International
Corporate Finance (ICF)
Jim Cook
Cook-Hauptman Associates, Inc. (USA)
Agenda
 Thursday – (Sessions am: 8:30-12:00, pm: 1:30-5:00)
 am: Structures, Statements, Value, Analysis, Currency
 pm: Time & Currency Discounting/Trading of Money
 Friday – (Sessions am: 8:30-12:00, pm: 1:30-5:00)
 am: Workshop on Evaluating Financials. Discussion of the RMB
 pm: Internal Operations: Cash Management & Project Evaluation
 Saturday – (Sessions am: 8:30-12:00, pm: 1:30-5:00)
 am: Workshop on Financial Projections and Raising Capital
 pm: External Operations: Markets’ instruments and practices
 Sunday – (Sessions am: 8:30-12:00, pm: 1:30-5:00)
 am: Workshop on Mini-Cases: Process, Discrete, Software, eBay
 pm: Reviewing important points. Final Exam.
On the Internet at:
International Corporate Finance
http://cha4mot.com/ICF0411
Day 2 in the pm # 2 / 34
The Operating Cycle
 Operating cycle – time between purchasing the
inventory and collecting the cash
 Inventory period – time required to purchase
and sell the inventory
 Accounts receivable period – time to collect on
credit sales
 Operating cycle = inventory period + accounts
receivable period
International Corporate Finance
Day 2 in the pm # 3 / 34
Cash Cycle
 Cash cycle
 time period for which we need to finance our inventory
 Difference between when we receive cash from the sale and
when we have to pay for the inventory
 Accounts payable period – time between purchase of
inventory and payment for the inventory
 Cash cycle = Operating cycle – accounts payable
period
International Corporate Finance
Day 2 in the pm # 4 / 34
Operating Cycle Chart
Inventory
purchased
Inventory
sold
Time
Cash paid
for Inventory
Cash
received
Operating Cycle
The operating cycle is the time period from inventory purchase until the receipt of cash. (The
Operating cycle may not include the time from placement of the order until arrival of the stock.
The cash cycle is the time period from when cash is paid out to when cash is received.
International Corporate Finance
Day 2 in the pm # 5 / 34
Example Information
 Inventory:
 Beginning = 5000
 Ending = 6000
 Accounts Receivable:
 Beginning = 4000
 Ending = 5000
 Accounts Payable:
 Beginning = 2200
 Ending = 3500
 Net sales = 30,000
 Cost of Goods sold = 12,000
International Corporate Finance
Day 2 in the pm # 6 / 34
Example – Operating Cycle
 Inventory period
 Average inventory = (5000 + 6000)/2 = 5500
 Inventory turnover = 12,000 / 5500 = 2.18 times
 Inventory period = 365 / 2.18 = 167 days\
 Receivables period
 Average receivables = (4000 + 5000)/2 = 4500
 Receivables turnover = 30,000/4500 = 6.67 times
 Receivables period = 365 / 6.67 = 55 day
 Operating cycle = 167 + 55 = 222 days
International Corporate Finance
Day 2 in the pm # 7 / 34
Example – Cash Cycle
 Payables Period
 Average payables = (2200 + 3500)/2 = 2850
 Payables turnover = 12,000/2850 = 4.21
 Payables period = 365 / 4.21 = 87 days
 Cash Cycle = 222 – 87 = 135 days
 We have to finance our inventory for 135 days
 We need to be looking more carefully at our
receivables and our payables periods – they both
seem extensive
International Corporate Finance
Day 2 in the pm # 8 / 34
Credit Management: Key Issues
Granting credit increases sales
Costs of granting credit
Chance that customers won’t pay
Financing receivables
Credit management examines the tradeoff between increased sales and the
costs of granting credit
International Corporate Finance
Day 2 in the pm # 9 / 34
Components of Credit Policy
Terms of sale
Credit period
Cash discount and discount period
Type of credit instrument
Credit analysis – distinguishing between
“good” customers that will pay and “bad”
customers that will default
Collection policy – effort expended on
collecting on receivables
International Corporate Finance
Day 2 in the pm # 10 / 34
Cash Flows from Granting Credit
Credit Sale
Check Mailed
Check Deposited
Cash Available
Cash Collection
Accounts Receivable
International Corporate Finance
Day 2 in the pm # 11 / 34
Terms of Sale
 Basic Form: 2/10 net 45
 2% discount if paid in 10 days
 Total amount due in 45 days if discount not taken
 Buy $500 worth of merchandise with the credit
terms given above
 Pay $500(1 - .02) = $490 if you pay in 10 days
 Pay $500 if you pay in 45 days
International Corporate Finance
Day 2 in the pm # 12 / 34
Example: Cash Discounts
Finding the implied interest rate when customers do
not take the discount
Credit terms of 2/10 net 45 and $500 loan
 $10 interest (.02*500)
 Period rate = 10 / 490 = 2.0408%
 Period = (45 – 10) = 35 days
 365 / 35 = 10.4286 periods per year
EAR = (1.020408)10.4286 – 1 = 23.45%
The company benefits when customers choose to
forego discounts
International Corporate Finance
Day 2 in the pm # 13 / 34
Credit Policy Effects
 Revenue Effects
 Delay in receiving cash from sale
 May be able to increase price
 May increase total sales
 Cost Effects
 Cost of sale is still incurred even though the cash from the sale
has not been received
 Cost of debt – must finance receivables
 Probability of nonpayment – some percentage customers will
not pay for products purchased
 Cash discount – some customers will pay early and pay less
than the full sales price
International Corporate Finance
Day 2 in the pm # 14 / 34
Short-Term Financial Policy
 Size of investments in current assets
 Flexible policy – maintain a high ratio of current
assets to sales
 Restrictive policy – maintain a low ratio of current
assets to sales
 Financing of current assets
 Flexible policy – less short-term debt and more
long-term debt
 Restrictive policy – more short-term debt and less
long-term debt
International Corporate Finance
Day 2 in the pm # 15 / 34
Carrying vs. Shortage Costs
 Managing short-term assets involves a tradeoff between carrying costs and shortage
costs
 Carrying costs – increase with increased levels of
current assets, the costs to store and finance the
assets
 Shortage costs – decrease with increased levels of
current assets, the costs to replenish assets
Trading or order costs
Costs related to safety reserves, i.e., lost sales and
customers and production stoppages
International Corporate Finance
Day 2 in the pm # 16 / 34
Understanding Float
 Float – difference between cash balance recorded in
cash account and cash balance recorded at the bank
 Disbursement float
 Generated when a firm writes checks
 Available balance at bank – book balance > 0
 Collection float
 Checks received increase book balance before the bank
credits the account
 Available balance at bank – book balance < 0
 Net float = disbursement float + collection float
International Corporate Finance
Day 2 in the pm # 17 / 34
Example: Types of Float
You have $3000 in your checking
account. You just deposited $2000 and
wrote a check for $2500.
What is the disbursement float?
What is the collection float?
What is the net float?
What is your book balance?
What is your available balance?
International Corporate Finance
Day 2 in the pm # 18 / 34
Example: Measuring Float
 Size of float depends on the dollar amount and the time delay
 Delay = mailing time + processing delay + availability delay
 Suppose you mail a check for $1000 and it takes 3 days to reach
its destination, 1 day to process and 1 day before the bank will
make the cash available
 What is the average daily float (assuming 30 day months)?
 Method 1: (3+1+1)(1000)/30 = 166.67
 Method 2: (5/30)(1000) + (25/30)(0) = 166.67
International Corporate Finance
Day 2 in the pm # 19 / 34
Example: Cost of Float
 Cost of float – opportunity cost of not being
able to use the money
 Suppose the average daily float is $3 million
with a weighted average delay of 5 days.
 What is the total amount unavailable to earn
interest?
5*3 million = 15 million
 What is the NPV of a project that could reduce the
delay by 3 days if the cost is $8 million?
Immediate cash inflow = 3*3 million = 9 million
NPV = 9 – 8 = $1 million
International Corporate Finance
Day 2 in the pm # 20 / 34
Choosing the Best Policy
 Cash reserves
 Pros – firms will be less likely to experience financial distress and are
better able to handle emergencies or take advantage of unexpected
opportunities
 Cons – cash and marketable securities earn a lower return and are zero
NPV investments
 Maturity hedging
 Try to match financing maturities with asset maturities
 Finance temporary current assets with short-term debt
 Finance permanent current assets and fixed assets with long-term debt
and equity
 Interest Rates
 Short-term rates are normally lower than long-term rates, so it may be
cheaper to finance with short-term debt
 Firms can get into trouble if rates increase quickly or if it begins to have
difficulty making payments – may not be able to refinance the short-term
loans
 Have to consider all these factors and determine a compromise policy that
fits the needs of your firm
International Corporate Finance
Day 2 in the pm # 21 / 34
Capital Budgeting Foundations
 For good selections, there must be good possibilities
 Have clear long term goals and specific direction
 Engage everyone to contribute ideas and improvements
 Research the emerging markets, competition, and technologies
 For good outcomes, there must be clear structures






Divide Capital Budgeting into Acquisitions and Projects
Be sure that Buy versus Make is always considered
Appoint a Process Master for Acquisitions and one for Projects
Acquisitions may be centered in Purchasing or Finance, whereas
Projects may be centered in Engineering or Manufacturing.
Have an Investment Decision Council for integrating approvals
 For Project Priortization, consider the Gartner Program (which
follows immediately) as a starting reference
International Corporate Finance
Day 2 in the pm # 22 / 34
Classification of Projects
1. New products or expansion of existing products
2. Purchase or Renovation of equipment or buildings
3. Research and Development
4. Exploration
5. Other
6. Mandated
key requirement: greater than one year!
International Corporate Finance
Day 2 in the pm # 23 / 34
Prioritization Success Factors
1. Establish governance and clear accountabilities
2. Allocate sufficient resources to support the process
3. Ensure the process is disciplined and sustained
4. Develop an objective prioritization framework
5. Support decision-making with tools
6. Maintain communication and education programs
Source: Getting Priorities Straight, Gartner Group, 2002.10
International Corporate Finance
Day 2 in the pm # 24 / 34
Organizing the Prioritization
 Assign a process owner to oversee the process
implementation and execution
 Create a qualified support team
 Review investments on an ongoing basis
 Disciplined process ensures all project proposals go
though the same screening
 End-to-end process manages portfolio proactively
through entire project life cycle
 Review the portfolio periodically to adjust both the
process and the portfolio to changing conditions
 Integrate with the project management process to
track project status at major decision points
International Corporate Finance
Day 2 in the pm # 25 / 34
Project Portfolio Management
 Leading enterprises are adopting portfolio
management techniques to gain benefits
 Project portfolio management (PPM) is a 5-step
process for prioritizing and managing initiatives
Define
initiatives
Evaluate
initiatives
Prioritize
& balance
Match
resources
Manage
portfolio
 Process is not sequential, but has feedback loops
International Corporate Finance
Day 2 in the pm # 26 / 34
Prioritization Framework
International Corporate Finance
Day 2 in the pm # 27 / 34
Prioritize the Initiatives
 Investment categories can be used to group initiatives
with similar characteristics
 Scoring model should reflect management objectives
 Weightings define the relative importance of each criterion
 Combine financial/non-financial measures into single score
 Force rank initiatives based on overall weighted scores
Evaluation criterion
Score
Weight
%
Weighted
score
Return on investment
8
50
40
Strategic fit
7
30
21
Probability of success
5
20
10
Project Score
International Corporate Finance
71
Day 2 in the pm # 28 / 34
Notes on the Scoring Model
1)
2)
3)
4)
5)
6)
7)
8)
Should closely match the Prioritization Framework
No need for weightings to sum to 100, for example, a fantastic
flexibility capability should not lose out, nor should something
of significant possibilities
Fatal items should be multiplied, not summed, for example,
confidence (if near zero, don’t do it!)
Some visibility should be given to buy versus make
ALL, projects are interdependent; they constitute the company!
Maps can be a great help to justifying the right projects; maps
of technology, of capability, and of opportunity – often, in the
real world, you must do three (or so) suboptimal projects to
have a platform of substantial consequence.
Some provision should be made for learning from and
improving the management processes
Ask often, what do I wish we had funded and why didn’t we?
International Corporate Finance
Day 2 in the pm # 29 / 34
Financial Analysis
 But, how to do the Financial Analysis?
 Every Capital Budget Request must have a projected Cash
Flow of revenue recognition and direct costs (Finance can
put in the overhead, taxes, but not interest or depreciation!)
 The revenue recognition should be “signed off” by someone
responsible for getting those revenues (or savings)
 The resolution should be by month and should be CASH, not
bookings, or even sales.
 Key events and key contingencies should be highlighted
 There must be a “champion” who will go as the project goes
International Corporate Finance
Day 2 in the pm # 30 / 34
Incremental Cash Flows
 Initial cash outflow -- the initial net cash
investment.
 Interim incremental net cash flows -- those net
cash flows occurring after the initial cash
investment but not including the final period’s
cash flow.
 Terminal-year incremental net cash flows -- the
final period’s net cash flow.
International Corporate Finance
Day 2 in the pm # 31 / 34
Cash Flow Rules
1)
Include Cash, but not accounting income (don’t include
depreciation, for example)
2)
Operating flows, but not financing flows (no interest charges)
3)
Include all other cash flows (that includes tax effects)
4)
Just the incremental flows (attributable to project)
5)
Include opportunity costs & side effects
6)
Ignore sunk costs and allocated overhead costs (neither are
incremental)
7)
Include project-driven changes in working capital net of
spontaneous changes in current liabilities
8)
Include effects of inflation/deflation as can best be determined
International Corporate Finance
Day 2 in the pm # 32 / 34
Analytical Issues
 What Technique and Metrics should be used?
 Net Present Value
 Internal Rate Return (hurdle rate)
 Average Accounting Return
 Payback Period
 ROA, RONA, ROE (The Dupont Method)
International Corporate Finance
Day 2 in the pm # 33 / 34
Concluding Remarks
 Questions and Answers
 Thank you, again.
You can find a copy of this lecture (450 KB) on
the Internet at:
http://cha4mot.com/ICF0411
International Corporate Finance
Day 2 in the pm # 34 / 34