Copyright 2005 by Thomson Learning, Inc. SHORT-TERM FINANCIAL MANAGEMENT Terry S. Maness and John T. Zietlow SHORT-TERM FINANCIAL MANAGEMENT Terry S

Copyright Copyright 2005 by Thomson Learning, Inc. 2005 by Thomson Learning, Inc.

SHORT-TERM FINANCIAL MANAGEMENTSHORT-TERM FINANCIAL MANAGEMENT Terry S. Maness and John T. Zietlow Terry S. Maness and John T. Zietlow

Copyright Copyright 2005 Thomson Learning, Inc. 2005 Thomson Learning, Inc.

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ISBN: 0-324-20293-8; ISBN: 0-324-20293-8; Support Website: Support Website: http://www.swlearning.com/finance/maness/short-term3e/short-term3e.htmlhttp://www.swlearning.com/finance/maness/short-term3e/short-term3e.html


Chapter 1Chapter 1The Role of Working CapitalThe Role of Working Capital

SalesSales

A /RA /R

CashCash

InvInv


ObjectivesObjectives

View firm as a system of cash flowsView firm as a system of cash flows

How WC and depreciation create disparities How WC and depreciation create disparities between profit and cash flowbetween profit and cash flow

Management aspects of various WC accountsManagement aspects of various WC accounts


The Cash Flow TimelineThe Cash Flow Timeline

OrderOrder Order Order Sale Sale Payment Sent Payment Sent CashCash PlacedPlaced Received Received ReceivedReceived Accounts CollectionAccounts Collection < Inventory > < Receivable > < Float >< Inventory > < Receivable > < Float >

Time ==>Time ==> Accounts Disbursement Accounts Disbursement

< Payable > < Float >< Payable > < Float > Invoice Received Payment Sent Invoice Received Payment Sent Cash DisbursedCash Disbursed

OrderOrder Order Order Sale Sale Payment Sent Payment Sent CashCash PlacedPlaced Received Received ReceivedReceived Accounts CollectionAccounts Collection < Inventory > < Receivable > < Float >< Inventory > < Receivable > < Float >

Time ==>Time ==> Accounts Disbursement Accounts Disbursement

< Payable > < Float >< Payable > < Float > Invoice Received Payment Sent Invoice Received Payment Sent Cash DisbursedCash Disbursed


...in the beginning...in the beginning

Balance Sheet - June 1Balance Sheet - June 1

CashCash $1,000$1,000 DebtDebt $$ 500500 Common Stock 500Common Stock 500

TotalTotal $1,000$1,000 Total Total $1,000$1,000


CashCash $1,000$1,000 DebtDebt $$ 500500 Common Stock 500Common Stock 500

TotalTotal $1,000$1,000 Total Total $1,000$1,000


The Next Day, June 2The Next Day, June 2

Balance Sheet - June 2Balance Sheet - June 2Purchase Fixed Assets and InventoryPurchase Fixed Assets and Inventory

CashCash $ $ 400400 A/PA/P $ $ 300300InventoryInventory 300300 Debt Debt 500 500Fixed AssetsFixed Assets 600 600 Common StockCommon Stock 500 500

TotalTotal $1,300$1,300 TotalTotal $1,300$1,300

Balance Sheet - June 2Balance Sheet - June 2Purchase Fixed Assets and InventoryPurchase Fixed Assets and Inventory

CashCash $ $ 400400 A/PA/P $ $ 300300InventoryInventory 300300 Debt Debt 500 500Fixed AssetsFixed Assets 600 600 Common StockCommon Stock 500 500

TotalTotal $1,300$1,300 TotalTotal $1,300$1,300


End of JuneEnd of June


Sale of product, incur operating expenses,Sale of product, incur operating expenses, incur depreciation, and generate profitincur depreciation, and generate profit

CashCash $ $ 325325 A/PA/P $ 300$ 300A/RA/R 700700 AccrualsAccruals 200200InventoryInventory 0 0 Debt Debt 500 500Fixed AssetsFixed Assets 600 600 Common Stock Common Stock 500 500(Accum Depr) (Accum Depr) (100)(100) Retained Earnings Retained Earnings 25 25TotalTotal $1,525$1,525 TotalTotal $1,525$1,525


Sale of product, incur operating expenses,Sale of product, incur operating expenses, incur depreciation, and generate profitincur depreciation, and generate profit

CashCash $ $ 325325 A/PA/P $ 300$ 300A/RA/R 700700 AccrualsAccruals 200200InventoryInventory 0 0 Debt Debt 500 500Fixed AssetsFixed Assets 600 600 Common Stock Common Stock 500 500(Accum Depr) (Accum Depr) (100)(100) Retained Earnings Retained Earnings 25 25TotalTotal $1,525$1,525 TotalTotal $1,525$1,525


July 1July 1

Balance Sheet - July 1Balance Sheet - July 1

Pay operating accruals with cashPay operating accruals with cash

CashCash $ $ 125125 A/PA/P $ 300$ 300A/RA/R 700 700 AccrualsAccruals 0 0InventoryInventory 0 0 Debt Debt 500 500Fixed AssetsFixed Assets 600 600 Common Stock Common Stock 500 500(Accum Depr) (100)(Accum Depr) (100) Retained Earnings 25Retained Earnings 25TotalTotal $1,325$1,325 TotalTotal $1,325$1,325


Pay operating accruals with cashPay operating accruals with cash

CashCash $ $ 125125 A/PA/P $ 300$ 300A/RA/R 700 700 AccrualsAccruals 0 0InventoryInventory 0 0 Debt Debt 500 500Fixed AssetsFixed Assets 600 600 Common Stock Common Stock 500 500(Accum Depr) (100)(Accum Depr) (100) Retained Earnings 25Retained Earnings 25TotalTotal $1,325$1,325 TotalTotal $1,325$1,325


July 15July 15


Pay payables with cashPay payables with cash

CashCash $ $ ( 175)( 175) A/PA/P $ $ 0 0A/RA/R 700 700 AccrualsAccruals 0 0InventoryInventory 0 0 Debt Debt 500 500Fixed AssetsFixed Assets 600 600 Common Stock Common Stock 500 500(Accum Depr) (100)(Accum Depr) (100) Retained Earnings 25Retained Earnings 25TotalTotal $1,025$1,025 TotalTotal $1,025$1,025


Pay payables with cashPay payables with cash

CashCash $ $ ( 175)( 175) A/PA/P $ $ 0 0A/RA/R 700 700 AccrualsAccruals 0 0InventoryInventory 0 0 Debt Debt 500 500Fixed AssetsFixed Assets 600 600 Common Stock Common Stock 500 500(Accum Depr) (100)(Accum Depr) (100) Retained Earnings 25Retained Earnings 25TotalTotal $1,025$1,025 TotalTotal $1,025$1,025


July 31July 31


Collect accounts receivableCollect accounts receivable

CashCash $ $ 525 525 A/PA/P $ $ 00A/RA/R 00 AccrualsAccruals 0 0InventoryInventory 0 0 Debt Debt 500 500Fixed AssetsFixed Assets 600 600 Common Stock Common Stock 500 500(Accum Depr) (100)(Accum Depr) (100) Retained Earnings 25Retained Earnings 25TotalTotal $1,025$1,025 TotalTotal $1,025$1,025


Collect accounts receivableCollect accounts receivable

CashCash $ $ 525 525 A/PA/P $ $ 00A/RA/R 00 AccrualsAccruals 0 0InventoryInventory 0 0 Debt Debt 500 500Fixed AssetsFixed Assets 600 600 Common Stock Common Stock 500 500(Accum Depr) (100)(Accum Depr) (100) Retained Earnings 25Retained Earnings 25TotalTotal $1,025$1,025 TotalTotal $1,025$1,025


Profit versus Cash FlowProfit versus Cash Flow

QuestionQuestion: Why did the firm end up with $125 in : Why did the firm end up with $125 in additional cash while earning a profit of $25?additional cash while earning a profit of $25?

Answer: Some expenses are not cash expenses.Answer: Some expenses are not cash expenses.

QuestionQuestion: Why did the firm run out of cash during : Why did the firm run out of cash during its operating cycle?its operating cycle?

Answer: The cash deficit was due to the differences Answer: The cash deficit was due to the differences between the timing of cash disbursements and cash between the timing of cash disbursements and cash receipts.receipts.


Important PointsImportant Points

#1: The firm must manage its cost structure to #1: The firm must manage its cost structure to generate a profitgenerate a profit

#2: WC accounts must be managed so that #2: WC accounts must be managed so that liquidity is maintained.liquidity is maintained.


Relationship Between Accrual Relationship Between Accrual Income and Cash FlowIncome and Cash Flow

Income StatementIncome Statement Adjustment AccountAdjustment Account Cash Flow AccountCash Flow Account

SalesSales - Change in accounts receivable- Change in accounts receivable = Cash collected= Cash collected

Cost of goods soldCost of goods sold - Change in accounts payable- Change in accounts payable+ Change in inventory+ Change in inventory = Cash paid to suppliers= Cash paid to suppliers

Operating expensesOperating expenses - Change in operating accruals- Change in operating accruals- Depreciation- Depreciation = Cash paid for = Cash paid for

operating expensesoperating expenses

InterestInterest - Change in accrued interest- Change in accrued interest = Cash paid to creditors= Cash paid to creditors

TaxesTaxes - Change in accrued taxes- Change in accrued taxes- Change in deferred taxes- Change in deferred taxes = Cash paid for taxes= Cash paid for taxes

__________________________________ ______________________________________Net ProfitNet Profit Operating Cash FlowOperating Cash Flow


Managing the Cash CycleManaging the Cash Cycle

Managing InventoryManaging Inventory

Managing ReceivablesManaging Receivables

Managing PayablesManaging Payables

Electronic CommerceElectronic Commerce


Managing InventoryManaging Inventory

JITJIT

Trade-offs between:Trade-offs between:

– stock-out costsstock-out costs

– cost of excess inventorycost of excess inventory

– ordering costsordering costs


Managing ReceivablesManaging Receivables

Who should receive credit and how much?Who should receive credit and how much?

Credit termsCredit terms

Monitoring the outstanding balanceMonitoring the outstanding balance

Speeding up the receipt of payments through Speeding up the receipt of payments through lockboxeslockboxes


Managing PayablesManaging Payables

Search for terms that match with cash receiptsSearch for terms that match with cash receipts

Timing of paymentTiming of payment

Controlled disbursementControlled disbursement


Electronic CommerceElectronic Commerce

Revolutionizing management of cash cycleRevolutionizing management of cash cycle

Proprietary systemsProprietary systems

Impact of InternetImpact of Internet


How Much WC is EnoughHow Much WC is Enough

One viewOne view– optimal level is zerooptimal level is zero

– WC is an idle resourceWC is an idle resource

– Provides little valueProvides little value

How much in resources to commit?How much in resources to commit?– Why inventory?Why inventory?

– Why receivables and payables?Why receivables and payables?

– Why short-term investments?Why short-term investments? Chrysler’s $5 billion cushion of investmentsChrysler’s $5 billion cushion of investments


How Management of Working How Management of Working Capital is ChangingCapital is Changing

Exhibit 1-6Working Capital Requirements as a Percent of Sales

-10%

-5%

0%

5%

10%

15%

20%

25%

30%

35%

1994 1995 1996 1997 1998 1999 2000 2001 2002

Years

Per

cent

of S

ales

Dell

Apple

Compaq

Gateway


SummarySummary

Firm must operate at a profitable level.Firm must operate at a profitable level.

A profitable firm may still struggle financially.A profitable firm may still struggle financially.

Working capital soaks up cash flow and may cause Working capital soaks up cash flow and may cause an otherwise profitable firm to fail.an otherwise profitable firm to fail.

A successful firm’s operation is managed from a A successful firm’s operation is managed from a – profit, and a profit, and a

– cash flow perspective.cash flow perspective.

Documents

Copyright 2005 by Thomson Learning, Inc. SHORT-TERM FINANCIAL MANAGEMENT Terry S. Maness and John T. Zietlow SHORT-TERM FINANCIAL MANAGEMENT Terry S