Chapter 19 Key Concepts and Skills

• Understand S-T Financial Decisions

(Working Capital Management)
•Short-Term Finance • Understand the components of the cash
cycle and the operating cycle and why it is
and Planning important
• Be able to prepare a cash budget

19-0 19-1

S-T Finance
• To this point, we have described many of • S-T finance is primarily concerned with the
the decisions of L-T finance (Example: analysis of decisions that affects CAs and CLs.
capital budgeting, financial structure). • NWC – is associated with S-T financing decision
making. (CA-CL)
• The most important difference between S-
• S-T Financial Management : Working Capital
T and L-T finance is the timing of the cash Management
flows. (S-T financial decision involves cash
• Example :
inflows or outflows that occur within a year
• What is a reasoable level of cash to keep on hand
or less)
(in a bank) to pay bills?
• How much should the firm borrow in the S-T?
19-2 • How much credit should be extended to customers?
19-3

Sources and Uses of Cash Activities that increase Cash

• Balance sheet identity (rearranged) • Increasing L-T Debt (borrow over the long-
• NWC + fixed assets = long-term debt + equity
term)
• NWC = (cash + other CA) – CL
• Cash = long-term debt + equity + CL – CA other than • Increasing Equity (selling some stock)
cash – fixed assets
• Increasing Current Liabilities (getting a 90-
• Sources of Cash
• Increasing long-term debt, equity or current liabilities
day loans)
• Decreasing current assets other than cash or fixed • Decreasing current asset other than cash
assets
(selling some inventory other for cash)
• Uses of Cash
• Decreasing long-term debt, equity or current liabilities • Decreasing fix assets (selling some
• Increasing current assets other than cash or fixed inventory)
assets
19-4 19-5
 Example 19.1: Label each as a source or Use
Activities that decrease Cash and describe its effect on the firm’s cash
balance
• Decrease L-T debt (paying-off a L-T debt) • A $500 dividend was paid
• Decrease Equity (repurchase some stock) • Account Payable Increased by $500
• Decrease Current Liabilities (paying-off a • Fixed asset purchased were $900
90-day loans) • Inventories increased by $625
• Increase current asset other than cash • L-T Debt decreased by $1,200.
(buying some inventory other for cash)
• Increasing fix assets (buying some
inventory)

19-6 19-7

The Operating Cycle and Cash

Answer 19.1
Cycle
The primary concern in S-T finance is the firms short –run
operating and financing activities. For manufacturing firm, for
short-run activities might consist of;

• Events Decisions
• Buying raw materials How much inventory to order
• Paying cash Whether to borrow/draw down
cash balances
• Manufacturing the What choice of production
product technology to use
• Selling the product Whether credit should be
extended to a particular customer
• Collecting cash How to collect
19-8 19-9

Characteristics of a firm with a long

The Operating Cycle
Operating Cycle?
• Operating cycle – time between
•Operating Cycle = Inventory Period +
purchasing the inventory and collecting the
cash from selling the inventory •Acc Receivable Period
• Inventory period – time required to • Firms with relatively long inventory periods
purchase and sell the inventory and/ relatively long receivable periods.
• Accounts receivable period – time • i.e. such firm tends to keep inventory on
required to collect on credit sales hand, and they allow customer to purchase
• Operating cycle = inventory period + on credit and take a relatively long time to
accounts receivable period pay.
19-10 19-11
 Characteristics of a firm with a
Cash Cycle
long Cash Cycle?
• Cash cycle •Cash Cycle = Operating Cycle -
• Amount of time we finance our inventory Account Payable Period
• Difference between when we receive cash from
the sale and when we have to pay for the • A firm have relatively L-T between the time
inventory
purchased inventory is paid for and the
• Accounts payable period – time between time that inventory is sold and payment
purchase of inventory and payment for the received.
inventory
• Cash cycle = Operating cycle – accounts • Thus, these are firms that have relatively
payable period short payables periods and/or long
receivable cycles.
19-12 19-13

Example 19.2: Calculate Operating

Figure 19.1
Cycle and Cash Cycle?
• 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
19-14 19-15

Answer 19.2: Cash Cycle Cash Budget

• Cash Budget is the primary tool in short-term
finacial planning, which allows financial
manager to idendify short-term financial needs
and opportunities.
• It records estimates of cash receipts (cash in)
and disbursments (cash out)
• Forecast of cash inflows and outflows over the
next short-term planning period
• Cash budget can be prepared quarterly,
monthly, weekly, or even daily bases.
• The result is an estimate of the cash surplus or
19-16 deficit. 19-17
 Greenwell Corporation
The Cash Budget
Cash Budget (in millions) Q1 Q2 Q3 Q4
• Sales and Cash Collections • Beginning receivables
• + Sales
• Example: If a company has a 45-day receivables, or average collection
period. This means that half of the sales in a given quarter will be • - Cash Collections (Beg. rec. + 1/2 Sales)
collected the following quarter. (We are assuming that each quarter is • Ending Receivables (Beg. rec + sales - collections)
90 days)
• Payment of Accounts
• Cash Collection = Beg. Acc. Receivables+1/2 Sales • + Wages, Taxes and Other Expenses
• Endind receivables = Beg. Receivables + Sales -Collections • + Capital Expenditures
• Cash Outflows (Cash Disbursement, or payments) • + Interest and Dividend payments
• Total Cash Disbursement
• Payments of Acc. Payable
• Wages, Taxes and other expenses • Total Cash Collections
• Capital expenditures • - Total Cash Disbursement
• L-T Financing expenses (Int. Payments on L-T debt outstanding and • Net Cash Inflow
dividend payments to shareholders)
• Beginning Cash Balance
• The Cash Balance • + Net Cash Inflows
• The predicted net cash inflow is the difference between cash • Ending Cash Balance
collections and cash discursements. • - Minimum Cash Balance
19-18 19-19
• Cumulative Surplus (Deficit)

Example 19.3: Prepare a Cash Example 19.3: Cash Budget

Budget Information.......Continued
• Pet Treats Inc. specializes in gourmet pet treats • Other expenses
and receives all income from sales • Wages, taxes and other expense are
• Sales estimates (in millions) 30% of sales
• Q1 = 500; Q2 = 600; Q3 = 650; Q4 = 800 • Interest and dividend payments are $50
• Accounts receivable
• A major capital expenditure of $200 is
• Beginning receivables = $250
expected in the second quarter
• Average collection period = 30 days
• Accounts payable • The initial cash balance is $80 and the
• Purchases = 50% of next quarter’s sales company maintains a minimum balance of
• Beginning payables = 125 $50
• Accounts payable period is 45 days 19-20 19-21

Example 19.4: The Operating and Example 19.5: Cash Balance for
Cash Cycle Greenwell Corporation
• Consider the following Financial Statement • The Greenwell Corporation has a 60-day
information for the Route 66 Company. average collection period and wishes to
• Item Beginning Ending maintain a $160 million minimum cash
Inventory $1,273 $1,401 balance. Based on this the information given
Acc. Rec. 3,782 3,368 in the following cash budget, complete the
Acc. Pay. 1,795 2,025 cash budget. What conclusion do you draw?
• Net Sales $14,750
• COGS $11,375

• Calculate the Operating and the Cash Cycles.

19-22 19-23
 Greenwell Corporation
Sugested Problems
Cash Budget (in millions)
Q1 Q2 Q3 Q4
• Beginning receivables $240
• 1, 3, 6.
• Sales 150 165 180 135
• Cash Collections
• Ending Receivables

• Total Cash Collections

• Total Cash Disbursement 170 160 185 190
• Net Cash Inflow

• Beginning Cash Balance 45

• Net Cash Inflows
• Ending Cash Balance
• Minimum Cash Balance
• Cumulative Surplus (Deficit) 19-24