Transcript Chapter 1
SHORT-TERM FINANCIAL MANAGEMENT, 2e Terry S. Maness and John T. Zietlow
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2002 by South-Western, a division of Thomson Learning. Thomson Learning TM is a trademark used herein under license.
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Produced in the United States of America ISBN: 0-030-31517-4 Copyright
2002 by South-Western, a division of Thomson Learning TM
Chapter 1 The Role of Working Capital
Sales Inv A /R Cash Copyright
2002 by South-Western, a division of Thomson Learning TM
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
Discussion of appropriate level of WC Copyright
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The Cash Flow Timeline
Order Placed Order Received Sale Accounts Collection < Inventory > < Receivable > < Float >
Cash Received
Time ==> Accounts Disbursement < Payable > < Float > Invoice Payment
Cash
Received Sent
Paid
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...in the beginning
Cash Total $1,000 $1,000 Balance Sheet - June 1 Debt $ 500 Common Stock 500 Total $1,000 Copyright
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The Next Day, June 2
Balance Sheet - June 2 Purchase Fixed Assets and Inventory Cash Inventory Fixed Assets $ 400 300 600 Total $1,300 A/P Debt Common Stock Total $ 300 500 500 $1,300 Copyright
2002 by South-Western, a division of Thomson Learning TM
End of June
Balance Sheet - June 30 Sale of product, incur operating expenses, incur depreciation, and generate profit Cash A/R Inventory Fixed Assets $ 325 700 0 600 (Accum Depr) (100) Total $1,525 A/P Accruals Debt Common Stock $ 300 200 500 500 Retained Earnings Total 25 $1,525 Copyright
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July 1
Balance Sheet - July 1 Pay operating accruals with cash Cash A/R Inventory Fixed Assets $ 125 700 0 600 (Accum Depr) (100) Total $1,325 A/P Accruals Debt Common Stock $ 300 0 500 500 Retained Earnings 25 Total $1,325 Copyright
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July 15
Balance Sheet - July 15 Pay payables with cash Cash A/R Inventory Fixed Assets $ ( 175) 700 0 600 (Accum Depr) (100) Total $1,025 A/P Accruals Debt Common Stock $ 0 0 500 500 Retained Earnings 25 Total $1,025 Copyright
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July 31
Balance Sheet - July 31 Collect accounts receivable Cash A/R Inventory Fixed Assets $ 525 0 0 600 (Accum Depr) (100) Total $1,025 A/P Accruals Debt Common Stock $ 0 0 500 500 Retained Earnings 25 Total $1,025 Copyright
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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.
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2002 by South-Western, a division of Thomson Learning TM
Two Important Points to Remember
(1) The firm must manage its cost structure to generate a profit
(2) Working Capital accounts must be managed so that liquidity is maintained.
Example: Dell and its “Golden Triangle” Copyright
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Income Statement
Sales Cost of goods sold Operating expenses Interest Taxes _________________ Net Profit
Relationship Between Accrual Income and Cash Flow
Adjustment Account
- Change in accounts receivable
Cash Flow Account
= Cash collected - Change in accounts payable + Change in inventory - Change in operating accruals - Depreciation = Cash paid to suppliers - Change in accrued interest = Cash paid for operating expenses = Cash paid to creditors - Change in accrued taxes - Change in deferred taxes = Cash paid for taxes ___________________ Operating Cash Flow Copyright
2002 by South-Western, a division of Thomson Learning TM
Managing the Cash Cycle
Managing Inventory
Managing Receivables
Managing Payables
Electronic Commerce Copyright
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Managing Inventory
Just-In-Time (JIT)
Trade-offs between:
–
stock out costs
–
cost of excess inventory
–
ordering costs Copyright
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Managing Receivables
Who should receive credit and how much?
Credit terms
Monitoring the outstanding balance
Speeding up the receipt of payments through lockboxes Copyright
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Managing Payables
Search for terms that match with cash receipts
Timing of payment
Controlled disbursement Copyright
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Electronic Commerce
Revolutionizing management of cash cycle
Proprietary systems
Impact of Internet Copyright
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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
2002 by South-Western, a division of Thomson Learning TM
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 cash flow perspective Copyright
2002 by South-Western, a division of Thomson Learning TM