Finance 4412 Short Term Financial Management Topic Outline for First Exam 1 Be able to explain the main problem that short term financial management is trying to solve for a firm Given balance sheet information for two firms be able to a compute measures of the two firm s liquidity e g net working capital b determine which firm is more liquid and c how this can affect solvency Also what is implied for long term or short term assets and liabilities when net working capital is or and is one situation less risky than the other Why The key problem is that the payables go out before the receivables come in the firm needs to finance the time gap between these two events The goal of short term financial management is to manage each of the firms CA CL to achieve a balance between profitability and risk that maximizes shareholder value Working capital req receivables gives credit to customers inventory tied up funds payables credit given to the firm CA Cash A R Inv prepaids CL A P debt and notes payable 1 year Liquidity CA CL NWC CA CL A firm is solvent when it can liquidate its total liabilities with total assets TA TL If CA CL then long term debt is financing CA which is safer because CL is reduced relative to CA If CA CL then some long term assets are financing CL which is not safe because L T Assets aren t easily liquidated 2 Given the value of a firm s account payable its short term bank borrowing rate and the payment terms of the payable e g 2 10 net 30 be able to determine if the firm should pay the payable early and what the implied rate of return is for an early payment If a firm has a 10 000 invoice at a 2 10 net 30 schedule means that a firm can get a 2 discount 200 if they pay by day 10 otherwise pay the 10 000 on day 30 Option A Liquidate S T investments at 8 opp cost 9 800 08 365 20 days 43 Option B Borrow from bank at 10 opp cost 9 800 10 365 20 days 54 Implied Annual return from 2 discount 9 800 X 365 20 days 200 X 37 2 Firm should liquidate 9 800 in S T investments to pay early and save 157 3 Be able to determine the cash conversion period and what it implies for a firm s working capital needs What is Lambda and how is it used to assess the probability of a purchasing firm to pay the A Ps of a supplying firm In addition be able to explain what a sustainable growth rate is and the logic behind how it is derived and what it implies compared to a firm s desired versus actual sales growth rate CCP DIH days FG Inv is held DSO A R outstanding DPO A P outstanding Inv A P A R DIH and DSO tie up money that can be spent elsewhere the smaller the CCP the better reduces need for NWC Lambda Cash Antic Cash Std Dev Of Cash is a liquidity measure for the likelihood a company will exhaust its liquid reserve and run into a liquidity problem If a company has a Lambda of 1 then demand cash payments A Lambda of 1 means a company has a 16 chance of running into a problem A Lambda of 1 65 means a company has a 5 chance of running into a problem A Lambda of 3 means a company has a 05 chance of running into a problem Lambda encompass the cash conversion period The sustainable growth rate is a measure of how much a firm can grow without borrowing more money If actual growth is desired sales growth it must borrow funds from external sources to facilitate growth 4 Be able to assess the effect on net present value NPV of a change in a firm s account receivable credit policy payment terms similar to that shown in pages 66 70 in the text This was discussed in the class notes as well Initial Investment Sales Increase COGS day Base Case 0 0 Assuming 100 000 in sales and a COGS Sales rate of 65 COGS Day is 65 000 Alternative 0 3 Assuming a 3 sales increase totaling 103 000 and a COGS Sales rate of 65 COGS Day is 66 950 Net 30 30 days 10 days Payment Terms PT Inventory Conversion Period Inventory to production lag IPL Production to sale lag PSL Discount Rate Assume Annual Sales Daily Sales PV cash inflow Net 60 30 days 10 days PV cash outflow 10 36 500 000 100 000 98 118 28 100 000 1 discount rate PT IPL PSL 365 64 470 11 65 000 1 discount rate IPL 98 118 28 64 470 11 33 648 17 10 37 595 000 103 000 100 253 33 103 000 1 discount rate PT IPL PSL 365 66 404 21 66 950 1 discount rate IPL 100 253 33 66 404 21 33 849 12 10 365 10 365 33 849 12 123 549 293 03 In this case an increase in Payment Terms creates an increase in NPV A sensitivity analysis may be required in the case of bad debt expense and if there is a change in sales policy 10 365 10 365 33 648 17 122 815 823 69 Interest Rate Aggregate NPV Daily NPV 5 Given the necessary information be able to determine the Economic Order Quantity EOQ for a firm s inventory of raw material inputs Volume discount on Also be able to determine the optimal lot size LS of a production run associated with producing an inventory of finished goods prior to their sale Be able to illustrate your comparison with a graph so that your answer is clear How does a good sales forecast fit into this problem What are the problems associated with adopting just in time inventory Finding Minimum Cost and EOQ Given Inventory Management T 500 000 scrap metal F 20 fixed cost H 1 25 holding cost Q 2 average inventory TC F T Q H Q 2 Q 2FT H Q 2 20 500 000 1 25 4 000 tons per order of orders T Q 125 orders over the period At Q 4 000 total inventory costs are minimized At this point Holding Cost HQ 2 Order Cost FT Q Lot Size using a projected sales forecast in order to find the optimal balance between inventory holding costs and production set up costs if the lot size is smaller the set up costs will be higher Finding Minimum Lot Size Given Production Set Up Cost T 100 000 units for 1 yr expected sales F 20 000 fixed cost per set up H 80 unit LS 2FT H 2 20 000 100 000 80 70 711 optimal lot size At 70 711 total FG Inv is minimized and inventory holding costs production set up costs A good sales forecast is important because everything is tied to it …