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Lesson 11 - Short-Term Financial Planning
Financial Management (FIN2004)
National University of Singapore
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FINANCE FIN2004 Lesson 11 Short-Term Financial Planning RWJLT Chapters 18, 19, 20 Scope • Working Capital and Terminology • Tracing Cash and Net Working Capital • The Operating Cycle and the Cash Cycle • Cash Management • Receivables Management • Short-Term Borrowings • Appendix 1: Short-Term Financing Policy & Inventory Management (not examinable) • Appendix 2: Illustrative Example – Preparing a MultiPeriod Cash Budget (not examinable) 11-1 Working Capital Terminology Gross Working Capital: Total Current Assets. Net Working Capital: Current Assets minus Current Liabilities. Net Operating Working Capital (NOWC): Current Assets (or Operating Current Assets) minus Non-interest-bearing Current Liabilities (or Operating Current Liabilities). NOWC = Operating CA – Operating CL = (Op. Cash + Inventory + A/R) – (Accruals + A/P) Working Capital Policy: Deciding the level of each type of current assets to hold, and how to finance the current assets. 11-3 Tracing Cash and Net Working Capital Current Liabilities (CL) Long-Term Debt (LTD) Assets = Liabilities + Equity Current Assets (CA) Net Fixed Assets (NFA) CA + NFA = CL + LTD + EQ* CA = CL + LTD + EQ – NFA (Cash + Other CA ) = CL + LTD + EQ – NFA Cash = LTD + EQ + CL – NFA – Other CA *Equity (EQ) includes Share Capital and Retained Earnings, which are increased by Net Income less Dividends. 11-4 The Operating Cycle & Cash Cycle Inventory 365 = COGS/365 Inventory Turnover Inventory purchased Receivable s 365 = Sales/365 Receivable s Turnover Inventory sold Inventory Period Accounts Payable Period 365 Payables Turnover Accounts Receivable Period Cash Cycle Cash paid for inventory Cash received from credit sales Operating Cycle 11-6 The Operating Cycle Operating Cycle – time between purchasing the inventory and collecting the cash from selling the inventory. Inventory Period – time between purchasing the inventory and sell the inventory. Accounts Receivable Period (or Days Sales Outstanding) – time between selling the inventory and collecting cash from sales. Operating Cycle = Inventory Period + Accounts Receivable Period 11-7 Accounts Payable Period Accounts Payable Period (Payables Deferral Period): time between purchase of inventory and payment for the inventory. 365 Accounts Payable Period = Payables Turnover Total Purchases from Suppliers Payables Turnover = Average Payable COGS + End Inventory - Beginning Inventory = Average Payable 11-9 Example: Selected ratios for SKI Inc. SKI Ind. Avg. 2 1 Debt/Assets 58% 50% Turnover of Cash 16 22 Days Sales Outstanding 46 days 32 days Inventory Turnover 4 7 Fixed Assets Turnover 11 12 Total Assets Turnover 2 3 Profit Margin 2% 3% Return on Equity (ROE) 10% 21% Current Ratio 11-10 Cash Cycle of SKI CC = Inventory Period + Accounts Accounts Receivable – Payable Period Period Accounts 365 365 = Inv. Turnover + – Payable Rec. Turnover Period = 365 4 + 46 – 30 = 92 days may be estimated by the credit 365 OR terms provided by suppliers. Payables Turnover 11-12 Cash As Cash does not earn a profit, why hold it? 1. Transactions – need to have some cash to operate the business. 2. Precaution – as a “safety stock” (can be fulfilled by having line of credit and marketable securities). 3. Compensating Balances – to meet minimum account balance demanded by banks when bank loans or bank services are provided. 4. Speculation – to take advantage of bargains and discounts on cash purchases. 11-13 Ways To Improve Cash Or Minimize Excess Cash Holding Hold marketable securities. Negotiate a line of credit from the bank. Insist on wire transfers from customers. Use a remote disbursement account. Increase cash forecast accuracy to reduce need for “safety stock” of cash. Use a lockbox. 11-15 Lockbox Minimizes the delay in receiving cheques sent by the company’s customers through mail. Particularly relevant for companies and customers separated by great geographical distances in the same country. Incoming cheques by customers are sent to the nearest PO boxes (prepaid envelopes may be used for the convenience of customers) which are arranged by the company with its bank. The bank helps to collect the cheques frequently and deposit them into the company’s account. The bank also provides daily record to the company. 11-16 Example: Investment in Lockbox Service • A proposed lockbox service by a bank will reduce collection time by 2 days on average. • Daily interest rate on T-bills = 0% (opportunity cost of cash). • Average number of daily cheques sent to the lockbox is 3,000. • Average size of each cheque payment is $600. • The processing fee charged by the bank is $0 per cheque plus $10 flat service fee each day. If the company needs to invest $450,000 (in addition to charges by the bank) to implement this lockbox service, is the investment worthwhile? 11-18
Lesson 11 - Short-Term Financial Planning
Course: Financial Management (FIN2004)
University: National University of Singapore
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