Principles of corporate finance 6th brealey myers chapter 29

Cash Conversion Cycle - Period between firm’s payment for materials and collection on its sales.. Strategy A: A permanent cash surplus Strategy B: Short-term lender for part of year an

 Short Term Financial Planning

Principles of Corporate Finance

Slides by

29- 3

Working Capital

Net Working Capital - Current assets minus current

liabilities Often called working capital.

Cash Conversion Cycle - Period between firm’s

payment for materials and collection on its sales.

Carrying Costs - Costs of maintaining current assets,

including opportunity cost of capital.

Shortage Costs - Costs incurred from shortages in

current assets

Firm’s Cumulative Capital Requirement

Lines A, B, and C show alternative amounts of long-term finance.

Strategy A: A permanent cash surplus

Strategy B: Short-term lender for part of year and borrower for

remainder Strategy C: A permanent short-term borrower

A B C

Year 2 Year 1

Dollars

Cumulative capital requirement

Time

29- 5

Working Capital

Simple Cycle of operations

Cash

Working Capital

Simple Cycle of operations

Cash

Raw materials inventory

Raw materials inventory

Working Capital

Simple Cycle of operations

Cash

Finished goods inventory Receivables Raw materials inventory

Changes in Cash & W.C.

Example - Dynamic Mattress Company

115 95

equity s

owner' 115

95 Assets

Total

and Liab Total

50 40

Assets Net Fixed

20 16

Depr less

70 56

investment Gross

Assets Fixed

76 65

Worth Net

65 55

Assets Curr

Total

12 5

Debt Term

Long 30

25 Recv

Accts

27 25

Curr Liab Total

25 26

Inventory

27 20

Payable Accts

5

0 Securities

Mark

0 5

oans Bank L

5 4

Cash

abilities Current Li

5 4

Assets Current

1999 1998

Equity

&

s Liabilitie 1999

1998 Assets

29- 11

Changes in Cash & W.C.

Example - Dynamic Mattress Company

Income Statement

Operating Costs 321 Depreciation 4

Pretax income 24 Tax at 50% 12 Net Income $12

Assume dividend = $1 mil R.E.=$11 mil

Changes in Cash & W.C.

cash

in Increase

$30 Uses

Total

1 Dividend

5 receivable

accounts Increased

5 securities

marketable Purchased

14 assets

fixed

in Invested

5 loan

bank short term

Repaid

Uses

$31 Sources

Total

4 on

Depreciati

12 income

Net

operations from

Cash

7 payable

accounts Increased

1 s

inventorie Reduced

7 debt

term long

Issued

Sources

29- 13

Changes in Cash & W.C.

Example - Dynamic Mattress Company

Dynamic used cash as follows:

 Paid $1 mil dividend.

 Repaid $5 mil short term bank loan.

 Invested $14 mil.

 Purchased $5 mil of marketable securities.

 Accounts receivable expanded by $5 mil.

Cash Budgeting

Steps to preparing a cash budget

Step 1 - Forecast the sources of cash.

Step 2 - Forecast uses of cash.

Step 3 - Calculate whether the firm is facing a cash

shortage or surplus.

29- 15

Cash Budgeting

Example - Dynamic Mattress Company

Dynamic forecasted sources of cash

AR ending balance = AR beginning balance + sales -

collections

Quarter 1st 2nd 3rd 4th Sales, $mil 87.50 78.50 116.00 131.00

Cash Budgeting Example - Dynamic Mattress Company

Dynamic collections on AR

Qtr 1st 2nd 3rd 4th

1 Beginning receivables 30.0 32.5 30.7 38.2

2 Sales 87.5 78.5 116.0 131.0

3 Collections Sales in current Qtr (80%) 70 62.8 92.8 104.8 Sales in previous Qtr (20%) 15.0 17.5 15.7 23.2 Total collections 85.0 80.3 108.5 128.0

4 Receivables at end of period (4 = 1 + 2 - 3) $32.5 $30.7 $38.2 $41.2

29- 17

Cash Budgeting Example - Dynamic Mattress Company

Dynamic forecasted uses of cash

 Payment of accounts payable

 Labor, administration, and other expenses

 Capital expenditures

 Taxes, interest, and dividend payments

Cash Budgeting Example - Dynamic Mattress Company

minus (sources

inflow cash

Net

93.0 95.0

95.3 131.5

cash of uses Total

5.0 4.5

4.0 4.0

dividends

&

interest, ,

taxes

8.0 5.5

1.3 32.5

es expenditur capital

30.0 30.0

30.0 30.0

expenses admin

and labor

50.0 55.0

60.0 65.0

AP of payment

cash of Uses

128.0 121.0

80.3 85.0

Sources Total

0.0 12.5

0.0 0.0

other

128.0 108.5

80.3 85.0

AR on s collection

cash of Sources

4th 3rd

2nd 1st

Qtr

29- 19

Cash Budgeting Example - Dynamic Mattress Company

Dynamic short term financing requirements

$.5 -

$35.5

$61.5

$46.5

period) of

end

at caash minus

balance cash

(minimum required

financing short term

Cumulative

5 5

5 5

balance cash

operating Min

4.5 + 30.5

56.5 -

-41.5 -

period of

end

at Cash

=

35 + 26

+ 15

46.5 -

-flow cash

Net +

30.5 -

56.5 -

41.5 -

5 period

of start

at Cash

A Short Term Financing Plan Example - Dynamic Mattress Company

Dynamic forecasted deferrable expenses

40 44

48 52

$mil errable,

Amount Def

4th 3rd

2nd 1st

Quarter

Interest payments: