7-st finance

8/7/2019 7-ST finance

1/36

Short term finance

&

Cash and liquidity Management


2/36

2

Introductiony Cash and Net Working Capital

y From Long Termto Short Termissues.

y Relatedtocurrent assets & current liabilities.

y Timingincash flows: 1 Yearmaximum.

y Tracingcash:

Current assets = cash+ other assets < 1 year


3/36

3

Tracing Cash

NWC+ Fixed Assets

= LT Debt+ Equity

NWC= (Cash + other current assets)

- current liabilities

CASH

=LTdebt+ equity+current liabilities- current assets other than cash

- fixed assets


4/36

4

Increasing & decreasing cash

Increase of cash =

LT DebtEquity

Current liab.

OR

Current assetOther than cash

Fixed assets

Decrease of cash

= LT Debt

EquityCurrent liab.

O

RCurrent asset

Other than cashFixed assets


5/36

5

ST Finance & Planning: 1.The

different CyclesDAY ACTIVITY CASH EFFECT

0 Acquire inventory None

30 Pay for inventory - 1000

60 Sell inventory oncredit None

105 Collect on sale + 1400

5


6/36

6

1.1 The Operating Cycley From 0 to 105 days = Operating cycle

y The entire cycle.

y From 0 to 60 days = Inventory periody = Time to acquire and sell the inventory.

y From 60 to 105 days = Accounts receivableperiod

y = Time to collect on sale.

Inventory Period Account receivable period Cash


7/36

7

1.2 The Cash Cycle

yFirst remark: move towards cash.

ySecond: no time synchronisation.yFrom 0 to 30 days = accounts payable period

yAnd 105 days - 30 days = Cash Cycle = 75

days.yCash Cycle = Operating Cycle - accounts

payable period


8/36

8

1.3 The Cash Flow Time Line

Time

Inventory purchased Inventory sold

Inventory period Accounts receivable period

Cash paidon inventory Cash received

Accounts payable period Cash Cycle

Operating cycle


9/36

9

Exampley Operating Cycle

y 8.2 M spent on inventory

y Average inventory2,5 M

y Inventory turnover 8,2/2,5=3,28 times

y Inventory period = 365/3.28 =111,3 days.

y Receivables turnover= Credit

sales 11,5 M/ Average accountsreceivable 1,8M=6,4

y Receivable period= 365/6,4=57days

y Operating cycle= 111+57=168

y Cash cycley Average payables 875 000 and

cost of good sold 8,2M(inventory)

y Payable turnover8,2M/,875=9,4 times

y Payables period 365/9,4= 39days

y Cash cycle = operating cycle -accounts payable period:

y 168 - 39 = 129daysy = i.e. 129 days between the

payment and the collectiondate.


10/36

10

2. ST Financial Policy & Planning

yTwo ideas:

yThe size of the firms investment incurrent assets.

yThe financing of current assets.


11/36

11

2.1 The size of the firms investment in

current assets

y ST financial policies could be flexible:

y High level of cash and marketable securities;

y Large investment in inventoriesy Liberal credit terms high level of accounts

receivable.

y Restrictive ST financial policies = the opposite.

y Low cash, small investment in inventory, few orno credit sales.


12/36

12

The Trade offy Carrying costs = costs that rise with increases in the

level of investment in current assets. Close toopportunity costs associated to current assets

y Shortage costs = costs that fall with increases in thelevel of investment in current assets. Close to cash-out.Two kinds:

y Trading or order costs.y Costs related to lack of safety reserve.


13/36

13

2.2 The optimal investment in

current assets

CA* Amount of current assets

Carrying costs

Shortage costs

CA* represents the optimal amount of current assets. Holding this amountminimizes total costs. (Source: Fundamental of corporate Finance)


14/36

14

The different scenariosPolicy F Policy R

Marketable securities

Total assetrequirement

LT FINDOLLAR

Time

LT FIN

Total assetRequirement

ST Financing

F= ST cash surplus+investment in marketablesecurities

R = use LT financing for permanent assetRequirement only + ST borrowing for sea-sonal variations.


15/36

15

3.1 Sales & Cash Collections

y The different items on the left hand side:

y Beginning receivablesy Sales

y Cash collections

y

Ending receivables (which become the beginningreceivable of the next period)

y Meaning money coming in and dispatch in time.


16/36

16

Which one is the best?y Policies F and R are extreme.

y There is no definitive answer.

y Elements to be considered:y Cash reserves: cash is good, because no financial

distress risk, but it has a cost.

y Maturity hedging: mismatch is risky and STinterest rates are more volatile than long ones.

y Relative Interest rates: depends on term structureof interest rates.


17/36

17

3. The Cash Budget

yPrimary tool in short-run financial

planning.y Identification of ST financial needs and

opportunities.

yTo explore the need in ST borrowing.yTo estimate the cash surplus or deficit.


18/36

18

Exampley Fun toys starts with 120 receivable, has 45-day

receivables, = 1/2 of the sales of a given quarter will becollected next quarter.

y Cash collections= Beginning accounts receivable+ 1/2sales

Q1 Q2 Q3 Q4

Sales 200 300 250 400


19/36

19

Example continued

Q1 Q2 Q3 Q4

Beginning

Receivables120 100 150 125

Sales 200 300 250 400

Cash

collections220 250 275 325

Ending

receivables100 150 125 200

Collections= beginning receiv.+1/2 x sales Ending receiv. = beginning receiv.+sales-collections= 1/2 sales

19


20/36

20

3.2 Cash Outflows

y Money coming out

yPayment of accounts payable

yWages, taxes and other expenses

yCapital expenditures

y LT Financing expenses


21/36

21

Table for Cash Outflows

Q1 Q2 Q3 Q4

Payment of

accounts(60% of sales)

120 180 150 240

Wages taxes & expenses 40 60 50 80

Capital expenditures 0 100 0 0

LT Financing expenses

Total cash disbursement

20

180

20

360

20

220

20

340

21


22/36

22

Net Cash Inflow & Cash BalanceQ1 Q2 Q3 Q4Tot. cash collection 220 250 275 325

Tot. Cash disburst 180 360 220 340

Net cash inflow 40 -110 55 -15Q1 Q2 Q3 Q4

Beg. cash balance 20 60 -50 5

Net cash flow 40 -110 55 -15

Ending cash balance 60 -50 5 -10

Minimum cash bal. -10 -10 -10 -10

Cumul. surplus deficit 50 -60 -5 -20


23/36

23

Final remarks on the exampley The 20 beginning cash balance is an

assumption(The figures are in million USD).

y The 10 is considered as a buffer againstunforeseen contingencies.

y The negative figures in the second quarter is

not negative: delayed collections on sales.y The figures are based on a forecast: could be

worst or better.


24/36

24

4. Short Term Borrowing

4.1 Unsecured loansy Unsecured loans Line of credit

y Borrowing authorisation up to a certain amount,

defined in the line of credit.y Cleanup period: back to 0 for 60 days, f.ex.

y Committed or non committed.

y Fee for committed line 0,25%of the amount.

y Revolving credit arrangement= > 2 years

y Floating rate: prime rate + margin.


25/36

25

4.1 Unsecured loansy Compensating balances

y As counterparty, money is left with the bank in

low interest or non interest bearing accountsy Between 2 and 5% of the amount borrowed.

y Compensating balance= opportunity cost.

y Letters of credit

y Common arrangement in international finance:with the letter the issuing bank promises to makea loan under certain conditions.


26/36

26

4.2 Secured Loansy Accounts receivable financing

y Assigning receivables: the lender has the

receivables as security, but the borrower is stillresponsible.

y Factoring receivables: discounted and sold to thelender (the factor). The factor is then responsible

for money collection.y Maturity factoring: collection and credit.

y Inventory loans


27/36

27

4.3 Other Sources

y Commercial Paper

y ST notes issued by large and highly rated firms.y Up to 270 days. > 270 days: registration statement with

the SEC.

y Direct issue, very interesting rate.

y Trade Credit

y Could be expansive


28/36

28

5. Short Term Financial PlanQ1 Q2 Q3 Q4Beg. cash balance

Net cash flow

20

40

60

-110

10

55

10

-15

New ST BorrowingInterest on ST borrow

ST Loan repaid

- 60 --3

-52

15,4-0,4

Ending cash balance 60 10 10 10

Minimum cash bal. -10 -10 -10 -10

Cumul. surplus deficit

Begin ST borrowing

Change in ST debt

Ending ST debt

50

0

0

0

0

0

60

60

0

60

-52

8

0

8

15,4

23,4


29/36

29

Few Commentsy The firm deficit = 60 M at the end Q2(slide22)

y IR20 % annual basis= 5% quarterly

y

ST borrowing 60 M= 3 M Interesty At the end of Q352 M repayment,8M left

y At Q4 new borrowing 15,4M

y Regular ST needs and expansive ST fundingy Time to see alternatives: raising money or bond issue.

Moving from ST to LT!


30/36

30

Cash & Liquidity Management

yObjective: investment in cash as low as

possible.y Collect early and pay late.

y Investment in ST marketable securities.


31/36

31

1. Reasons for Holding Cashy The Motives

y Speculative motives: bargain prices, attractive interest

rates, FX fluctuationsy Precautionary motive.

y Transaction motive: normal activity. In & out.

y Compensating balances: previously mentioned.

yCost of holding cashy Opportunity cost vs. liquidity needs.

y Cash on hand + near cash or cash equivalent.


32/36

32

1.1 The Floaty Difference between theavailable (collected) balance &

the book (ledger) balance.

y

Net effect of checks in the clearing process.y Disbursement float = checks written but not

presented.

y Collection float = checks received.

Net Float= Collection Float - Disbursement Float


33/36

33

1.2 The Float Managementy Collection & disbursement control.

y Mailing time: checks trapped in the postal system.

y Processing delay: in the firm.

y Availability delay: in the bank.

y Cost of float= opportunity cost.

y The end of the float?y No more checks in some countries.

y Internet payment+Check 21 = float reduction.

y Check 21= electronic image of the check, no more physical,2004 Oct 29 in the States.


34/36

34

2. Cash Collection & Concentrationy Depends on business area and nature.

y The issue: to speed cash collection:

y To multiply the cash collection points.y To use a concentration bank to pool the funds obtained

from the different local banks.

y Banks are offering this kind of service: trade off between

the bank fee and the money saved.y Managing cash disbursement

y To slow down the payment: ethic + reputation?


35/36

35

Controlling disbursementsy Maximising the disbursement float= poor business

practice.

y Move to efficient practices: zero balance accountsy In cooperation with a bank to have a master account and

a set of sub accounts

y The idea: the amount of cash held as a buffer is smaller

with a zero balance arrangement.


36/36

Lets watch a videoy The Fall of Lehman Brothers P1

7-st finance

Documents