C H A P T E R
12
Short-Term Financial
Management
Chapter 12
Chapter Objectives
• Understand the definition of net working capital and
see how net working capital 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.
• Describe how firms manage the granting of credit and
how they set credit terms.
• Identify issues that arise as businesses engage in
collections management, the conversion of accounts
receivable to cash.
Key Terms
Net Working Capital
• Current assets – 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
Current Assets
Current Assets
• Cash and other assets that are expected to
be converted to cash within one year
Accounts Receivable
• Unpaid bills for goods and services that
have been sold to customers
• An extremely important current asset based
on the value of accounts receivable relative
to other current assets
(continued)
Current Assets (continued)
Types of Current Assets
• Cash
• Marketable securities
• Accounts receivable
• Inventories
• Prepaid expenses
• Other types of current assets
Current Liabilities
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
Current Assets and Liabilities
Current assets and liabilities for all U.S. manufacturing corporations
in second quarter of 2011. All numbers are in billions.
Current Assets ($ billions)
Current Liabilities ($ billions)
Cash
344.1
Short-term debt
166.0
Marketable securities
172.3
Accounts payable
510.6
Accounts receivable
669.6
Accrued income taxes
31.4
Inventories
672.3
Current payments due
on long-term debt
117.8
Other current assets
391.2
Other current
liabilities
732.7
Total
$2,249.5
Data from U.S. Department of Commerce 2011.
Total
$1,558.50
Cash Management Decisions
• Cash management: The efficient collection and
disbursement of cash.
• How much cash to hold?
• How best to replenish cash?
– Marketable securities vs. borrowing
• 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).
Collection and Disbursement of Cash
The financial manager’s true concern is with available
balance rather than ledger balance.
• 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).
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).
Methods of Reducing Float
Concentration Banking
• This method involves making payments to a local office as
opposed to corporate headquarters.
• It reduces mail time, and local checks reduce check
processing time.
Lockbox System
• Concentration banking can also be combined with a
lockbox system.
• In a lockbox system, the company pays a local bank to
handle the administrative chores so it is not necessary to
establish a branch office to handle receipt of payments.
(continued)
Methods of Reducing Float (continued)
Disbursements
• Slowing down disbursements is another technique
for reducing float.
Electronic Fund Transfers
• This method reduces 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
o Customers receive a 1% discount for paying within 10 days
2/10/30
o 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
• Assume Under Armour annual sales are $4
million.
• Therefore, its average daily sales = $4,000,000 /
365 days = $10,959 per day.
o The average daily sales outstanding = (avg. daily sales) /
(current accounts receivable).
o Assume that accounts receivable equal $186,300.
• Then the average daily sales outstanding equals
$186,300 / $10,959 = 17 days.
• This means that when making a purchase, the
average Under Armour customer pays in 17 days.
Aging Report
• An aging report tabulates receivables by account ages.
o Can provide more detailed information
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%
over 121 days
4%
Total
100%
• This company has serious collections problems and should be
reviewing its collections policies.
o A significant number of customers are past due (40% are accounts
outstanding more than 30 days).
Questions for 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?
3. Businesses can increase cash flow by stretching out
payments to vendors by an additional fifteen days. If this is
so obvious, why is it that companies do not necessarily do
this?
4. If a company has excess cash available, should it use that
cash to pay its vendors more quickly?
(continued)
Questions for Class Discussion
(continued)
5. Is it better business practice to make all customers pay
before receiving a product, as opposed to having
receivables?
6. For a professional sport organization such as an NFL
team, list some of the financial activities that may be
classified under short-term financial management.