Chapter 19

Fundamentals of
Corporate Short-Term Financial
Finance Planning
Fifth Edition

Slides by
Matthew Will

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Topics Covered
Links Between Long-Term and Short-Term
Financing
Working Capital
Tracing Changes in Cash and Working Capital
Cash Budgeting
A Short-Term Financing Plan
Sources of Short-Term Financing
The Cost of Bank Loans

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19- 3

Firm’s Cumulative Capital Requirement

Dollars A
B
C

Cumulative
capital requirement

Year 1 Year 2 Time

Lines A, B, and C show alternative amounts of long-term finance.

Strategy A: A permanent cash surplus

Strategy B: Short-term lender for part of year and borrower for
remainder
Strategy C: A permanent short-term borrower
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19- 4

Working Capital
Net Working Capital - Current assets minus current
liabilities. Often called working capital.
Cash Conversion Cycle - Period between firm’s
payment for materials and collection on its sales.
Carrying Costs - Costs of maintaining current
assets, including opportunity cost of capital.
Shortage Costs - Costs incurred from shortages in
current assets.

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19- 5

Working Capital
Simple Cycle of operations

Cash

Raw materials
Receivables inventory

Finished goods
inventory

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Working Capital

average inventory
Inventory period =
annual COGS / 365

average accounts receivable

Receivables period =
annual sales / 365

average accounts payable

Payable period =
annual COGS / 365

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19- 7

Working Capital
Example - Cash Conversion Cycle
Given the aggregate balance sheet and income
statement for US Manufacturing firms, calculate
the cash conversion cycle.

Income Statement Balance Sheet

3rdQtr '04 End 4th qtr '03 End of 4th qtr '04
Sales 4,951 Inventory 453 490
COGS 4,451 A/R 500 552
A/P 335 382

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Working Capital
Example - Cash Conversion Cycle
Given the aggregate balance sheet and income statement
for US Manufacturing firms, calculate the cash conversion
cycle.

average inventory
Inventory period =
annual COGS/365

(490  453)/2
=
4,451/365

 38.7 days
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19- 9

Working Capital
Example - Cash Conversion Cycle
Given the aggregate balance sheet and income statement
for US Manufacturing firms, calculate the cash conversion
cycle.

average accounts receivable

Receivable s period =
annual sales/365

(552  500)/2
=
4,951/365

= 38.8 days

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19- 10

Working Capital
Example - Cash Conversion Cycle
Given the aggregate balance sheet and income statement
for US Manufacturing firms, calculate the cash conversion
cycle.
average accounts payable
Payable period =
annual COGS/365

(382  335)/2
=
4,451 / 365

= 29.4 days

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19- 11

Working Capital
Example - Cash Conversion Cycle
Given the aggregate balance sheet and income statement
for US Manufacturing firms, calculate the cash conversion
cycle.

Inventory period  38.7 days

Receivables period = 38.8 days

Payable period = 29.4 days

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19- 12

Changes in Cash & W.C.

Example - Dynamic Mattress Company
Assets 2005 2006 Liabilities & Equity 2005 2006
Current Assets 4 5 Current Liabilities
Cash 4 5 Bank Loans 5 0
Mark Securities 0 5 Accts Payable 20 27
Inventory 26 25 Total Curr Liab 25 27
Accts Recv 25 30 Long Term Debt 5 12
Total Curr Assets 55 65 Net Worth 65 76
Fixed Assets
Gross investment 56 70
less Depr 16 20
Net Fixed Assets 40 50 Total Liab and
Total Assets 95 115 owner's equity 95 115

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Changes in Cash & W.C.

Example - Dynamic Mattress Company
Income Statement
Sales $350 Assume
Operating Costs 321 dividend = $1 mil
Depreciation 4 R.E.=$11 mil
EBIT 25
Interest 1
Pretax income 24
. Tax at 50% 12
Net Income $12

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19- 14

Changes in Cash & W.C.

Example -
Dynamic
Sources
Mattress
Company Issued long term debt 7
Reduced inventories 1
Increased accounts payable 7
Cash from operations
Net income 12
Depreciation 4
Total Sources $31
Uses
Repaid short term bank loan 5
Invested in fixed assets 14
Purchased marketable securities 5
Increased accounts receivable 5
Dividend 1
Total Uses $30
Increase in cash balance $1

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19- 15

Changes in Cash & W.C.

Example - Dynamic Mattress Company

Dynamic used cash as follows

 Paid $1 mil dividend.
 Repaid $5 mil short term bank loan
 Invested $14 mil
 Purchased $5 mil of marketable securities
 Accounts receivable expanded by $5 mil

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19- 16

Cash Budgeting

Steps to preparing a cash budget

Step 1 - Forecast the sources of cash.
Step 2 - Forecast uses of cash.
Step 3 - Calculate whether the firm is facing a cash
shortage or surplus.

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Cash Budgeting
Example - Dynamic Mattress Company

Dynamic forecasted sources of cash

Quarter 1st 2nd 3rd 4th

Sales, $mil 87.50 78.50 116.00 131.00

AR ending balance = AR beginning balance + sales -

collections

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Cash Budgeting
Example - Dynamic Mattress Company
Dynamic collections on AR
Qtr
1st 2nd 3rd 4th
1. Beginning receivables 30.0 32.5 30.7 38.2
2. Sales 87.5 78.5 116.0 131.0
3. Collections
. Sales in current Qtr (80%) 70 62.8 92.8 104.8
. Sales in previous Qtr (20%) 15.0 17.5 15.7 23.2
Total collections 85.0 80.3 108.5 128.0
4. Receivables at end of period
. (4 = 1 + 2 - 3) $32.5 $30.7 $38.2 $41.2

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Cash Budgeting
Example - Dynamic Mattress Company

Dynamic forecasted uses of cash

 Payment of accounts payable
 Labor, administration, and other expenses
 Capital expenditures
 Taxes, interest, and dividend payments

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Cash Budgeting
Example - Dynamic Mattress Company
Qtr
Dynamic 1st 2nd 3rd 4th

cash budget Sources of cash

collections on AR 85.0 80.3 108.5 128.0
other 1.5 0.0 12.5 0.0
Total Sources 86.5 80.3 121.0 128.0
Uses of cash
payment of AP 65.0 60.0 55.0 50.0
labor and admin expenses 30.0 30.0 30.0 30.0
capital expenditures 32.5 1.3 5.5 8.0
taxes, interest, & dividends 4.0 4.0 4.5 5.0
Total uses of cash 131.5 95.3 95.0 93.0

Net cash inflow $45.0 $15.0 $26.0 $35.0

(sources minus uses)
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Cash Budgeting
Example - Dynamic Mattress Company
Dynamic short term financing requirements

Cash at start of period 5 - 40 - 55 - 29

+ Net cash flow - 45 - 15 + 26 + 35
= Cash at end of period - 40 - 55 - 29 + 6
Min operating cash balance 5 5 5 5

Cumulative short term financing $45 $60 $34 - $1

required (minimum cash balance
minus caash at end of period)

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A Short Term Financing Plan

Example - Dynamic Mattress Company

Dynamic forecasted deferrable expenses

Quarter 1st 2nd 3rd 4th

Amount Deferrable, $mil 52 48 144 40

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19- 23

A Short Term Financing Plan

Qtr
1st 2nd 3rd 4th
Example - Cash Requirements

Dynamic 1. Cash for operations

2. Interest on bank loan
45
0
15
.8
- 26
.8
- 35
.6

Mattress 3. Interest on stretechd payables 0 0 .8 0

4. Total cash required 45 15.8 - 24.4 - 34.4
Company- Cash Raised
5. Bank loan 40 0 0 0
Financing Plan 6. Stretched payables 0 15.8 0 0
7. Securities sold 5 0 0 0
8. Total cash raised 45 15.8 0 0
Repayments
9. Of stretched payables 0 0 15.8 0
10. Of line of credit 0 0 8.6 31.4
Increase in cash balances
11. Addition to cash balances 0 0 0 3
Line of credit
12. Beginning of quarter 0 40 40 31.4
13. End of quarter 40 40 31.4 0
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19- 24

Sources of Short Term Financing

Bank loans
Commercial paper
Secured loans

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Cost of Bank Loans

Simple Interest
annual interest rate
Amount of loan X
number of periods in the year

Effective annual rate

(1 + quoted annual interest rate

n ) n
- 1

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Cost of Bank Loans

Discount Interest

Face value of loan X 1 - ( quoted annual interest rate

number of periods in the year )

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