chapter
12
Short-Term
Financial
Management
Lonni Steven Wilson, Medaille College
Key Chapter Objectives
• Understand the definition of net working capital
and see how it is calculated.
• Discuss cash management by sport businesses,
including how much cash to hold.
• Understand what is involved in the efficient
collection and disbursement of cash.
• Identify issues that arise as businesses engage in
collections management, the conversion of
accounts receivable to cash.
Key Terms
net working capital—As discussed earlier, net working
capital equals current assets minus current liabilities.
short-term financial management—Centers on current
assets and current liabilities, which generate inflows or
outflows of cash to or from a business within one year or
less.
accounts receivable—Unpaid bills for goods and services
that have been sold to customers.
current assets—Cash and other assets that are expected to
be converted to cash within one year.
Accounts Receivable
• As shown in table 12.1 (see next slide),
accounts receivable are an extremely
important current asset.
• Typically, accounts receivable have the
largest value relative to other current assets.
Table 12.1 from the Text
Current assets ($)
Current liabilities ($)
Cash
265.5
Short-term
debt
138.3
Marketable
securities
198.8
Accounts
payable
436.4
Accounts
receivable
633.9
Accrued
income taxes
65.1
Inventories
569.7
Current
payments
due on longterm debt
103.7
Other current
liabilities
723.2
Other current 311.3
assets
Total $1,979.2
Total $1,466.7
All numbers are in billions
From U.S. Department of Commerce, Bureau of the Census, Quarterly Financial Report for Manufacturing, Mining
and Trade Corporations: 2006: Quarter 2.
Types of Current Assets
•
•
•
•
•
•
Cash
Marketable securities
Accounts receivable
Inventories
Prepaid expenses
Other types of current assets
Types of Current Liabilities
•
•
•
•
•
•
•
Short-term debt
Accounts payable
Accrued income taxes
Current payments on long-term debt
Accrued liabilities
Unearned or deferred credits
Other types of current liabilities
Cash Management Decisions
• How much cash to hold
• How best to replenish cash (marketable
securities versus borrowing)
• How to achieve efficient collection and
disbursement of cash
Why hold cash?
The reason for holding cash (despite the fact
that it doesn’t earn interest) is the need for
liquidity (i.e., having an asset on hand for
immediate transactions).
Key Terms
payment float—Checks written by the firm and not
yet cleared.
availability float—Checks received by the firm and
deposited but not yet cleared.
net float—The net effect of checks in the process of
collection (payment-availability float).
The Benefit of Float
Interest is earned on available balance from the
bank while payment float occurs (assuming the
business has an interest-earning account with the
bank).
The financial manager’s true concern is with
available balance rather than ledger balance.
Methods of Reducing Float
• Concentration banking: Making payments
to a local office as opposed to corporate
headquarters. Reduces mail time; local
checks reduce processing time.
• Lockbox system: Sending payments to a
post office box (regional collection point); a
bank collects and deposits the payments on
behalf of the company.
(continued)
Methods of Reducing Float
(continued)
Disbursements: Having regional banking accounts
whereby suppliers in that region have
disbursement checks written to them from a
relatively close bank. Note: This system can also
be used to increase float if, for example,
companies use banks in remote locations such as
Helena, Montana, or Pierre, South Dakota, which
would then mean it would take suppliers extra
days to receive and cash checks.
Electronic funds transfers: Reducing the use of
paper checks, thereby speeding up collections and
reducing availability float.
Credit Management
The terms of credit become important in determining
the amount of accounts receivable appearing on
the balance sheet.
• 1/10/30: Customers receive a 1% discount for
paying within 10 days.
• 2/10/30: Customers receive a 2% discount for
paying within 10 days.
If customers have a poor credit record
• COD (cash on delivery)
• CBD (cash before delivery)
Average Daily Sales Outstanding
• SMC’s annual sales are $4 million.
• Therefore, its average daily sales = $4,000,000 /
365 days = $10,959 per day.
• The average daily sales outstanding is equal to
the average daily sales divided by current
accounts receivable.
• Assume that accounts receivable equal $186,300.
• The average daily sales outstanding therefore
equals $186,300 / $10,959 = 17 days.
• This means that when making a purchase, the
average SMC customer pays in 17 days.
Aging Report
An aging report tabulates receivables by accounts’ ages.
Table 12.2 Sample Aging Report
Age of account
Percent of total accounts
receivable
0 to 30 days
60
31 to 60 days
15
61 to 90 days
15
90 to 120 days
6
121 days plus
4
Total
100%
(continued)
Aging Report (continued)
• An aging report can provide more detailed
information.
• Note that in table 12.1, a significant number
of customers are past due (40% of accounts
are outstanding more than 30 days).
• Any company that displays a report like the
one shown in table 12.2 has serious
collections problems and should be
reviewing its collections policies.
Questions for In-Class Discussion
1. How should a business monitor collections
activity?
2. How has the advent of greater volumes of
electronic funds transfers affected the
accumulation of float by a business?