The Sales Forecast
Additional Funds Needed
Pro Forma Financial Statements

A. Two Important “Cycles”
1.
Operating Cycle = Inventory Conversion
Period + Accounts Receivable Period
2.
Cash Cycle = OC – Payables Deferral Period
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(Cash Conversion Cycle)
A. The Cash Cycle (CC) = ICP + RCP - PDP
1.
The Inventory Conversion Period (ICP)
 ICP = Average Inventory / (COGS / 365)
2.
Receivables Collection Period (RCP)
 RCP = Average Receivables / (Cr. Sales / 365)
3.
Payables Deferral Period (PDP)

PDP = Payables / (COGS / 365)
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4. CC are shortened by a. Reducing the ICP.
b. Reducing the RCP.
c. Lengthening the PDP.
d. The CC Equation (using a 360-day year)
CC =
Inv
COGS

A/R
SALES

A/P
COGS
365 365 365
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H. Working Capital Requirements.
1.
Cash {WC} must be sufficient to cover the CC.
2.
Cash {WC} provided by Profits, Borrowing, and/or
Trade Credit.
I. The Liquidity Paradox.
1.
Cash and equivalents are the least profitable assets.
2.
Returns on other asset investments much greater.
3.
Consider investment returns on; a.
inventory.
b.
receivables.
c.
fixed assets.
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A. How do we finance seasonal variations?
1.
Conservative a. High Current Ratios: > 3.0x
b. Draw on excess cash
2.
Moderate a. Industry Average CR’s: ~ 2.0x
b. Use some cash and some trade credit
3.
Aggressive a. Low Current Ratios: ~ 1.0 – 1.3x
b. Rely on trade credit and borrowing S-T c. Zero WC strategy
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FINANCING SEASONAL
VARIATIONS
C. Major Sources of Short Term Capital
1. Spontaneous Sources; a.
Accruals.
b.
Trade credit from suppliers.
c.
Trade credit is not free when offered with discount terms.
2.
Cost of Trade Credit, A/B Net C =
100
A

3.
Commercial Banks, Money Markets
A
*
360
B

C
Short-term loans, notes, revolving lines of credit (RLOC) agreements a.
Simple interest = rate b.
Discount interest = rate / (1 - rate)
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FINANCING SEASONAL
VARIATIONS
4. Commercial Paper.
a. S-T IOU's issued by most creditworthy corporations
(AAA).
b. Maturities less than 270 days.
c. Average Maturities; 120-150 Days.
d. Rates typically at 50 To 150 basis points < prime.
5. Bankers Acceptances; finance import activity.
6. Factors, Commercial Credit Corporations.
a. Factoring receivables.
b. Inventory-pledged loans.
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FINANCING SEASONAL
VARIATIONS
7.
Receivables / Inventory Secured Loans.
a. Factoring; selling A/R to factors (expensive).
b. Pledging A/R: using A/R as collateral for bank loans.
c. Blanket liens (UCC).
d. Trust receipts: field warehouse financing (expensive).
8.
Term Loans.
a.
Amortized [typically] in less than 15 years.
b. Private placements; amortized over 15 years or longer.
c.
Term loans usually carry restrictive covenants:
9.
Installment Loans a. Regular payments of principal and interest.
b. Effective cost of these funds a function of terms.
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THE CASH BUDGET
A. Budgets are planning ( and control ) tools.
B. Estimate receipts and disbursements
1.
Timing
2.
Magnitude
C. Cash budgets identify the flow of cash into and out of the firm.
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D. Cash budgets identify when the firm will need short-term sources of finance.
1.
Bank borrowing (notes payable)
2.
Floating commercial paper (notes payable)
E. Cash budgets identify when firm will have excess cash.
1.
Excess cash may be invested to earn interest.
2.
2. Excess cash may be used to retire debt
(usually short-term debt).
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A. Self-Test: 16-1, c, d, f
B. Questions: 16-1, 16-4
C. Problems: 16-1, 16-4, 16-6
7 th Ed same problems, values different from 6 th Ed
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