Short-Term Financial Decisions

Short-Term Financial
Decisions
Working Capital Basics
• Working capital = current assets - current liabilities

• Importance: Measure of liquidity and short-term solvency
• Operating cycle: Time to convert inventory to cash
- Inventory days + Receivables days
• Cash conversion cycle: Operating cycle - Payables days
Cash Conversion Cycle
• Inventory days = 365 / Inventory turnover

• Receivables days = 365 / Receivables turnover
• Payables days = 365 / Payables turnover
• Cash conversion period = Inventory days + Receivables days -
Payables days
• Shorter cycle is generally better for liquidity
Cash Conversion Cycle
• Inventory days = 365 / Inventory turnover

• Receivables days = 365 / Receivables turnover
• Payables days = 365 / Payables turnover
• Cash conversion period = Inventory days + Receivables days - Payables
days
• Shorter cycle is generally better for liquidity
Cash Management
• Reasons for cash balances: Transactions, precautions, speculations

• Costs: Opportunity cost of capital
• Benefits: Avoiding cash shortages and related costs
• Techniques: Cash budgeting, concentrating/disbursing, float
management
Inventory Management
• Raw materials, work-in-process (WIP), finished goods

• ABC analysis: Categorize by value/importance
• EOQ model: Balancing ordering and holding costs
Economic Order Quantity
• EOQ = sqrt(2DS/H)
D = annual demand, S = ordering cost, H = holding cost
• Assumptions: Constant demand, lead times, costs

• Reorder point = Lead time demand + Safety stock
Just-in-Time (JIT) Inventory
• Principles: Reduce waste, continuous improvement

• Small, frequent deliveries timed to demand
• Benefits: Lower inventory, defects, space needs
• Requires: Close supplier relations, frequent deliveries
Accounts Receivable Management
• Credit terms: Credit period, cash discounts, etc.

• Written credit policy: Requirements, approvals, collections
• 5 C's of credit: Character, capacity, capital, collateral,
conditions
Credit Analysis
• Credit scoring models

• Sources: Credit reports, bank references, financial
statements
• Costs of trade credit = Required rate of return + Default risk
Monitoring Receivables
• Aging schedule: Value by time period (e.g. current, 1-30 days,

etc.)
• Days sales outstanding (DSO) = 365 / Receivables turnover
• Collection efforts: Letters, calls, legal action
Accounts Payable Management
• Standard terms: Net 30, 2/10 net 60

• Benefits of stretching: Short-term financing source
• Costs: Lost cash discounts, damaged credit reputation
Other Current Liabilities
• Accrued wages, taxes, interest, etc.

• Analyzing trends vs revenues/expenses
• Managing payment timing for cash flows
Short-Term Debt Sources
• Lines of credit from banks

• Secured loans using receivables/inventory
• Accounts receivable securitization
• Commercial paper for larger, rated firms
Comparing Short-Term Financing
• Interest rates (prime, LIBOR, etc.)

• Upfront fees (commitment, compensating balances)
• Reliability and access of different sources
• Weighted average cost of capital calculations
Determining Working Capital Needs
• Sales/cash collection forecasts

• Purchase/cash outflow projections
• Short/long cash budgets
• Financing requirements period
Working Capital Policies
• Aggressive: Minimize working capital investment

• Higher returns but more risk
• Conservative: Higher working capital levels

• Reduces risk but lowers returns
• Assess operational and financial risk tolerance

Short-Term Financing Plan
• Forecast financing needs from cash budgets

• Determine optimal financing mix
• Establish sources, credit lines, etc.
• Continuously monitor and update plan
International Cash Management
• Currency risk from transferring between countries

• Centralized pooling vs decentralized structures
• Netting: Bilateral (2 parties) and multilateral
International Receivables/Inventory
• Longer operating cycles in some countries

• Assessing creditworthiness globally
• Issues with mobility of inventory across borders
International Short-Term Financing
• Lines of credit from local banks

• Banker's acceptances and letters of credit
• Private financing from institutional lenders
• Sources vary by country banking systems

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Short-Term Financial

• Working capital = current assets - current liabilities

• Inventory days = 365 / Inventory turnover

• Inventory days = 365 / Inventory turnover

• Reasons for cash balances: Transactions, precautions, speculations

• Raw materials, work-in-process (WIP), finished goods

• Assumptions: Constant demand, lead times, costs

• Principles: Reduce waste, continuous improvement

• Credit terms: Credit period, cash discounts, etc.

• Credit scoring models

• Aging schedule: Value by time period (e.g. current, 1-30 days,

• Standard terms: Net 30, 2/10 net 60

• Accrued wages, taxes, interest, etc.

• Lines of credit from banks

• Interest rates (prime, LIBOR, etc.)

• Sales/cash collection forecasts

• Aggressive: Minimize working capital investment

• Conservative: Higher working capital levels

• Assess operational and financial risk tolerance

• Forecast financing needs from cash budgets

• Currency risk from transferring between countries

• Longer operating cycles in some countries

• Lines of credit from local banks

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