Chapter 15: Short Term Financial Management
I.
Operating Cycle
a. Time from purchase of raw materials to collection of monies from
sale of product
b. Focus on physical production
c. Cash Conversion Cycles
i. Time from purchase of raw materials to collection of monies
from sale of product
ii. Focus on time cash of tied up
1. CCC = (Average Age Inventory + Average Collection
Period)
- Average Payment Period
d. Example – Page 451
Annual Sales
Expenses
Earnings
Materials
of $10,000,000
75% of $10,000,000 up for 60 days in inventory
100% of $10,000,000 tied up for 40 days in accounts receivable
65% of $10,000,000 tied up for 35 days
Inventory
Expenses
Materials
Resources
Invested
Annual Data
$10,000,000
$ 7,500,000
$ 6,500,000
Days in
Current
Cycle
60
40
35
Pro Rated
Annual Data
$1,250,000
$1,111,111
$ 473,958
$ 1,887,153
e. Funding requirements for Cash Conversion Cycle
i. Permanent and seasonal funding – Figure 15.2
1. EX: large Christmas sales
ii. Aggressive versus conservative strategies
1. Aggressive relies on short term debt
2. Conservative relies on longer term debt
f. Strategies
i. Inventory turnover
ii. Collection of accounts receivable
iii. Accounting
iv. Pay accounts payable as slow as possible
II.
Inventory Management
a. Goal – reduce average inventory age
b. Different views of inventory
i. Financial manager – keep them low
ii. Marketing manager – keep them high
iii. Production manager – keep raw materials inventory high
iv. Purchasing manager – keep supplies high
c. Inventory Management Techniques
i. ABC system
1. Divide inventory into three groups most expensive to
least expensive
2. Monitor Group A most intensely
3. Group C uses two bin method
ii. Economic Order Quantity Model
1. Ordering costs
a. Clerical costs of ordering and receiving
materials
2. Carrying costs
a. Storage costs
b. Insurance
c. Deterioration
d. Financial cost
3. Order costs decrease with size while carrying cost
increases
4. Select order size to minimize order + carrying costs
iii. Just in Time Systems
1. No or little inventory in production pipeline
2. Extensive computerized tracking
3. Can be risky but tremendous cost savings
iv. Materials Requirement Planning
1. Computerize management system
2. Works back from final product
3. Traditional computerized method
4. Basically, MRP is a calculation method geared toward
determining how much of which raw materials are
required and roughly when they should be ordered to
fulfill a set of product orders. MRP generally consists
of four steps:
1. Bill of Materials Explosion - looking backward from
each product, determine which intermediates and raw
materials are required, and in what quantities.
2. Netting - compare the above quantities against
current inventory.
3. Lot Sizing - determine how the needed materials
will be purchased or produced.
4. Start Date Determination - based on cycle time
information, determine when each order should start
production.
III.
Account Receivable Management
a. Credit Selection and Standards
i. 5 Cs of Credit
ii. Credit scoring
1. Rates credit worthiness using past default rates
applied to different personal or firm characteristics
iii. Credit Standards
1. Determines who get credit
2. Extending credit more freely increases sales column
3. But may cost in collection expenses and/or debt write
offs
b. Credit Terms
i. Terms of credit offered to customers
ii. Easier terms more sales but more costs
iii. 30 days payable is less expensive than 60 days payable
iv. 25% down is less expensive that 10% down
c. Cash Discounts
i. Make accounts receivable less expensive
ii. Reduce sales revenue
d. Credit monitoring
i. Average age of account receivable
ii. Sort accounts receivable by age
iii. Collection techniques – Table 15.3
IV.
Management of Receipts and Disbursements
a. Float – bills paid but not yet available to the firm
b. Speeding up collection period
i. Use modern electronic technology
c. Slow down payments
i. Pay bills only when due
ii. Cash concentration – new technology for automating bill
paying process
iii. Zero balance account
1. Only keep money needed for paying bills in checking
2. Invest rest in short term debt to earn interest
V.
Current Liabilities Management
a. Spontaneous liabilities
i. Accruals – example wages
1. Typically not managed as a source of funds
ii. Accounts payable
1. Evaluate cash discount when offered
2. Depends on the implied interest rate on the cash
discount compared to prevailing short term rates
available to the firm.
iii. Sources of short term financing
1. Bank loans – short term self liquidating loans
a. Single payment notes
b. Line of credit
i. Operating restrictions
ii. Compensating balance
iii. Annual cleanup
c. Revolving credit agreement
2. Commercial paper
a. Short term IOUs issued by a company
b. From a few days to 9 months
3. Secured Short Term Financing
a. Secured loan has assets pledged as collateral
b. Use of accounts receivable as collateral
i. Sale of account receivable at a discount
c. Use of inventory as collateral
i. Floating inventory lien
1. loan on inventory hard to count
ii. Trust receipt inventory loan
iii. Warehouse Receipt Loan
1. Inventory under control of neutral
agent