Transcript Chapter 1
SHORT-TERM FINANCIAL MANAGEMENT Terry S. Maness and John T. Zietlow Copyright 2005 Thomson Learning, Inc. All rights reserved. No part of the computer program embodied in this diskette may be reproduced or transmitted in any form or by any means, electronic or mechanical, including input into or storage in any information system, without permission in writing from the publisher. Lecture slides may be displayed and may be reproduced in print form for instructional purposes only, provided a proper copyright notice appears on each slide. Requests for permission to make copies of any part of the work should be mailed to: Permissions Department. Produced in the United States of America ISBN: 0-324-20293-8; Support Website: http://www.swlearning.com/finance/maness/short-term3e/short-term3e.html Copyright 2005 by Thomson Learning, Inc. Chapter 1 The Role of Working Capital Sales Inv A /R Cash Copyright 2005 by Thomson Learning, Inc. Objectives View firm as a system of cash flows How WC and depreciation create disparities between profit and cash flow Management aspects of various WC accounts Copyright 2005 by Thomson Learning, Inc. The Cash Flow Timeline Order Placed Order Received < Inventory > Sale Payment Sent Cash Received Accounts Collection < Receivable > < Float > Time ==> Accounts < Payable > Invoice Received Disbursement < Float > Payment Sent Cash Disbursed Copyright 2005 by Thomson Learning, Inc. ...in the beginning Balance Sheet - June 1 Cash $1,000 Debt Common Stock $ 500 500 Total $1,000 Total $1,000 Copyright 2005 by Thomson Learning, Inc. The Next Day, June 2 Balance Sheet - June 2 Purchase Fixed Assets and Inventory Cash $ 400 Inventory 300 Fixed Assets 600 A/P Debt Common Stock $ 300 500 500 Total Total $1,300 $1,300 Copyright 2005 by Thomson Learning, Inc. End of June Balance Sheet - June 30 Sale of product, incur operating expenses, incur depreciation, and generate profit Cash $ 325 A/R 700 Inventory 0 Fixed Assets 600 (Accum Depr) (100) Total $1,525 A/P Accruals Debt Common Stock Retained Earnings Total $ 300 200 500 500 25 $1,525 Copyright 2005 by Thomson Learning, Inc. July 1 Balance Sheet - July 1 Pay operating accruals with cash Cash $ 125 A/R 700 Inventory 0 Fixed Assets 600 (Accum Depr) (100) Total $1,325 A/P Accruals Debt Common Stock Retained Earnings Total $ 300 0 500 500 25 $1,325 Copyright 2005 by Thomson Learning, Inc. July 15 Balance Sheet - July 15 Pay payables with cash Cash $ ( 175) A/R 700 Inventory 0 Fixed Assets 600 (Accum Depr) (100) Total $1,025 A/P Accruals Debt Common Stock Retained Earnings Total $ 0 0 500 500 25 $1,025 Copyright 2005 by Thomson Learning, Inc. July 31 Balance Sheet - July 31 Collect accounts receivable Cash $ 525 A/R 0 Inventory 0 Fixed Assets 600 (Accum Depr) (100) Total $1,025 A/P Accruals Debt Common Stock Retained Earnings Total $ 0 0 500 500 25 $1,025 Copyright 2005 by Thomson Learning, Inc. Profit versus Cash Flow Question: Why did the firm end up with $125 in additional cash while earning a profit of $25? Answer: Some expenses are not cash expenses. Question: Why did the firm run out of cash during its operating cycle? Answer: The cash deficit was due to the differences between the timing of cash disbursements and cash receipts. Copyright 2005 by Thomson Learning, Inc. Important Points #1: The firm must manage its cost structure to generate a profit #2: WC accounts must be managed so that liquidity is maintained. Copyright 2005 by Thomson Learning, Inc. Relationship Between Accrual Income and Cash Flow Income Statement Adjustment Account Cash Flow Account Sales - Change in accounts receivable = Cash collected Cost of goods sold - Change in accounts payable + Change in inventory = Cash paid to suppliers Operating expenses - Change in operating accruals - Depreciation Interest - Change in accrued interest Taxes - Change in accrued taxes - Change in deferred taxes _________________ Net Profit = Cash paid for operating expenses = Cash paid to creditors = Cash paid for taxes ___________________ Operating Cash Flow Copyright 2005 by Thomson Learning, Inc. Managing the Cash Cycle Managing Inventory Managing Receivables Managing Payables Electronic Commerce Copyright 2005 by Thomson Learning, Inc. Managing Inventory JIT Trade-offs between: – stock-out costs – cost of excess inventory – ordering costs Copyright 2005 by Thomson Learning, Inc. Managing Receivables Who should receive credit and how much? Credit terms Monitoring the outstanding balance Speeding up the receipt of payments through lockboxes Copyright 2005 by Thomson Learning, Inc. Managing Payables Search for terms that match with cash receipts Timing of payment Controlled disbursement Copyright 2005 by Thomson Learning, Inc. Electronic Commerce Revolutionizing management of cash cycle Proprietary systems Impact of Internet Copyright 2005 by Thomson Learning, Inc. How Much WC is Enough One view – optimal level is zero – WC is an idle resource – Provides little value How much in resources to commit? – Why inventory? – Why receivables and payables? – Why short-term investments? Chrysler’s $5 billion cushion of investments Copyright 2005 by Thomson Learning, Inc. How Management of Working Capital is Changing Exhibit 1-6 Working Capital Requirements as a Percent of Sales 35% 30% Percent of Sales 25% 20% Dell 15% Apple 10% Compaq 5% Gateway 0% -5% 1994 1995 1996 1997 1998 1999 2000 2001 2002 -10% Years Copyright 2005 by Thomson Learning, Inc. Summary Firm must operate at a profitable level. A profitable firm may still struggle financially. Working capital soaks up cash flow and may cause an otherwise profitable firm to fail. A successful firm’s operation is managed from a – profit, and a – cash flow perspective. Copyright 2005 by Thomson Learning, Inc.