Working Capital and the Financing Decision C H A P T E R S I X Limited 2000
Figure 6-1a The nature of asset growth A. Stage I: Limited or no Growth PPT 6-1 Dollars Temporary current assets Capital assets Time period Limited 2000
Figure 6-1b The nature of asset growth B. Stage II: Growth Dollars Temporary current assets PPT 6-1 Permanent current assets Capital assets Time period Limited 2000
Figure 6-1b The nature of asset growth B. Stage II: Growth Dollars Temporary current assets PPT 6-1 Permanent current assets Capital assets Time period Limited 2000
Figure 6-2a Sales and earnings for, 1990-1998 PPT 6-2 35000 30000 25000 $ thousands 20000 15000 10000 5000 0 3rd 90 3rd 91 3rd 92 Sources: www.sedar.com www.mcgrawhill.ca Symbol: MHR 3rd 93 3rd 94 3rd 95 Quarterly sales 3rd 96 3rd 97 3rd 98 Limited 2000
Figure 6-2b Sales and earnings for, 1990-1998 PPT 6-2 5000 4000 3000 2000 $ thousands 1000 0-1000 3rd 90 3rd 91 3rd 92 3rd 93 3rd 94 3rd 95 3rd 96 3rd 97 3rd 98-2000 -3000-4000 -5000 Sources: www.sedar.com www.mcgrawhill.ca Symbol: MHR Quarterly earnings Limited 2000
Figure 6-3a Sales and earnings for Hudson s Bay Co. and Sears Canada PPT 6-2 2500 2000 $ millions 1500 1000 500 0 1990 1991 1992 1993 1994 1995 1996 1997 1998 Sales Sources: www.sedar.com www.hbc.com Symbol: HBC www.sears.ca Symbol: SCC Hudson's Bay Sears Limited 2000
Figure 6-3b Sales and earnings for Hudson s Bay Co. and Sears Canada 200000 PPT 6-2 150000 100000 $ thousands 50000 0-50000 1990 1991 1992 1993 1994 1995 1996 1997 1998-100000 Earnings Sources: www.sedar.com www.hbc.com Symbol: HBC www.sears.ca Symbol: SCC Hudson's Bay Sears Limited 2000
Expanded cash flow cycle PPT 6-3 Customers Inventory Finished Goods Goods in in process Raw Raw materials Materials and and service Suppliers: accts. accts. payable Labor: wages payable Other: expenses Sales Sales Geographical area area Product or or division Customer type type Cash Accounts receivable 0-30 0-30 days days 31-60 31-60 days days 61-90 61-90 days days 91-120 days days Marketable securities Interest and dividends Government taxes taxes Federal income taxes taxes Provincial taxes taxes Other Other taxes taxes -term lenders Chartered banks banks Non-bank lenders Foreign banks banks and and lenders Limited 2000
Table 6-1 Yawakuzi sales forecast (in units) PPT 6-4 1st Quarter 2nd Quarter 3rd Quarter Quarter October. 300 January.. 0 April.1,000 July. 2,000 November..150 February. 0 May..2,000 August.1,000 December... 50 March.. 600 June..2,000 September..500 Total sales of 9,600 units at $3,000 each = $28,800,000 in sales. Limited 2000
Table 6-2 Yawakuzi s production schedule and inventory PPT 6-5 Inventory Production (at cost of Beginning (level Ending $2,000 inventory + production) Sales = inventory per unit) October 800 800 300 1,300 $2,600,000 November 1,300 800 150 1,950 3,900,000 December 1,950 800 50 2,700 5,400,000 January 2,700 800 0 3,500 7,000,000 February 3,500 800 0 4,300 8,600,000 March 4,300 800 600 4,500 9,000,000 April 4,500 800 1,000 4,300 8,600,000 May 4,300 800 2,000 3,100 6,200,000 June 3,100 800 2,000 1,900 3,800,000 July 1,900 800 2,000 700 1,400,000 August 700 800 1,000 500 1,000,000 September 500 800 500 800 1,600,000 Limited 2000
Table 6-3a Sales forecast, cash receipts and payments, and cash budget PPT 6-6 Oct Nov Dec Jan Feb Mar Apr May June July Aug Sept Sales Forecast ($ millions) Sales (units) 300 150 50 600 1,000 2,000 2,000 2,000 1,000 500 Sales $0.9 $0.45 $0.15 $1.8 $3.0 $6.0 $6.0 $6.0 $3.0 $1.5 (unit price, $3,000) 50% cash.45 $.225 $.075 $0.9 $1.5 $3.0 $3.0 $3.0 $1.5 $.75 50% cash from prior month s sales.75* 0.450 0.225 0.075 0. 9 1.5 3.0 3.0 3.0 1.50 Total cash receipts $1.20 0.675 $0.300 $0.075 $0.9 $2.4 $4.5 $6.0 $6.0 $4.5 $2.25 *Assumes September sales of $1.5 million. Cash Receipts Schedule ($ millions) Limited 2000
Table 6-3b Sales forecast, cash receipts and payments, and cash budget Oct Nov Dec Jan Feb Mar Apr May June July Aug Sept Cash Payments Schedule ($ millions) PPT 6-6 Constant production of 800 units/month (cost $2,000 per unit) $1.6 $1.6 $1.6 $1.6 $1.6 $1.6 $1.6 $1.6 $1.6 $1.6 $1.6 $1.6 Overhead.4.4.4.4.4.4.4.4.4.4.4.4 Dividends & interest 1.0 Taxes.3.3.3.3 Total cash payments $2.3 $2.0 $2.0 $2.3 $2.0 $2.0 $2.3 $2.0 $2.0 $2.3 $3.0 $2.0 Cash Budget ($ millions; required minimum balance is $0.25 million) Cash flow $(1.1) $(1.325) $(1.7) $(2.225) $(2.0) $(1.1) $.1 $2.5 $4.0 $3.7 $1.5 $.25 Beginning cash.25.25.25.25.25.25.25.25.25.25 1.1 2.60 Cumulative cash balance $(.85)$(1.075) $(1.45) $(1.975) $(1.75) $(.85) $.35 $2.75 $4.25 $3.95 $2.6 $2.85 Monthly loan or (repayment) 1.1 1.325 1.7 2.225 2.0 1.1 (0.1) (2.5) (4.0) (2.85) Cumulative loan 1.1 2.425 4.125 6.350 8.35 9.45 9.35 6.85 2.85 Ending cash balance.25.25.25.25.25.25.25.25.25 1.1 2.6 2.85 Assumes cash balance of $.25 million at the beginning of October and that this is the desired minimum cash balance. Limited 2000
Table 6-4 Total current assets, first year ($ millions) PPT 6-7 Accounts Total Current Cash Receivable Inventory Assets October $0.25 $0.450 $2.6 $3.30 November 0.25 0.225 3.9 4.375 December 0.25 0.075 5.4 5.725 January 0.25 0.00 7.0 7.25 February 0.25 0.00 8.6 8.85 March 0.25 0.90 9.0 10.15 April 0.25 1.50 8.6 10.35 May 0.25 3.00 6.2 9.45 June 0.25 3.00 3.8 7.05 July 1.10 3.00 1.4 5.50 August 2.60 1.50 1.0 5.10 September 2.85 0.75 1.6 5.20 Limited 2000
End of First Year Second Year PPT 6-8 Table 6-5a Cash budget and assets for second year with no growth in sales ($ millions) Sept Oct Nov Dec Jan Feb Mar Apr May June July Aug Sept Cash flow $0.25 $(1.1) $(1.325) $(1.7) $(2.225 $(2.0) $(1.1) $0.1 $2.5 $4.0 $3.7 $1.5 $0.25 Beginning cash 2.60 2.85 1.75 0.425 0.25 0.25 0.25 0.25 0.25 0.25 0.25 3.7 5.2 Cumulative 2.85 1.75 0.425 (1.275) (1.975) (1.75) (0.85) 0.35 2.75 4.25 3.95 5.2 5.45 cash balance Monthly loan or (repayment) 1.525 2.225 2.0 1.1 (0.1) (2.5) (4.0) (0.25) Cumulative loan 1.525 3.750 5.75 6.85 6.75 4.25 0.25. Ending cash balance $2.85 $1.75 $0.425 $0.25 $0.25 $0.25 $0.25 $0.25 $0.25 $0.25 $3.70 $5.2 $5.45 Limited 2000
End of First Year Second Year Sept Oct Nov Dec Jan Feb Mar Apr May June July Aug Sept Total Current Assets PPT 6-8 Table 6-5b Cash budget and assets for second year with no growth in sales ($ millions) Ending cash balance $2.85 $1.75 $0.425 $0.25 $0.25 $0.25 $0.25 $0.25 $0.25 $0.25 $3.70 $5.2 $5.45 Accounts receivable 0.75 0.45 0.225 0.075.. 0.95 1.50 3.0 3.0 3.0 1.5 0.75 Inventory 1.6 2.6 3.9 5.4 7.0 8.6 9.0 8.6 6.2 3.8 1.4 1.0 1.60 Total current assets $5.2 $4.8 $4.55 $5.725 $7.25 $8.85 $10.15 $10.35 $9.45$7.05 $8.1 $7.7 $7.80 Limited 2000
Figure 6-6 The nature of asset growth (Yawakuzi) 11 $ millions PPT 6-9 10 9 8 7 Accounts receivable Total current assets 6 5 4 3 2 1 Inventory Cash Inventory O N D J F M A M J J A S O N D J F M A M J J A S Cash Accounts receivable Inventory Limited 2000
Figure 6-7 Matching long-term and short-term needs Dollars Temporary current assets PPT 6-10 -term financing Permanent current assets Long-term financing Capital assets (debt & equity) Time period Limited 2000
Figure 6-8 Using long-term financing for part of short-term needs PPT 6-11 Dollars Temporary current assets -term financing Permanent current assets Long-term financing (debt & equity) Capital assets Time period Limited 2000
Figure 6-9 Using short-term financing for part of long-term needs PPT 6-11 Dollars Temporary current assets -term financing Permanent current assets Long-term financing Capital assets (debt & equity) Time period Limited 2000
Figure 6-11 A. Flat yield curve, March 1999 PPT 6-12 Percent 9.00 8.00 7.00 6.00 5.00 4.00 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 Years Limited 2000
Figure 6-11(2) A. Normal yield curve, July 1993 PPT 6-12 Limited 2000
Figure 6-11(3) C. Inverted yield curve, December 1989 PPT 6-12 Limited 2000
Figure 6-12 Long-term and short-term interest rates PPT 6-13 Limited 2000
Table 6-7 Alternative financing plans EDWARDS CORPORATION Plan A Plan B Part 1. Current assets Temporary....... $250,000 $250,000 Permanent....... 250,000 250,000 Total current assets... 500,000 500,000 -term financing (6%).. 500,000 150,000 Long-term financing (10%). 0 350,000 $500,000 $500,000 Part 2. Capital assets Plant and equipment.... $100,000 $100,000 Long-term financing (10%). $100,000 $100,000 PPT 6-14 Part 3. Total financing (summary of parts 1 & 2) -term (6%)..... $500,000 $150,000 Long-term (10%..... 100,000 450,000 $600,000 $600,000 Limited 2000
Table 6-8 Impact of financing plans on earnings EDWARDS CORPORATION Plan A Earnings before interest and taxes $200,000 Interest (short-term), 6% $500,000 30,000 Interest (long-term), 10% $100,000 10,000 Earnings before taxes 160,000 Taxes (50%) 80,000 Earnings aftertaxes $ 80,000 Plan B Earnings before interest and taxes $200,000 Interest (short-term), 6% $150,000 9,000 Interest (long-term), 10% $450,000 45,000 Earnings before taxes 146,000 Taxes (50%) 73,000 Earnings aftertaxes $ 73,000 PPT 6-14 Limited 2000
Table 6-9 Expected returns under different economic conditions EDWARDS CORPORATION PPT 6-15 1. Normal Expected higher return Probability of Expected conditions under Plan A normal conditions outcome $7,000.80 = + $5,600 2. Tight Expected lower return Probability of money under Plan A tight money ($15,000).20 = (3,000) Expected value of return for Plan A versus Plan B = +$2,600 Limited 2000
Table 6-10 Expected returns for high-risk firm PPT 6-15 EDWARDS CORPORATION 1. Normal Expected higher return Probability of Expected conditions under Plan A normal conditions outcome $7,000.80 = +$5,600 2. Tight Expected lower return Probability of money under Plan A tight money ($50,000).20 = (10,000) Expected value of return for Plan A versus Plan B = ($4,400) Limited 2000
Table 6-11 Current asset liquidity and asset financing plan PPT 6-16 Asset Liquidity Financing Plan Low Liquidity High Liquidity 1 2 -term High Profit Moderate profit High risk Moderate risk 3 4 Long-term Moderate profit Low profit Moderate risk Low risk Limited 2000
Chapter 6 - Outline LT 6-1 What is Working Capital? Hedged Approach to Financing -Term vs. Long-Term Financing Term Structure of Interest Rates Working Capital Financing Plans Limited 2000
Working Capital LT 6-2 Working Capital is financing and controlling the current assets of a firm Sales growth often leads to a buildup in inventory and accounts receivable. Firm may require additional external financing Crucial to short-term success or failure of a business Limited 2000
Hedged Approach to Financing LT 6-3 Match liquidity (life) of your assets to the maturity (term) of your financing Means your assets will be generating cash when your liabilities come due Balanced Financing Temporary (seasonal) build-up in inventory and accounts receivable finance with trade credit, short-term bank loans, short-term notes payable Permanent (minimum) levels of inventory, receivables + Property and equipment, long-term investments finance with long-term loans, leases, bonds, capital stock, retained earnings Limited 2000
-Term vs. Long-Term Financing LT 6-4 -term financing is less expensive but riskier lower interest rates short-term rates are volatile risk of default if sales slow down risk that bank may not extend / renew loans Long-term financing is more expensive but less risky usually higher interest rates, you may pay interest on funds you don t always need you have capital at all times Firm must decide the appropriate mix Limited 2000
Term Structure of Interest Rates LT 6-5 The Term Structure of Interest Rates is also known as the Yield Curve A graph showing the interest rate for Government of Canada securities with different maturity dates Normally, long-term rates are higher than short-term rates Limited 2000
Working Capital Financing Plans LT 6-6 A moderate (balanced) firm: S/T financing and high liquidity OR L/T financing and low liquidity An aggressive (risky) firm: S/T financing and low liquidity A conservative (safe or cautious) firm: L/T financing and high liquidity Appropriate strategy is determined based on company s tolerance for risk Limited 2000