PowerPoint PresentationKey Concepts and SkillsChapter OutlineBalance Sheet Model of the Firm18.1 Tracing Cash and Net Working CapitalDefining Cash in Terms of Other ElementsSlide 7Activities that Increase and Decrease Cash18.2 The Operating Cycle and the Cash CycleThe Operating Cycle and the Cash CycleExample: Operating and Cash Cycle FactsExample: Operating Cycle CalculationsExample: Cash Cycle CalculationsInterpretation of the Cash Cycle18.3 Some Aspects of Short-Term Financial PolicySize of Investment in Current AssetsCarrying Costs and Shortage CostsAppropriate Flexible PolicyAppropriate Restrictive PolicyAlternative Financing Policies18.4 The Cash BudgetExampleExample: Cash InflowsExample: Cash OutflowsExample: Cash Budget18.5 Short-Term BorrowingQuick Quiz18-1SHORT-TERM FINANCE AND PLANNINGChapter 18Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.18-2KEY CONCEPTS AND SKILLS•Describe the components of the cash cycle and why it is important•Define the pros and cons of the various short-term financing policies•Prepare a cash budget•Outline the various options for short-term financing18-3CHAPTER OUTLINE18.1 Tracing Cash and Net Working Capital18.2 The Operating Cycle and the Cash Cycle18.3 Some Aspects of Short-Term Financial Policy18.4 The Cash Budget18.5 Short-Term Borrowing18.6 A Short-Term Financial Plan18-4BALANCE SHEET MODEL OF THE FIRMHow much short-term cash flow does a company need to pay its bills?Net Working CapitalCurrent AssetsFixed Assets1 Tangible2 IntangibleShareholders’ EquityCurrent LiabilitiesLong-Term Debt18-518.1 TRACING CASH AND NET WORKING CAPITAL•Current Assets are cash and other assets that are expected to be converted to cash within the year.•Cash•Marketable securities•Accounts receivable•Inventory•Current Liabilities are obligations that are expected to require cash payment within the year.•Accounts payable•Accrued wages•Taxes18-6DEFINING CASH IN TERMS OF OTHER ELEMENTSNet Working Capital+Fixed Assets=Long-Term Debt+ EquityNet Working Capital= CashOther Current AssetsCurrent Liabilities–+18-7DEFINING CASH IN TERMS OF OTHER ELEMENTS•An increase in long-term debt and or equity leads to an increase in cash—as does a decrease in fixed assets or a decrease in the non-cash components of net working capital.•The sources and uses of cash follow from this reasoning.Cash =Long-Term Debt+ Equity –Net Working Capital (excluding cash)Fixed Assets–18-8ACTIVITIES THAT INCREASE AND DECREASE CASHIncrease Cash•Increase Long Term Debt•Sell Additional Equity•Increase Current Liabilities•Sell Current Assets•Sell Fixed AssetsDecrease Cash•Pay off Long Term Debt•Repurchase Equity•Pay off Current Liabilities•Buy Current Assets•Buy Fixed Assets18-918.2 THE OPERATING CYCLE AND THE CASH CYCLETimeAccounts payable periodCash cycleOperating cycleCash received Accounts receivable periodInventory periodFinished goods soldFirm receives invoice Cash paid for materialsOrder PlacedStock ArrivesRaw material purchased18-10THE OPERATING CYCLE AND THE CASH CYCLE•In practice, the inventory period, the accounts receivable period, and the accounts payable period are measured by days in inventory, days in receivables, and days in payables. Cash cycle = Operating cycle –Accounts payable period18-11EXAMPLE: OPERATING AND CASH CYCLE FACTS•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 = 820,00018-12EXAMPLE: OPERATING CYCLE CALCULATIONS•Inventory period•Average inventory = (200,000+300,000)/2 = 250,000•Inventory turnover = 820,000 / 250,000 = 3.28 times•Inventory period = 365 / 3.28 = 111 days•Receivables period•Average receivables = (160,000+200,000)/2 = 180,000•Receivables turnover = 1,150,000 / 180,000 = 6.39 times•Receivables period = 365 / 6.39 = 57 days•Operating cycle = 111 + 57 = 168 days18-13EXAMPLE: CASH CYCLE CALCULATIONS•Payables Period•Average payables = (75,000+100,000)/2 = 87,500•Payables turnover = 820,000 / 87,500 = 9.37 times•Payables period = 365 / 9.37 = 39 days•Cash Cycle = 168 – 39 = 129 days•We have to finance our inventory for 129 days.•If we want to reduce our financing needs, we need to look carefully at our receivables and inventory periods – they both seem excessive.18-14INTERPRETATION OF THE CASH CYCLE•Cash cycle increases when:•Inventory and receivable periods get longer•Cash cycle decreases when:•Payables periods are extended and receivables periods shortened•There is a direct connection between a company’s cash cycle and profitability•Total asset turnover is a useful measure18-1518.3 SOME ASPECTS OF SHORT-TERM FINANCIAL POLICY•There are two elements of the policy that a firm adopts for short-term finance.•The size of the firm’s investment in current assets, usually measured relative to the firm’s level of total operating revenues.•Flexible •Restrictive•Alternative financing policies for current assets, usually measured as the proportion of short-term debt to long-term debt.•Flexible •Restrictive18-16SIZE OF INVESTMENT IN CURRENT ASSETS•A flexible short-term finance policy would maintain a high ratio of current assets to sales.•Keeping large cash balances and investments in marketable securities•Large investments in inventory•Liberal credit terms•A restrictive short-term finance policy would maintain a low ratio of current assets to sales.•Keeping low cash balances, no investment in marketable securities•Making small investments in inventory•Allowing no credit sales (thus no accounts receivable)18-17CARRYING COSTS AND SHORTAGE COSTS$Investment in Current Assets ($)Shortage costsCarrying costsTotal costs of holding current assets.CA*Minimum point18-18APPROPRIATE FLEXIBLE POLICY$Investment in Current Assets ($)Shortage costsCarrying costsTotal costs of holding current assets.CA*Minimum point18-19APPROPRIATE RESTRICTIVE POLICY$Investment in Current Assets ($)Shortage costsCarrying costsTotal costs of holding current assets.CA*Minimum point18-20ALTERNATIVE FINANCING POLICIES•A flexible short-term finance policy means a low proportion of short-term debt relative to long-term financing.•A restrictive short-term finance policy