asset & liabilities management chapter 1
TRANSCRIPT
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Copyright 2005 by Thomson Learning, Inc.
SHORT-TERM FINANCIAL MANAGEMENT
Terry S. Maness and John T. Zietlow
Copyright 2005 Thomson Learning, Inc.
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Chapter 1The Role of Working Capital
Sales
A /R
Cash
Inv
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Objectives
View firm as a system of cash flows
How WC and depreciation create disparitiesbetween profit and cash flow
Management aspects of various WC accounts
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The Cash Flow Timeline
Order Order Sale Payment Sent Cash
Placed Received ReceivedAccounts Collection
< Inventory > < Receivable > < Float >
Time ==>
Accounts Disbursement
< Payable > < Float >
Invoice Received Payment Sent Cash Disbursed
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...in the beginning
Balance Sheet - June 1
Cash $1,000 Debt $ 500
Common Stock 500
Total $1,000 Total $1,000
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The Next Day, June 2
Balance Sheet - June 2
Purchase Fixed Assets and Inventory
Cash $ 400 A/P $ 300
Inventory 300 Debt 500
Fixed Assets 600 Common Stock 500
Total $1,300 Total $1,300
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End of June
Balance Sheet - June 30
Sale of product, incur operating expenses,
incur depreciation, and generate profit
Cash $ 325 A/P $ 300
A/R 700 Accruals 200
Inventory 0 Debt 500Fixed Assets 600 Common Stock 500
(Accum Depr) (100) Retained Earnings 25
Total $1,525 Total $1,525
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July 1
Balance Sheet - July 1
Pay operating accruals with cash
Cash $ 125 A/P $ 300
A/R 700 Accruals 0
Inventory 0 Debt 500Fixed Assets 600 Common Stock 500
(Accum Depr) (100) Retained Earnings 25
Total $1,325 Total $1,325
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July 15
Balance Sheet - July 15
Pay payables with cash
Cash $ ( 175) A/P $ 0
A/R 700 Accruals 0
Inventory 0 Debt 500Fixed Assets 600 Common Stock 500
(Accum Depr) (100) Retained Earnings 25
Total $1,025 Total $1,025
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July 31
Balance Sheet - July 31
Collect accounts receivable
Cash $ 525 A/P $ 0
A/R 0 Accruals 0
Inventory 0 Debt 500Fixed Assets 600 Common Stock 500
(Accum Depr) (100) Retained Earnings 25
Total $1,025 Total $1,025
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Profit versus Cash Flow
Question: Why did the firm end up with $125 inadditional cash while earning a profit of $25?
Answer: Some expenses are not cash expenses.
Question: Why did the firm run out of cash duringits operating cycle?
Answer: The cash deficit was due to the differencesbetween the timing of cash disbursements and cashreceipts.
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Important Points
The firm must manage its cost structure togenerate a profit
WC accounts must be managed so that liquidity ismaintained.
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Relationship Between AccrualIncome and Cash Flow
Income Statement Adjustment Account Cash Flow Account
Sales - Change in accounts receivable = Cash collected
Cost of goods sold - Change in accounts payable+ Change in inventory = Cash paid to suppliers
Operating expenses - Change in operating accruals+ Depreciation = Cash paid for
operating expenses
Interest - Change in accrued interest = Cash paid to creditors
Taxes - Change in accrued taxes- Change in deferred taxes = Cash paid for taxes
_________________ ___________________
Net Profit Operating Cash Flow
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Managing the Cash Cycle
Managing Inventory
Managing Receivables
Managing Payables
Electronic Commerce
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Managing Inventory
JIT
Trade-offs between:
stock out costs
cost of excess inventory
ordering costs
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Managing Receivables
Who should receive credit and how much?
Credit terms
Monitoring the outstanding balance
Speeding up the receipt of payments through
lockboxes
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Managing Payables
Search for terms that match with cash receipts
Timing of payment
Controlled disbursement
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Electronic Commerce
Revolutionizing management of cash cycle
Proprietary systems
Impact of Internet
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How Much WC is Enough
One view optimal level is zero
WC is an idle resource
Provides little value
How much in resources to commit? Why inventory?
Why receivables and payables?
Why short-term investments? Chryslers $5 billioin cushion of investments
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How Management of WorkingCapital is Changing
Exhibit 1-6
Working Capital Requirements as a Percent of Sales
-10%
-5%
0%
5%
10%
15%
20%
25%
30%
35%
1994 1995 1996 1997 1998 1999 2000 2001 2002
Years
P
ercentofSales
Dell
Apple
Compaq
Gateway
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Summary
Firm must operate at a profitable level.
A profitable firm may still struggle financially.
Working capital soaks up cash flow and may causean otherwise profitable firm to fail.
A successful firms operation is managed from a profit, and a
cash flow perspective.