musings of a budding social entrepeneur

Sunday, September 13, 2009

Finance Chapter19 - Short-Term Financial Planning

Summary of chapter  -
  • show how long term financing decisions impact short term
  • Components of working capital and the cash conversion cycle
  • how managers forecast month by month cash requirements or surpluses
  • Sources of short-term finance
Def - Total Capital Requirement. The total cost of all assets.

Figure 19-2. illustrates different long-term financing strategies
  • relaxed strategy - keep permanent short term cash surplus
  • restrictive strategy - firm is always in need for short-term borrowing,
  • intermediate strategy - firm fluctuates between surplus that it can lend away and needing to borrow.
What is the better strategy? No clear answer, depends. Several practicabl observations
  • Matching Maturities. Matching the type of financing with the type of asset. for example use long term financing (borrowing/equity) for long-lived assets like plant and machinery. Use short-term bank loans for inventory and AR.
  • Permanent working capital requirements.  Working capital should be funded with long-term financing
  • Consider liquidity advantages.  Certain types of firms need more liquidity than others. very predictable firms (manufacturing) need less. biotech need high in case a new drug gets approved they need large amounts of immediate cash to deploy to manufacturing.
19.2 Components of Working Capital
Current Assets
  • Accounts Receivable - unfinished payments from other companies or end consumers
  • Inventory - raw material, work in progress, finished goods awaiting sale
  • Cash - in form of bills or bank deposits
  • Marketable securities - "commercial paper - short-term unsecured debt sold by other firms" or "Treasury bills (T-bills) - short term debts sold by gov't"
Current Liabilities
  • Accounts Payable - outstanding payments due to other companies
  • short-term borrowing.
Working capital and the cash conversion cycle

Def - Net working capital = Current assets - current liabilities. Often called "working capital". For average manufacturing, this is positive. Assets are 30% greater than liabilities.

Def - Cash Conversion Cycle = (inventory period + receivables period) - accounts payable period. The amount of time between a firm's payment for materials and collection on it's sales.

Def - Inventory Period = inventory / annual COGS/365
Def - AR Period = AR / (Annual sales/365)

Def - AP Period = AP / (Annual COGS/365)

NOTE: Example 19.1 - Cash Conversion Cycle

Def  - Carrying Costs: Costs of maintaining current assets, including opportunity cost of capital.

Def - Shortage Costs: Costs incurred from shortages in current assets.

Def - Economic Value Added (EVA).

19.4 Cash Budgeting
Step1: Forecast the sources of cash
Step2: Forecast uses of cash
Step3: Calculate whether the firm is facing a shortage or surplus


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