Corporate finance 7e ross ch26

Chapter Outline26.1 Tracing Cash and Net Working Capital 26.2 Defining Cash in Terms of Other Elements 26.3 The Operating Cycle and the Cash Cycle 26.4 Some Aspects of Short-Term Financi

26

Short-Term Finance

and Planning

Chapter Outline

26.1 Tracing Cash and Net Working Capital

26.2 Defining Cash in Terms of Other Elements 26.3 The Operating Cycle and the Cash Cycle

26.4 Some Aspects of Short-Term Financial

Policy

26.5 Cash Budgeting

26.6 The Short-Term Financial Plan

26.7 Summary & Conclusions

26.1 Tracing Cash and Net Working Capital

26.2 Defining Cash in Terms of Other Elements 26.3 The Operating Cycle and the Cash Cycle

26.4 Some Aspects of Short-Term Financial

Policy

26.5 Cash Budgeting

26.6 The Short-Term Financial Plan

26.7 Summary & Conclusions

The Balance-Sheet Model of the Firm

Long-Term Debt

What term

long-investments should the firm engage in?

The Capital Budgeting Decision

The Balance-Sheet Model of the Firm

How can the firm raise the money for the required investments?

The Capital Structure Decision Current Assets

The Balance-Sheet Model of the Firm

How much term cash flow does a company need to pay its bills?

short-The Net Working Capital Investment Decision

Net Working Capital

26.1 Tracing Cash and Net Working Capital

Current Assets are cash and other assets that are expected to be

converted to cash with the year.

Cash Marketable securities Accounts receivable Inventory

Current Liabilities are obligations that are expected to require

cash payment within the year.

Accounts payable Accrued wages Taxes

Current Assets are cash and other assets that are expected to be

converted to cash with the year.

Cash Marketable securities Accounts receivable Inventory

Current Liabilities are obligations that are expected to require

cash payment within the year.

Accounts payable Accrued wages Taxes

26.2 Defining Cash in Terms of Other Elements

Net Working Capital +

Fixed Assets =

Term Debt

Long-+ Equity

Net Working Capital = Cash

Other Current Assets

Current Liabilities

+–

Cash =

Term Debt

Long-+ Equity – Net Working Capital

(excluding cash)

Fixed Assets–

26.2 Defining Cash in Terms

of Other Elements

An increase in long-term debt and or equity leads to an increase in cash—as does a decrease in fixed assets or a decrease in the non-cash components of net working capital

The Sources and Uses of Cash Statement follows from this reasoning

An increase in long-term debt and or equity leads to an increase in cash—as does a decrease in fixed assets or a decrease in the non-cash components of net working capital

The Sources and Uses of Cash Statement follows from this reasoning

Cash =

Term Debt

Long-+ Equity –

Net Working Capital

(excluding cash)

Fixed Assets–

26.3 The Operating Cycle and the Cash Cycle

Accounts receivable period Inventory period

Finished goods sold

Firm receives invoice Cash paid for materials

Order

Placed

Stock Arrives

Raw material

purchased

26.3 The Operating Cycle and the Cash Cycle

In practice, the inventory period, the accounts receivable period, and the accounts payable period are measured by days in inventory, days in receivables and days in

payables

In practice, the inventory period, the accounts receivable period, and the accounts payable period are measured by days in inventory, days in receivables and days in

payables

Cash cycle = Operating cycle –

Accounts payable period

26.4 Some Aspects of Short-Term

Flexible Restrictive

Alternative Financing Policies for Current Assets Usually measured as the proportion of short-term debt to long- term debt.

Flexible Restrictive

There are two elements of the policy that a firm adopts for short-term finance

The Size of the Firm’s Investment in Current Assets Usually measured relative to the firm’s level of total operating revenues.

Flexible Restrictive

Alternative Financing Policies for Current Assets Usually measured as the proportion of short-term debt to long- term debt.

Flexible Restrictive

The Size of the Investment

in Current Assets

A flexible policy short-term finance policy would

maintain a high ratio of current assets to sales

Keeping large cash balances and investments in marketable securities.

Large investments in inventory.

Liberal credit terms.

A restrictive short-term finance policy would maintain a low ratio of current assets to sales

Keeping low cash balances, no investment in marketable securities.

Making small investments in inventory.

A flexible policy short-term finance policy would

maintain a high ratio of current assets to sales

Keeping large cash balances and investments in marketable securities.

Large investments in inventory.

Liberal credit terms.

A restrictive short-term finance policy would maintain a low ratio of current assets to sales

Keeping low cash balances, no investment in marketable securities.

Making small investments in inventory.

Carrying Costs and Shortage Costs

$

Investment in Current Assets ($)

Appropriate Flexible Policy

$

Investment in Current Assets ($)

When a Restrictive Policy is Appropriate

$

Investment in Current Assets ($)

Shortage costs

Carrying costs

Total costs of holding current assets.

CA * Minimum

point

Alternative Financing Policies for

Current Assets

A flexible short-term finance policy means low

proportion of short-term debt relative to long-term

financing

A restrictive short-term finance policy means high

proportion of short-term debt relative to long-term

financing

A flexible short-term finance policy means low

proportion of short-term debt relative to long-term

financing

A restrictive short-term finance policy means high

proportion of short-term debt relative to long-term

financing

Alternative Financing Policies

for Current Assets

In an ideal world, short-term assets are always financed with short-term debt and long-term assets are always

financed with long-term debt

In this world, net working capital is always zero

In an ideal world, short-term assets are always financed with short-term debt and long-term assets are always

financed with long-term debt

In this world, net working capital is always zero

Financing Policy for an Idealized Economy

Long-term debt plus common stock

$

Time

Current assets = Short-term debt

Fixed assets:

a growing firm

Grain elevator operators buy crops after harvest, store them, and sell

them during the year Inventory is financed with short-term debt Net

Alternative Asset-Financing Strategies

$

Time

Long Term Financing

Short Term Financing

Total Asset Requirement

$

Time

Long Term Financing

Marketable Securities

Total Asset Requirement

Long-Term Financial Planning

A cash budget is a primary tool of short-run financial planning

The idea is simple: Record the estimates of cash receipts and disbursements

Long-Term Financial Planning

26.5 Cash Budgeting

The cash balance tells the manager what borrowing is required or what lending will be possible in the short run

The cash balance tells the manager what borrowing is required or what lending will be possible in the short run

26.6 The Short-Term Financial Plan

The most common way to finance a temporary cash deficit to arrange a short-term loan

The most common way to finance a temporary cash deficit to arrange a short-term loan

26.7 Summary & Conclusions

This chapter introduces the management of short-term finance

We examine the short-term uses and sources of cash

as they appear on the firm’s financial statements

We see how current assets and current liabilities arise

in the short-term operating activities and the cash cycle of the firm

From an accounting perspective, short-term finance involves net working capital

This chapter introduces the management of short-term finance

We examine the short-term uses and sources of cash

as they appear on the firm’s financial statements

We see how current assets and current liabilities arise

in the short-term operating activities and the cash cycle of the firm

From an accounting perspective, short-term finance involves net working capital

26.7 Summary & Conclusions

Managing short-term cash flows involves the

minimization of costs

The two major costs are:

Carrying costs—the interest and related costs incurred by overinvesting in short-term assets such as cash

Shortage costs—the cost of running out of short-term assets.

The objective of managing term finance and term financial planning is to find the optimal tradeoff

short-between these two costs

Managing short-term cash flows involves the

minimization of costs

The two major costs are:

Carrying costs—the interest and related costs incurred by overinvesting in short-term assets such as cash

Shortage costs—the cost of running out of short-term assets.

The objective of managing term finance and term financial planning is to find the optimal tradeoff

short-between these two costs

26.7 Summary & Conclusions

In an ideal economy, the firm could perfectly predict its short-term uses and sources of ash and net working

capital could be kept at zero

In the real world, net working capital provides a buffer that lets the firm meet its ongoing obligations

The financial manager seeks the optimal level of each of the current assets

In an ideal economy, the firm could perfectly predict its short-term uses and sources of ash and net working

capital could be kept at zero

In the real world, net working capital provides a buffer that lets the firm meet its ongoing obligations

The financial manager seeks the optimal level of each of the current assets

26.7 Summary & Conclusions

The financial manager can use the cash budget to

identify short-term financial needs

The cash budget tells the manager what borrowing is

required or what lending will be possible in the short

run

The financial manager can use the cash budget to

identify short-term financial needs

The cash budget tells the manager what borrowing is

required or what lending will be possible in the short

run