Lecture 1

IntroductionIntroduction

Reference:STFM Chapter 1Reference:STFM Chapter 1

ETM Chapter 1ETM Chapter 1

An Overview of Financial Management

Role of financial managementRole of financial management

Goals of the corporationGoals of the corporation

Issues of the new milleniumIssues of the new millenium

What causes a company to have a particular What causes a company to have a particular stock value?stock value?

How can managers make choices that add value How can managers make choices that add value to their companies?to their companies?

How can managers ensure that their companies How can managers ensure that their companies don’t run out of cash while executing their plans?don’t run out of cash while executing their plans?

What three questions do financial leaders seek to answer?

Corporate Financial DecisionsCorporate Financial Decisions

Capital Structure DecisionsCapital Structure Decisions Investment DecisionsInvestment Decisions Financing DecisionsFinancing Decisions Dividend DecisionsDividend Decisions

AmountAmount of cash flows expected by of cash flows expected by shareholdersshareholders

TimingTiming of the cash flow stream of the cash flow stream

RiskRisk of the cash flowsof the cash flows

Treasury ManagementFactors that Affect Stock Price

Treasury Management’sTreasury Management’sOverall ObjectiveOverall Objective

Efficient utilization of cash in a manner Efficient utilization of cash in a manner consistent with the consistent with the overall strategic overall strategic objectives of the firmobjectives of the firm..

Operating CycleOperating Cycle

1. Acquire Materials

or Resources

2. Convert Materials to Goods

Convert Resources to Services

3. Sell Goods or Services

4. Collect Payment

for Goods or Services

Major Objectives of Treasury Major Objectives of Treasury ManagementManagement

Maintaining liquidityMaintaining liquidity Optimizing cash resourcesOptimizing cash resources Establishing and maintaining access to short-term financingEstablishing and maintaining access to short-term financing Maintaining access to medium- and long-term financing (capital Maintaining access to medium- and long-term financing (capital

budgeting)budgeting) Maintaining shareholder relationsMaintaining shareholder relations Managing riskManaging risk Coordinating financial functions and sharing financial informationCoordinating financial functions and sharing financial information

Cash Flows and theCash Flows and theTimelineTimeline

Cash Concentration CashCash Concentration Cash

InflowsInflows And Liquidity And Liquidity Outflows Outflows

ManagementManagement

FlowsFlows

SalesSales– Current levelCurrent level

– Short-term growth rate in salesShort-term growth rate in sales

– Long-term sustainable growth rate in salesLong-term sustainable growth rate in sales

Operating expensesOperating expenses

Capital expensesCapital expenses

Three Determinants of Cash Flows

Factors that Affect the Level and Factors that Affect the Level and Risk of Cash FlowsRisk of Cash Flows

Decisions made by financial managers:Decisions made by financial managers:

– Investment decisions (product lines, production Investment decisions (product lines, production processes, geographic market, use of technology, processes, geographic market, use of technology, marketing strategy)marketing strategy)

– Financing decisions (choice of debt policy and Financing decisions (choice of debt policy and dividend policy) dividend policy)

The external environmentThe external environment

Cash ManagementCash ManagementvsvsTreasury ManagementTreasury Management

Liquid assets vs financial assetsLiquid assets vs financial assets

Short term vs long termShort term vs long term

Functional vs strategicFunctional vs strategic

Functions andFunctions andResponsibilities of aResponsibilities of aTreasury ManagerTreasury Manager

System Design, Implementation, and EvaluationSystem Design, Implementation, and Evaluation Funds ManagementFunds Management Banking System AdministrationBanking System Administration ForecastingForecasting Risk ManagementRisk Management FinancingFinancing

Daily Cash ManagementDaily Cash Management

Daily funds managementDaily funds management

– Prepare cash position Prepare cash position worksheetworksheet

– Monitor cash balancesMonitor cash balances

– Mobilize fundsMobilize funds

– Research and reconcile Research and reconcile exception itemsexception items

– Coordinate finance Coordinate finance functions with A/R, A/P and functions with A/R, A/P and accountingaccounting

Banking system administrationBanking system administration Liquidity managementLiquidity management ForecastingForecasting Systems design, implementation Systems design, implementation

and evaluationand evaluation Financial risk management Financial risk management

Factors Affecting TreasuryFactors Affecting TreasuryManagement PracticesManagement Practices

Banking StructureBanking Structure Mail SystemMail System Payment ConventionsPayment Conventions Interest RatesInterest Rates Regulatory EnvironmentRegulatory Environment Tax StatusTax Status Risk AppetiteRisk Appetite IT CapabilitiesIT Capabilities

Treasury Linkages & InterfacesTreasury Linkages & Interfaces

Treasury$

A/R

Risk Mgt.

InvestmentBorrowing

PensionMgt.

Purchasing A/P

GeneralLedger

InternalAudit

Treasury$

Banks

RegulatoryAgencies

SuppliersCustomers

ExternalInvestment

Mgrs.

FinancialMarkets A/P

IndustryTrade

Groups

ExternalAuditors

Intracorporate Integration Intercorporate Integration

Key to Success for aKey to Success for aTreasury ManagerTreasury Manager

Cooperation with other functionsCooperation with other functions

Differences Between theDifferences Between theU.S. and Other CountriesU.S. and Other Countries

Large number of banksLarge number of banks Lack of nationwide bankingLack of nationwide banking Extensive use of mail for paymentExtensive use of mail for payment Bills paid by checkBills paid by check

Bank and Treasury Management Prior Bank and Treasury Management Prior to 1950to 1950

Cash Management EvolutionCash Management Evolution 1950s 1950s

First LockboxFirst Lockbox The Accord and the Government Securities The Accord and the Government Securities

MarketMarket

Cash Management Evolution Cash Management Evolution 1960’s1960’s

Short Term Investment VehiclesShort Term Investment Vehicles Managing Banking BalancesManaging Banking Balances Lockbox ModelsLockbox Models

Cash Management Evolution 1970sCash Management Evolution 1970s

Remote DisbursementRemote Disbursement Controlled DisbursementControlled Disbursement Funds ConcentrationFunds Concentration Bank Balance ReportingBank Balance Reporting Electronic PaymentElectronic Payment Commercial PaperCommercial Paper

Cash Management Evolution 1980sCash Management Evolution 1980s

DIDMCA of 1980DIDMCA of 1980 Noon Presentment/Payor ServicesNoon Presentment/Payor Services Electronic Commerce and Data Electronic Commerce and Data

InterchangeInterchange

Personal ComputersPersonal Computers Internalization of Financial MarketsInternalization of Financial Markets Bank CreditworthinessBank Creditworthiness Cash Management EthicsCash Management Ethics

1980s Developments 1980s Developments (continued)(continued)

Cash Management Evolution 1990’sCash Management Evolution 1990’s

DerivativesDerivatives Electronic Payment of State and Federal Electronic Payment of State and Federal

TaxesTaxes Interstate BankingInterstate Banking InternetInternet Financial DeregulationFinancial Deregulation EMUEMU

Use of computers and electronic transfers Use of computers and electronic transfers of information and valueof information and value

The globalization of businessThe globalization of business

Financial Regulation ?Financial Regulation ?

Financial ManagementIssues of the New Millenium

The 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 How WC and depreciation create disparities between profit and cash flowdisparities between profit and cash flow

Management aspects of various WC Management aspects of various WC accountsaccounts

The Cash Flow TimelineThe Cash Flow Timeline

OrderOrder Order Order Sale Sale 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 Invoice Payment Payment Cash Cash Received Sent Received Sent DisbursedDisbursed

OrderOrder Order Order Sale Sale 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 Invoice Payment Payment Cash Cash Received Sent Received Sent DisbursedDisbursed

...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 600600 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 600600 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 2525TotalTotal $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 2525TotalTotal $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 00InventoryInventory 0 0 Debt Debt 500 500Fixed AssetsFixed Assets 600 600 Common Stock Common Stock 500 500(Accum Depr) (100)(Accum Depr) (100) Retained Earnings Retained Earnings 2525TotalTotal $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 00InventoryInventory 0 0 Debt Debt 500 500Fixed AssetsFixed Assets 600 600 Common Stock Common Stock 500 500(Accum Depr) (100)(Accum Depr) (100) Retained Earnings Retained Earnings 2525TotalTotal $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 $ $ 00A/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 Retained Earnings 2525TotalTotal $1,025$1,025 TotalTotal $1,025$1,025


Pay payables with cashPay payables with cash

CashCash $ $ ( 175)( 175) A/PA/P $ $ 00A/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 Retained Earnings 2525TotalTotal $1,025$1,025 TotalTotal $1,025$1,025

July 31July 31


Collect accounts receivableCollect accounts receivable

CashCash $ $ 525525 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 Retained Earnings 2525TotalTotal $1,025$1,025 TotalTotal $1,025$1,025


Collect accounts receivableCollect accounts receivable

CashCash $ $ 525525 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 Retained Earnings 2525TotalTotal $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

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

WC accounts must be managed so that 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 Speeding up the receipt of payments through lockboxesthrough lockboxes

Managing PayablesManaging Payables

Search for terms that match with cash Search for terms that match with cash receiptsreceipts

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?

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

Economy & Finance

Lecture 1