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Slide 1
Short-Term Finance and Planning
Chapter 18
Copyright 2013 by The McGraw-Hill Companies, Inc. All rights reserved.
McGraw-Hill/Irwin
18-#
1
Chapter Outline
Tracing Cash and Net Working Capital
The Operating Cycle and the Cash Cycle
The Cash Budget
18-#
2
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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4
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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5
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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7
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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9
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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11
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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12
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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16
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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17
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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20
Beginning Ending
Inventory200,000300,000
Accounts Receivable160,000200,000
Accounts Payable75,000100,000
Net sales
1,150,000
Cost of Goods sold
820,000
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
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
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
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
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