Finance
Lecture 9
Chapter 17. *)
Chapter 19, sections 1, 2, 5 and 6 only.
*) Chapter 17 will be examined as part of the
management control chapter in the final
examination ( management accounting part ).
MBI-5 2007/2008 Financial Management. Finance Lecture 9. 10-04-2007
1
Chapter 19. Working capital and shortterm planning.
1/2. Working capital and cash conversion cycle.
The main components of working capital are:
a. Cash and marketable securities
b. Accounts receivable
c. Inventories
d. Accounts payable.
The size of the components are determined by the
character of the firm’s activities and the trade-off
between the carrying costs and the shortage costs of
each component.
The operating ( or cash conversion ) cycle illustrates
the stages from cash expenditures in order to obtain
means of production until the cash receipts from
sales.
Cash
Inventories of raw materials and work-in-process
MBI-5 2007/2008 Financial Management. Finance Lecture 9. 10-04-2007
2
Inventory of finished goods
Receivables
Cash
The operating cycle starts with the purchase of
means of production. There may be a delay in the
payment to the suppliers:
Accounts payable period.
Means of production are transformed into finished
goods. Value is tied up in inventories until the sale
and delivery to customers:
Inventory period
If sales are not for cash, it takes time to collect the
sales revenue:
Accounts receivable period.
The cash conversion cycle is determined as:
Inventory period + accounts receivable period –
accounts payable period. ( Counted in days.)
The average periods can be computed by multiplying
365 with respectively:
MBI-5 2007/2008 Financial Management. Finance Lecture 9. 10-04-2007
3
Average inventory / Annual costs of goods sold
Average accounts receivable / Annual sales
Average accounts payable/Annual costs of goods sold
5. Short-term financing plan.
Following table should be made up quarterly or
weekly or even daily:
Plus
Minus
Plus
Minus
Minus
Minus
Minus
Minus
Minus
Plus
Plus
Plus
Minus
Receivables begin of the period
Sales of the period
Receivables end of the period
Collected from sales
Other operating collections
Payments of accounts payable
Labour and administrative expenses
Capital investment outlays
Taxes paid
Net operating cash inflow
Dividends and interest paid
Repayments of long-term debt
Proceeds from long-term debt issues
Proceeds from equity issues
Net cash inflow
Cash at start of period
Minimum operating cash balance
Cash excess or shortage
MBI-5 2007/2008 Financial Management. Finance Lecture 9. 10-04-2007
4
6. Sources of short-term financing.
 Bank loans ( line of credit, term loans )
 Commercial paper ( issue of IOU )
 Secured loans ( secured by receivables or
inventories )
 Factoring ( sale of receivables )
 Call money ( daily loan, near-banking )
 Secured and personal cheques
MBI-5 2007/2008 Financial Management. Finance Lecture 9. 10-04-2007
5
Notice: this chapter will be subject of examination in the second part
of the course ( management accounting ).
 Chapter 17:
Traditional Financial
Statement Analysis.
1. Foundations of financial statement analysis.
Most of the data used in this analysis are derived from the
a. annual income statement
b. the balance sheet
and is thus based on book values and accounting income,
implying all of its flaws.
MBI-5 2007/2008 Financial Management. Finance Lecture 9. 10-04-2007
6
2. Categories of ratios to be benchmarked.
a. leverage ratios, describing the firm’s debt position
b. liquidity ratios, describing whether the firm is able to meet
its short-term financial commitments
c. efficiency ( turnover ) ratios measuring the productivity of
the use of the firm’s assets
d. profitability ratios, determining the firm’s return on the
investments
3. Analysis.
The excel-sheet attached to this lecture provides you with an
example. ( problem 17-1 ).
4. Dupont system.
This short-cut insight into the main determinants of the Return
on Equity are provided in the excel-sheet as well.
The basic causes of profitability are:
 the ( net ) operating profit margin:
( net income + interest ) / sales
 the total asset turnover:
sales / total assets.
The return on assets ( ROA ) is:
operating profit margin * asset turnover
In order to determine the equity’s profitability, adjustments of
MBI-5 2007/2008 Financial Management. Finance Lecture 9. 10-04-2007
7
the ROA have to be made using:
 the leverage ratio:
assets / equity
 debt burden ratio:
net income / ( net income + interest )
The return on equity is:
ROA * leverage ratio * debt burden ratio
5. Use of the analysis.
Benchmarks for the ratios can be found in:
time series assessing the current situation with previous
periods.
industry-wide averages.
comparable companies.
own standards set by budgets or plans.
6. Comprehensive example: problem 17-1.
See excel-sheet problem solutions.
MBI-5 2007/2008 Financial Management. Finance Lecture 9. 10-04-2007
8