Chapter 19. Topics Covered. Working Capital. Short-Term Financial Planning

Transcription

1 19-1 Fundamentals of Corporate Finance Chapter 19 Short-Term Financial Planning Copyright Copyright 29 by The 29 McGraw-Hill by The McGraw-Hill Companies, Inc. Companies, All rights Inc. reserved All rights reserved 19-2 Topics Covered Links Between Long-Term and Short-Term Financing Tracing Changes in Cash and A Short-Term Financing Plan Sources of Short-Term Financing The 19-3 Factors in establishing working capital levels 1. Matching maturities 2. Permanent working capital requirements 3. The advantages of liquidity 1

2 19-4 Firm s Cumulative Capital Requirement Dollars A B C Cumulative capital requirement Year 1 Year 2 Time 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 19- Net - 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 Simple Cycle of operations Cash Receivables Raw materials inventory Finished goods inventory 2

3 19-7 Cash conversion cycle 19-8 inventory Inventory period = annual COGS/36 accounts receivable Accounts receivables period = annualsales/36 accounts payable Accounts payable period = annual COGS/ Example - Cash Conversion Cycle Given the aggregate balance sheet and income statement for US Manufacturing firms, calculate the cash conversion cycle. Income Statement Balance Sheet Sales 27,887 Inventory COGS,3 A/R A/P

4 19-1 Example - Cash Conversion Cycle Given the aggregate balance sheet and income statement for US Manufacturing firms, calculate the cash conversion cycle. inventory Inventory period = annual COGS/ =,3/36 = 42.2 days Example - Cash Conversion Cycle Given the aggregate balance sheet and income statement for US Manufacturing firms, calculate the cash conversion cycle. Receivable s period accounts receivable = annual sales/36 73 =,887/36 = 43.6 days 19- Example - Cash Conversion Cycle Given the aggregate balance sheet and income statement for US Manufacturing firms, calculate the cash conversion cycle. Payable period accounts payable = annual COGS/ =,3 / 36 = 32.4 days 4

5 19-13 Example - Cash Conversion Cycle Given the aggregate balance sheet and income statement for US Manufacturing firms, calculate the cash conversion cycle. Inventory period = 39.6 days Receivables period = 39.7 days Payable period = 3.3 days Cash conversion cycle = ( ) 32.4 = Changes in Cash & W.C. Assets Current Assets Cash Mark Securities Inventory Accts Recv Total Curr Assets Fixed Assets Gross investment less Depr Net Fixed Assets Total Assets Liabilities & Equity Current Liabilities Bank Loans Accts Payable Total Curr Liab Long Term Debt Net Worth Total Liab and owner' s equity Changes in Cash & W.C. Income Statement Sales $3 Assume Operating Costs 321 dividend = $1 mil Depreciation 4 R.E.=$11 mil EBIT 2 Interest 1 Pretax income 24. Tax at % Net Income $

6 19-16 Changes in Cash & W.C. Example - Dynamic Mattress Company Sources Issued long term debt Uses Reduced inventories Increased accounts payable Cash from operations Net income Depreciation TotalSources Repaidshort termbank loan Invested in fixed assets Purchased marketable securities Increased accounts receivable Dividend Total Uses Increasein cash balance $ $3 $ Changes in Cash & W.C. Dynamic used cash as follows Paid $1 mil dividend. Repaid $ mil short term bank loan Invested $14 mil Purchased $ mil of marketable securities Accounts receivable expanded by $ mil 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. 6

7 19-19 Dynamic forecasted sources of cash Quarter 1st 2nd 3rd 4th Sales, $mil AR ending balance = AR beginning balance + sales - collections 19-2 Dynamic collections on AR Qtr 1st 2nd 3rd 4th 1. Beginning receivables Sales Collections. Sales in current Qtr (8%) Sales in previous Qtr (2%) Total collections Receivables at end of period. (4 = ) $32. $3.7 $38.2 $ Dynamic forecasted uses of cash Payment of accounts payable Labor, administration, and other expenses Capital expenditures Taxes, interest, and dividend payments 7

8 19-22 Dynamic cash budget Sources of cash 1st Qtr 2nd 3rd 4th collections on AR other Total Sources Uses of cash payment of AP labor and admin expenses capital expenditures taxes, interest, & dividends Total uses of cash Net cash inflow -$4. -$1. $26. $3. (sources minus uses) Dynamic short term financing requirements Cash at start of period Net cash flow = Cash at end of period Min operating cash balance Cumulative short term financing required (minimum cash balance minus caash at end of period) $4 $6 $34 - $ Forecast Uses of Cash 1. Payments of accounts payable. 2. Labor, administrative, and other expenses. 3. Capital expenditures. 4. Taxes, interest, and dividend payments. 8

9 19-2 A Short Term Financing Plan Dynamic forecasted deferrable expenses Quarter 1st 2nd 3rd 4th Amount Deferrable, $mil A Short Term Financing Plan Example - Dynamic Mattress Company- Financing Plan Cash Requirements 1.Cash for operations 2. Interest on bank loan 3.Interest on stretechd payables 4. Total cash required Cash Raised. Bank loan 6.Stretched payables 7.Securities sold 8.Total cash raised Repayments 9. Of stretched payables 1.Of line of credit Increase in cash balances 11.Addition to cash balances Line of credit.beginning of quarter 13.End of quarter Qtr 1st nd 3rd th Sources of Short Term Financing Line of Credit Agreement by a bank that a company may borrow at any time up to an established limit. Bank loans Secured loans Inventory financing Commercial paper 9

10 19-28 Simple Interest Amount of loan X annual interest rate number of periods in the year Example: A bank quotes 6% annual interest on a $1, loan. What is the monthly simple interest?.6 1, = $ per month Effective annual rate quoted annualinterest rate m ( + ) 1 1 m Example: A bank quotes 6% annual interest on a $1, loan, compounded monthly. What is the effective annual rate?. 6 (1 + ) 1 =.617 or 6.17% 19-3 Discount Interest Annual Interest Paid Annual Rate = Cash Proceeds From Loan Effective annual rate on a discount loan (1 1 quoted annual interest rate m ) m 1 1

11 19-31 Example: A company can receive a 6% discount loan on $1,. What is the annual interest rate assuming annual payments? What is the effective annual interest rate given monthly payments? 6, Annual Rate = =.638 or 6.38% 94, 1 EAR = (1.6 ) 1 =.62or 6.2% Compensating Balance Annual Interest Paid Annual Rate = (Loan - Compensating balance) Effective annual rate on a compensating balance loan actualinterest paid borrowed funds available m Example: A company can receive a 6% discount loan on $1,, but must maintain a $2, compensating balance. What is the annual interest rate assuming annual payments? What is the effective annual interest rate given monthly payments? 6, Annual Rate = =.7or 7.% (1, - 2,) 6, EAR = =.776or 7.76% 8, 11