses of Cash:

Decreasing long-term debt, equity, or current liabilities

Increasing current assets other than cash, or fixed assets

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The Operating Cycle

Operating cycle time between purchasing the inventory and collecting the cash from sale of the inventory

Inventory period time required to purchase and sell the inventory

Accounts receivable period (ARP) time required to collect on credit sales

Operating cycle = Inventory Period + ARP

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Cash Cycle

Cash cycle

Amount of time we finance our inventory

Difference between when we receive cash from the sale and when we have to pay for the inventory

Accounts payable period (APP) time between purchase of inventory and payment for the inventory

Cash Cycle = Operating Cycle APP

Operating cycle = Inventory Period + ARP

Cash Cycle = Inventory Period + ARP APP

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Operating and Cash Cycles

Cash Cycle = Inventory Period + ARP APP

Cash Cycle = Operating Cycle APP

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Example Information

Inventory:

Beginning = 200,000

Ending = 300,000

Accounts Receivable:

Beginning = 160,000

Ending = 200,000

Accounts Payable:

Beginning = 75,000

Ending = 100,000

Net sales = 1,150,000

Cost of Goods sold = 820,000

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Example Solution Operating Cycle

Inventory period

Average inventory = (200,000+300,000)/2 = 250,000

Inventory turnover = COGS/AvgInv) = 820,000 / 250,000 = 3.28 times

Inventory period = 365/ Inv.TO = 365 / 3.28 = 111 days

Receivables period

Average receivables = (160,000+200,000)/2 = 180,000

Receivables turnover = Sales/Avg.Rec = 1,150,000 / 180,000 = 6.39 times

Receivables period = 365 / 6.39 = 57 days

Operating cycle = 111 + 57 = 168 days

Payables Period

Average payables = (75,000+100,000)/2 = 87,500

Payables turnover = COGS/Av.Payables = 820,000 / 87,500 = 9.37 times

Payables period = 365 / 9.37 = 39 days

Cash Cycle = Operating Cycle APP = 168 39 = 129 days

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Cash Cycle

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Solution Interpretation

So what does all this mean for the firm?

It has to finance its inventory for 129 days, that is, operate without cash inflows for 129 days (more than four months!)

If it wants to reduce its financing needs, it needs to look carefully at its receivables and inventory periods they both seem extensive.

A comparison to industry averages would help solidify this assertion.

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Cash Budget

Forecast of cash inflows and outflows over the next short-term planning period

Primary tool in short-term financial planning

Helps determine when the firm should experience cash surpluses and when it will need to borrow to cover working-capital requirements

Allows a company to plan ahead and begin the search for financing before the money is actually needed

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Example: Cash Budget Information

Pet Treats, Inc. specializes in gourmet pet treats and receives all income from sales

Sales estimates (in $millions)

Q1 = 500; Q2 = 600; Q3 = 650; Q4 = 800; Q1 next year = 550

Accounts receivable:

Beginning receivables = $250

Average collection period (ACP) = 30 days

Accounts payable

Purchases = 50% of next quarters sales

Beginning payables = 125

Accounts payable period (APP) is 45 days

Other expenses

Wages, taxes, and other expense are 30% of sales

Interest and dividend payments are $50

A major capital expenditure of $200 is expected in the second quarter

The initial cash balance is $80, and

The company maintains a minimum balance of $50

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Example: Cash Budget Cash Collections

ACP = 30 days; this implies that

2/3 of sales are collected in the quarter made

Remaining 1/3 are collected the following quarter

Beginning receivables of $250 will be collected in the first quarter

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Example: Cash Budget Cash Disbursements

Payables period is 45 days, so half of the purchases will be paid for each quarter and the remaining will be paid the following quarter

Beginning payables = $125

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Example: Cash Budget Net Cash Flow and Cash Balance

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So how will the company survive these deficits?

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Terminology

Net Working Capital (NWC)

Sources and Uses of Cash

Operating Cycle

Cash Cycle

Cash Budget

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Formulas

Operating cycle = inventory period + accounts receivable period

Cash cycle = Operating cycle accounts payable period

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Bring cash into the organization and dispersing it efficiently is the focus of working capital management.

The timing of cash is the key to insure we have sufficient funds to pay our bills on time.

The cash budget forecasts future cash needs.

The operating cycle and the cash cycle work together to demonstrate how much time it takes to go from inventory to cash received.

5. Short-term borrowing fills in the gaps of needed funds

What are the most important topics of this chapter?

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Beginning Ending

Inventory200,000300,000

Accounts Receivable160,000200,000

Accounts Payable75,000100,000

Net sales

1,150,000

Cost of Goods sold

820,000

Sheet1Beginning Ending Inventory200,000300,000Accounts Receivable160,000200,000Accounts Payable75,000100,000Net sales 1,150,000Cost of Goods sold 820,000

Sheet2

Sheet3

Beginning Ending AverageTurnover

Period in

Days

Inventory200,000300,000250,0003.280111.28

Accounts Receivable160,000200,000180,0006.38957.13

Accounts Payable75,000100,00087,5009.37138.95

Cost of Goods sold

820,000

Net sales

1,150,000

Oper.cycle = Inv Period + ARP168.41days

Cash Cycle = Oper.Cycle APP129.46days

Sheet1Beginning Ending AverageTurnoverPeriod in DaysInventory200,000300,000250,0003.280111.28Accounts Receivable160,000200,000180,0006.38957.13Accounts Payable75,000100,00087,5009.37138.95Cost of Goods sold 820,000Net sales 1,150,000Oper.cycle = Inv Period + ARP168.41daysCash Cycle = Oper.Cycle APP129.46days

Sheet2

Sheet3

Beginning Ending AverageTurnover

Period in

Days

Inventory200,000300,000250,0003.280111.28

Accounts Receivable160,000200,000180,0006.38957.13

Accounts Payable75,000100,00087,5009.37138.95

Cost of Goods sold

820,000

Net sales

1,150,000

Oper.cycle = Inv Period + ARP168.41days

Cash Cycle = Oper.Cycle APP129.46days

Sheet1Beginning Ending AverageTurnoverPeriod in DaysInventory200,000300,000250,0003.280111.28Accounts Receivable160,000200,000180,0006.38957.13Accounts Payable75,000100,00087,5009.37138.95Cost of Goods sold 820,000Net sales 1,150,000Oper.cycle = Inv Period + ARP168.41daysCash Cycle = Oper.Cycle APP129.46days

Sheet2

Sheet3

Q1Q2Q3Q4

Sales estimates500600650800

Purchases300325400275

AR250

2/3 current Quarter333.33400.00433.33533.33

1/3 next one (Ending AR)166.67200.00216.67

Total Cash Collection583.33566.67633.33750.00

Sheet1Beginning Ending AverageTurnoverPeriod in DaysInventory200,000300,000250,0003.280111.28Accounts Receivable160,000200,000180,0006.38957.13Accounts Payable75,000100,00087,5009.37138.95Cost of Goods sold 820,000Net sales 1,150,000Oper.cycle = Inv Period + ARP168.41daysCash Cycle = Oper.Cycle APP129.46days

Sheet2Sales estimates (in $millions)Q1 Beg AR$250ACP30daysPurchases 50%of next quarters salesBeginning AP125APP is 45 days45daysWages, taxes, and other expense 30%of salesInterest and dividend payments50A major capital expenditure in Q2200Initial Cash balance80Minimum Cash Balance50Q1Q2Q3Q4Q1 Next YearSales estimates500600650800550Purchases300325400275AR2502/3 current Quarter333.33400.00433.33533.331/3 next one (Ending AR)166.67200.00216.67Total Cash Collection583.33566.67633.33750.00AP12550% current Q150162.5200137.550% next Q150162.5200Total AP275312.5362.5337.5Wages, taxes, and other expense 150180195240Int & Div50505050Cap. Expenditure200Total Cash Disbursements475742.5607.5627.5Net Cash Inflow108.33-175.8325.83122.50Beginning balance80188.3312.5038.33Net Cash Inflow108.33-175.8325.83122.50Ending Balance188.3312.5038.33160.83Min Balance-50-50-50-50Cumultive Surplus (deficit)138.33-37.50-11.67110.83

Sheet3

Q1Q2Q3Q4

AP125

50% current Q150162.5200137.5

50% next Q150162.5200

Total AP275312.5362.5337.5

Wages, taxes, and other expense 150180195240

Int & Div50505050

Cap. Expenditure200

Total Cash Disbursements475742.5607.5627.5

Sheet1Beginning Ending AverageTurnoverPeriod in DaysInventory200,000300,000250,0003.280111.28Accounts Receivable160,000200,000180,0006.38957.13Accounts Payable75,000100,00087,5009.37138.95Cost of Goods sold 820,000Net sales 1,150,000Oper.cycle = Inv Period + ARP168.41daysCash Cycle = Oper.Cycle APP129.46days

Sheet2Sales estimates (in $millions)Q1 Beg AR$250ACP30daysPurchases 50%of next quarters salesBeginning AP125APP is 45 days45daysWages, taxes, and other expense 30%of salesInterest and dividend payments50A major capital expenditure in Q2200Initial Cash balance80Minimum Cash Balance50Q1Q2Q3Q4Q1 Next YearSales estimates500600650800550Purchases300325400275AR2502/3 current Quarter333.33400.00433.33533.331/3 next one (Ending AR)166.67200.00216.67Total Cash Collection583.33566.67633.33750.00Q1Q2Q3Q4Q1 Next YearAP12550% current Q150162.5200137.550% next Q150162.5200Total AP275312.5362.5337.5Wages, taxes, and other expense 150180195240Int & Div50505050Cap. Expenditure200Total Cash Disbursements475742.5607.5627.5Net Cash Inflow108.33-175.8325.83122.50Beginning balance80188.3312.5038.33Net Cash Inflow108.33-175.8325.83122.50Ending Balance188.3312.5038.33160.83Min Balance-50-50-50-50Cumultive Surplus (deficit)138.33-37.50-11.67110.83

Sheet3

Q1Q2Q3Q4

Beginning balance80188.3312.5038.33

Total Cash Collection583.33566.67633.33750.00

Total Cash Disbursements475742.5607.5627.5

Net Cash Inflow108.33-175.8325.83122.50

Ending Balance188.3312.5038.33160.83

Min Balance-50-50-50-50

Cumultive Surplus (deficit)138.33-37.50-11.67110.83

Sheet1Beginning Ending AverageTurnoverPeriod in DaysInventory200,000300,000250,0003.280111.28Accounts Receivable160,000200,000180,0006.38957.13Accounts Payable75,000100,00087,5009.37138.95Cost of Goods sold 820,000Net sales 1,150,000Oper.cycle = Inv Period + ARP168.41daysCash Cycle = Oper.Cycle APP129.46days

Sheet2Sales estimates (in $millions)Q1 Beg AR$250ACP30daysPurchases 50%of next quarters salesBeginning AP125APP is 45 days45daysWages, taxes, and other expense 30%of salesInterest and dividend payments50A major capital expenditure in Q2200Initial Cash balance80Minimum Cash Balance50Q1Q2Q3Q4Q1 Next YearSales estimates500600650800550Purchases300325400275AR2502/3 current Quarter333.33400.00433.33533.331/3 next one (Ending AR)166.67200.00216.67Total Cash Collection583.33566.67633.33750.00Q1Q2Q3Q4Q1 Next YearAP12550% current Q150162.5200137.550% next Q150162.5200Total AP275312.5362.5337.5Wages, taxes, and other expense 150180195240Int & Div50505050Cap. Expenditure200Total Cash Disbursements475742.5607.5627.5Net Cash Inflow108.33-175.8325.83122.50Q1Q2Q3Q4Beginning balance80188.3312.5038.33Total Cash Collection583.33566.67633.33750.00Total Cash Disbursements475742.5607.5627.5Net Cash Inflow108.33-175.8325.83122.50Ending Balance188.3312.5038.33160.83Min Balance-50-50-50-50Cumultive Surplus (deficit)138.33-37.50-11.67110.83

Sheet3