SHORT-TERM FINANCIAL MANAGEMENT

Terry S. Maness and John T. Zietlow

Copyright

2005 Thomson Learning, Inc.

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Copyright

2005 by Thomson Learning, Inc.

Chapter 1
The Role of Working Capital

Sales

Inv

A /R

Cash

Copyright

2005 by Thomson Learning, Inc.

Objectives

View firm as a system of cash flows

How WC and depreciation create disparities

between profit and cash flow

Management aspects of various WC accounts

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2005 by Thomson Learning, Inc.

The Cash Flow Timeline

Order
Order
Placed
Placed

Order
Order
Received
Received

Sale
Sale

Payment
PaymentSent
Sent Cash
Cash
Received
Received
Accounts
Collection
Accounts
Collection
<<Inventory
Inventory>> << Receivable
Receivable >> << Float
Float >>

Accounts
Accounts
<< Payable
Payable >>
Invoice
InvoiceReceived
Received

Disbursement
Disbursement
<< Float
>>
Float
Payment
Copyright
PaymentSent
Sent

Time
Time==>
==>

Cash
CashDisbursed
Disbursed

2005 by Thomson Learning, Inc.

...in the beginning

Balance
BalanceSheet
Sheet--June
June11
Cash
Cash

$1,000
$1,000

Debt
Debt
Common
CommonStock
Stock

$$ 500
500
500
500

Total
Total

$1,000
$1,000

Total
Total

$1,000
$1,000

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2005 by Thomson Learning, Inc.

The Next Day, June 2

Balance
BalanceSheet
Sheet--June
June22
Purchase
PurchaseFixed
FixedAssets
Assetsand
andInventory
Inventory

Cash
$$ 400
Cash
400
Inventory
300
Inventory
300
Fixed
600
FixedAssets
Assets
600

A/P
A/P
Debt
Debt
Common
CommonStock
Stock

$$ 300
300
500
500
500
500

Total
Total

Total
Total

$1,300
$1,300

$1,300
$1,300

Copyright

2005 by Thomson Learning, Inc.

End of June
Balance
BalanceSheet
Sheet--June
June30
30
Sale
Saleof
ofproduct,
product,incur
incuroperating
operatingexpenses,
expenses,
incur
incurdepreciation,
depreciation,and
andgenerate
generateprofit
profit
Cash
$$ 325
Cash
325
A/R
700
A/R
700
Inventory
00
Inventory
Fixed
600
FixedAssets
Assets
600
(Accum
(AccumDepr)
Depr) (100)
(100)
Total
$1,525
Total
$1,525

A/P
A/P
Accruals
Accruals
Debt
Debt
Common
CommonStock
Stock
Retained
RetainedEarnings
Earnings
Total
Total
Copyright

$$ 300
300
200
200
500
500
500
500
25
25
$1,525
$1,525

2005 by Thomson Learning, Inc.

July 1
Balance
BalanceSheet
Sheet--July
July11
Pay
Payoperating
operatingaccruals
accrualswith
withcash
cash

Cash
$$ 125
Cash
125
A/R
700
A/R
700
Inventory
00
Inventory
Fixed
600
FixedAssets
Assets
600
(Accum
(AccumDepr)
Depr) (100)
(100)
Total
$1,325
Total
$1,325

A/P
A/P
Accruals
Accruals
Debt
Debt
Common
CommonStock
Stock
Retained
RetainedEarnings
Earnings
Total
Total
Copyright

$$ 300
300
00
500
500
500
500
25
25
$1,325
$1,325

2005 by Thomson Learning, Inc.

July 15
Balance
BalanceSheet
Sheet--July
July15
15
Pay
Paypayables
payableswith
withcash
cash

Cash
$$((175)
Cash
175)
A/R
700
A/R
700
Inventory
00
Inventory
Fixed
600
FixedAssets
Assets
600
(Accum
(AccumDepr)
Depr) (100)
(100)
Total
$1,025
Total
$1,025

A/P
A/P
Accruals
Accruals
Debt
Debt
Common
CommonStock
Stock
Retained
RetainedEarnings
Earnings
Total
Total
Copyright

$$

00
00
500
500
500
500
25
25
$1,025
$1,025

2005 by Thomson Learning, Inc.

July 31
Balance
BalanceSheet
Sheet--July
July31
31
Collect
Collectaccounts
accountsreceivable
receivable

Cash
$$ 525
Cash
525
A/R
00
A/R
Inventory
00
Inventory
Fixed
600
FixedAssets
Assets
600
(Accum
(AccumDepr)
Depr) (100)
(100)
Total
$1,025
Total
$1,025

A/P
A/P
Accruals
Accruals
Debt
Debt
Common
CommonStock
Stock
Retained
RetainedEarnings
Earnings
Total
Total
Copyright

$$

00
00
500
500
500
500
25
25
$1,025
$1,025

2005 by Thomson Learning, Inc.

Profit versus Cash Flow

Question: Why did the firm end up with $125 in

additional cash while earning a profit of $25?
Answer: Some expenses are not cash expenses.
Question: Why did the firm run out of cash during
its operating cycle?
Answer: The cash deficit was due to the differences
between the timing of cash disbursements and cash
receipts.
Copyright

2005 by Thomson Learning, Inc.

Important Points

The firm must manage its cost structure to

generate a profit

WC accounts must be managed so that liquidity is

maintained.

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2005 by Thomson Learning, Inc.

Relationship Between Accrual

Income and Cash Flow
Income Statement

Adjustment Account

Cash Flow Account

Sales

- Change in accounts receivable

= Cash collect

Cost of goods sold

- Change in accounts payable

+ Change in inventory

= Cash paid to

Operating expenses - Change in operating accruals

+ Depreciation
Interest
Taxes
_________________
Net Profit

= Cash paid fo
operating expense

- Change in accrued interest

- Change in accrued taxes
- Change in deferred taxes

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= Cash

= Cash paid fo
___________________
Operating Cash Flow
2005 by Thomson Learning, Inc.

Managing the Cash Cycle

Managing Inventory

Managing Receivables

Managing Payables

Electronic Commerce

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2005 by Thomson Learning, Inc.

Managing Inventory

JIT

Trade-offs between:
stock out costs
cost of excess inventory
ordering costs

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2005 by Thomson Learning, Inc.

Managing Receivables

Who should receive credit and how much?

Credit terms

Monitoring the outstanding balance

Speeding up the receipt of payments through

lockboxes

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2005 by Thomson Learning, Inc.

Managing Payables

Search for terms that match with cash receipts

Timing of payment

Controlled disbursement

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2005 by Thomson Learning, Inc.

Electronic Commerce

Revolutionizing management of cash cycle

Proprietary systems

Impact of Internet

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2005 by Thomson Learning, Inc.

How Much WC is Enough

One view

optimal level is zero

WC is an idle resource
Provides little value

How much in resources to commit?

Why inventory?
Why receivables and payables?
Why short-term investments?
Chryslers $5 billioin cushion of investments

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2005 by Thomson Learning, Inc.

How Management of Working

Capital is Changing
Exhibit 1-6
Working Capital Requirements as a Percent of Sales
35%
30%
Percent of Sales

25%
20%

Dell

15%

Apple

10%

Compaq

5%

Gateway

0%
-5%

1994 1995

1996 1997

1998 1999 2000

2001 2002

-10%
Years

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2005 by Thomson Learning, Inc.

Summary

Firm must operate at a profitable level.

A profitable firm may still struggle financially.

Working capital soaks up cash flow and may cause

an otherwise profitable firm to fail.

A successful firms operation is managed from a

profit, and a
cash flow perspective.

Copyright

2005 by Thomson Learning, Inc.