Download - Ch16 Tool Kit
-
7/28/2019 Ch16 Tool Kit
1/18
1
2
3
4
5
6
7
8
9
10
11
12
13
1415
16
17
18
19
20
21
22
23
2425
26
27
28
A B C D E F
Tab 1. Cash Conversion Cycle (Section 16.3)
Figure 16-4. GBM's Cash Conversion Cycle (Dollars in Millions)
Panel a. Target CCC: Based on Planned Conditions
Cash
Conversion
Cycle (CCC)
=
Planned
Inventory
Conversion
Period (ICP)
+
Credit Terms
Offered to Our
Customers
-
= 50.0 + 60.0 -
Target CCC = 70.0
Panel b. Actual CCC: Based on Financial Statements
Sales $1,216.7
COGS $1,013.9
Inventories $140.0
Receivables $445.0
Payables $115.0
Days/year 365
Actual CCC =Inventory
COGS/365+
Receivables
Sales/365-
=
$140
($1,013.9/365) +
$445
($1,216.7/365) -= 50.4 + 133.5 -
Actual CCC = 142.5
Chapter 16: Tool Kit for Working Capital Manage
1 of 18
-
7/28/2019 Ch16 Tool Kit
2/18
29
30
31
32
33
34
35
36
37
38
39
40
41
42
43
4445
46
47
48
49
50
51
52
53
54
55
5657
58
59
60
61
62
63
64
65
66
67
68
69
70
71
72
73
A B C D E F
Panel c. Actual versus Target components
ICP ACP
Actual - Target = 50.4 - 50.0 133.5 - 60.0
= 0.4 + 73.5 -% Difference = 0.8% 122.5%OK VERY BAD
Figure 16-5. Benefits from Reducing the CCC (Dollars in Millions)
Old (Actual)Inventory conversion period (ICP, days) 50.4
Average collection period (ACP, days) 133.5
Payable deferral period (PDP, days) -41.4
Cash Collection Cycle (CCC, days) 142.5
Reduction in CCC
Effects of the CCC Reduction
Annual sales $1,216.7
Costs of goods sold (COGS) $1,013.9
Inventory = Actual Old, New = new ICP(COGS/365) $140.0
Receivables = Actual Old, New = new ACP(Sales/365) 445.0Payables = Actual Old, New = new PDP(COGS/365) -115.0
Net operating WC = Inv + Receivables Payables $470.0
Reduction in NOWC
Reduction in interest expense @ 10%
Actual dataDays of Working Capital (DWC): NOWC/(Sales/365) 141.0
CCC: NOWC component Sales or COGS 365 142.5
GBM's inventories are in line with its plans, and it's paying its suppliers about on time,
PDP are OK. However, some of its customers are paying quite late, so its average coll
DSO) is 133.5 days even though all customers should pay on Day 60.
In the chapter's opening vignette, we discussed "Days of working capital." DWC is ess
same as the CCC except that the CCC uses the COGS when calculating both the ICP an
whereas DWC uses sales for all calculations. Here's the DWC calculation for GBM:
The CCC is slightly larger than the DWC because Sales > COGS, and Sales is always u
DWC, lowering the result if inventories exceed payables. We regard the CCC as being s
1
$3
$
2 of 18
-
7/28/2019 Ch16 Tool Kit
3/18
1
2
3
4
5
6
7
8
9
10
11
12
13
1415
16
17
18
19
20
21
22
23
2425
26
27
28
G
4/11/2010
Credit Terms
Our Supplier
Offers Us
40.0
Payables
COGS/365
$115
($1,013.9/365)41.4
ent
3 of 18
-
7/28/2019 Ch16 Tool Kit
4/18
29
30
31
32
33
34
35
36
37
38
39
40
41
42
43
4445
46
47
48
49
50
51
52
53
54
55
5657
58
59
60
61
62
63
64
65
66
67
68
69
70
71
72
73
G
PDP
41.4 - 40.0
1.43.5%OK
New (Target)35.0
40.0
-50.0
25.0
$1,216.7
$1,013.9
$97.2
133.3-138.9
$91.7
so the ICP and
ction period (or
entially the
d the PDP
ed in the denom
omewhat better
7.5
8.3
7.8
4 of 18
-
7/28/2019 Ch16 Tool Kit
5/18
1
2
3
4
5
6
7
8
910
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
29
30
31
32
33
34
35
36
37
A B C D E F G H I J K L M
Tab 2. The Cash Budget (Section 16.4)
Educational Procucts Corporation (EPC), Cash Budget (Millions)
Description of the scenarios.
Current
ig Disc'
hort net
Base case (Current).The company sells on terms of 2/10, net 60. 20% of customers pay in the 1st month and
take discounts, 70% pay on time in the 2nd month, and 10% either pay in the 3rd month or never pay and end
up as bad debts. Purchases are 60% of next month's sales, and payments for purchases are made the month
after the purchase. Lease payments and payments due on a new plant are shown on the cash budget.
Monthly gross sales are shown on the cash budget, and sales are adjusted for the 2% cash discount. The
Big discount. Change the credit terms to 4/10, net 30. The payment pattern shifts as follows: 70% pay 1stmonth, 20% pay 2nd month, 10% pay 3rd month or never. Sales rise by 10% over the base case. Bad debts
remain at zero. 4% discount is a price cut, stimulates sales. The nominal cost of add'l credit is 76%, which
4/11/2010
The cash budget shows expected cash flows over a given period. EPC uses a monthly cash budget for the
coming year plus a daily cash budget for the coming month. The monthly cash budget is used for planning
purposes, the daily budget for actual cash control. The following monthly cash budget examines the firm's
projected cash flows for the last 6 months of 2011.
One of EPC's primary concerns is negotiating a loan from its bank to cover any cash shortfall that might occur
during the year. The treasurer, who is responsible for developing the cash budget, sets up several scenarios
that vary mainly in terms of the credit policy and the state of the economy. Information about each scenario is
given below, and the scenario data are shown below the verbal descriptions. Also, on a screen to the right,
the cost of additional credit (beyond the discount period) is provided for each scenario.
Short net period. Change the credit terms to 2/10, net 30. The payment pattern shifts as follows: 50% pay in
1st month, 40% pay in 2nd month, 10% pay in 3rd month or never. Sales fall by 10% versus the base case. Bad
debts remain at zero. Reducing the net period turns off some potential customers, reduces sales. The nominal
cost of add'l credit is 37%, which is high enough to stimulate early payment.
Long net period. Change the credit terms to 1/10, net 90. The payment pattern shifts as follows: 5% pay 1st
month, 5% pay 2nd month, 90% pay 3rd month or never. Sales rise by 20% versus the base case because of
the long credit period, but many new customers are weak credits. Bad debts rise to 15%. The nominal cost of
add'l credit is only 4.61%, which leads to few customers taking discounts.
-
7/28/2019 Ch16 Tool Kit
6/18
38
39
40
41
42
43
44
45
46
47
48
49
50
51
52
53
54
55
56
57
58
59
60
61
62
63
64
65
66
67
68
69
70
A B C D E F G H I J K L M
Long net
ad econ
Data set up to create scenarios (Milions of Dollars)
Use Scenario Manager to Pick a Scenario
Active Scenario Shown in Tan
Part 1. Inputs for the Cash Budget
Base
Case
Base
Case
Big
Discou
nt
Short
net
period
Long
net
period
Terrible
econo
my
% customers who take discounts and pay in 1st month 20% 20% 70% 50% 5% 15%
% who don't take discount and pay in 2nd month 70% 70% 20% 40% 5% 40%
% who don't pay in 1st or 2nd month. Lates + bad debts 10% 10% 10% 10% 90% 45%
Total: Must equal 100% 100% 100% 100% 100% 100% 100%
Purchases as a % of next month's sales 60% 60% 60% 60% 60% 60%
Other payments $30 $30 $30 $30 $30 $35
Construction cost for new plant (Sept) $150 $150 $150 $150 $150 $200
Target cash balance $10 $10 $10 $10 $10 $10
Disc % for early pmt; reduces 1st month collections 2% 2% 4% 2% 1% 2%
Discount period 10 10 10 10 10 10
Net period 60 60 30 30 90 60
Bad debt % (BD%); reduces 3rd month payments 0% 0% 0% 0% 15% 10%
Sales % change from base-case forecast 0% 0% 10% -10% 20% -20%
1. EPC sells on terms of 2/10, net 60, meaning that it gives a discount to customers
who pay within 10 days, and non-discount customers have 60 days to pay.
2. All discount customers pay on the 10th day, and other customers pay on the 60th
or 90th day, or are bad debts and never pay. No one pays after the 3rd month.
c ve
Scenar
io
Shown
Terrible economy. Leave credit terms unchanged. Due to the economy, the firm has more late payers, more
bad debts, lower sales, and fewer discount customers.
-
7/28/2019 Ch16 Tool Kit
7/18
71
72
73
74
75
76
77
78
7980
81
82
83
84
85
86
87
88
89
90
91
92
93
94
95
96
97
98
99
100
101
102
103
104
105
106
A B C D E F G H I J K L M
Figure 16-6. EPC's Cash Budget, July - December, 2011 (Dollars in Millions)
May June July August Sept Oct Nov Dec
Forecasted gross sales (manual inputs): $200.0 $250.0 $300.0 $400.0 $500.0 $350.0 $250.0 $200.0
Adjustment: % deviation from forecast 0% 0% 0% 0% 0% 0% 0% 0%
Adjusted gross sales forecast $200.0 $250.0 $300.0 $400.0 $500.0 $350.0 $250.0 $200.0
Collect ions on sales:
During sales' month: 0.2 (Sales)(1 discount %) $58.8 $78.4 $98.0 $68.6 $49.0 $39.2During 2nd month: 0.7 (prior month's sales) 175.0 210.0 280.0 350.0 245.0 175.0
Due in 3rd month: 0.1 (sales 2 months ago) 20.0 25.0 30.0 40.0 50.0 35.0
Less bad debts (BD% Sales 2 months ago) 0.0 0.0 0.0 0.0 0.0 0.0
Total collections $253.8 $313.4 $408.0 $458.6 $344.0 $249.2
Purchases: 60% of next month 's sales $180.0 $240.0 $300.0 $210.0 $150.0 $120.0 $120.0
Payments
Pmt for last month's purchases (30 days of credit) $180.0 $240.0 $300.0 $210.0 $150.0 $120.0
Wages and salaries 30.0 40.0 50.0 40.0 30.0 30.0
Lease payments 30.0 30.0 30.0 30.0 30.0 30.0
Other payments (interest on LT bonds, dividends, etc.) 30.0 30.0 30.0 30.0 30.0 30.0
Taxes 30.0 30.0
Payment for plant construction 150.0
Total payments $270.0 $340.0 $590.0 $310.0 $240.0 $240.0
Net cash f lows:
Assumed excess cash on hand at start of forecast period $0.0
Net cash flow (NCF): Total collections Total pmts -16.2 -26.6 -182.0 148.6 104.0 9.2
Cumulative NCF: Prior month cum plus this month's NCF -$16.2 -$42.8 -$224.8 -$76.2 $27.8 $37.0
Cash surplus (or loan requirement)
Target cash balance $10.0 $10.0 $10.0 $10.0 $10.0 $10.0Surplus cash or loan needed: Cum NCF Target cash -$26.2 -$52.8 -$234.8 -$86.2 $17.8 $27.0
Max required loan (most negative on Row 102)
Max investable funds (most positive on Row 102)
$234.8
$27.0
Base Case
-
7/28/2019 Ch16 Tool Kit
8/18
107
108
109
110
111
112
113
114
115116
117
118
119
120
121
122
123
124
125
126
127
128
129130
131
132
133
134
135
136
137
138
139
140
A B C D E F G H I J K L M
Max Loan Requirement
Base case $234.8
Big discount 103.5
Short net period 199.3
Long net period 550.7
Bad economy 470.9
% pay Max loan % bad Max loan % Sales Max Loan
late $234.8 debts $234.8 variation $234.8
0% $215 0% $235 -30% $311
15% $245 3% $257 -15% $273
30% $275 6% $280 0% $235
45% $305 9% $302 15% $197
60% $335 12% $325 30% $158
Graph scales are set for the Base Case. Lines won't show for some scenarios because max loan is out of displayed range.
Question: In the Base Case, suppose the credit manager did a bad job and the % of customers who paid late (3rdmonth rather than 2nd month) increased, and bad debts also rose. How would this affect the max loan required? Also,
from base-case values, how would changes in sales affect the max loan requirement?
$200
$240
$280
$320
0% 20% 40% 60%
Max Loan
% Late
Late Pay Effect
$230
$280
$330
0% 4% 8% 12%
Max Loan
% Bad Debts
Bad Debt Effect
$150
$200
$250
$300
-50%
Max
Loan
%
S
-
7/28/2019 Ch16 Tool Kit
9/18
141
142
143
144
145
146
147
148
149
150
151
152
153
154
155
156
157
158
159
160
161
162
163
164
165
166
167
168
169
170
171
172
173
174
175
176
177
A B C D E F G H I J K L M
Maximum Required Loan
BD% % Late Payers
$234.8 0% 15% 30% 45% 60%
0% $214.8 $244.8 $274.8 $304.8 $334.8
3% 237.3 267.3 297.3 327.3 357.36% 259.8 289.8 319.8 349.8 379.8
9% 282.3 312.3 342.3 372.3 402.312% 304.8 334.8 364.8 394.8 424.8
The higher the bad debt %, the larger the loan requirement. Similarly, the higher the % of late payers, the
larger the loan requirement. If EPC has high bad debts combined with a high % of late payers, it will have a
$200
$250
$300
$350
$400
$450
0% 2% 4% 6% 8% 10% 12%
Ma
xLoanRequired
% Bad Debts
Combined Effect: Bad Debts and Late
0% late
15% late
30% late
45% late
60% late
-
7/28/2019 Ch16 Tool Kit
10/18
4/11/2010
Tabl 3. Costs of Different Types of Short-Term Credit
Accruals and Accounts Payable (Trade Credit) (Section 16.9)
-
7/28/2019 Ch16 Tool Kit
11/18
Cost of Trade Credit
= x
100 Discount %
= x
= Periodic cost x Periods per year
= 0.02041 x 18.25
= 0.37245 = 37.24%
= (1 + Periodic rate)^No. of periods 1
= 0.44585 = 44.59%
Figure 16-7 Different Credit Terms and Their Associated Costs
Days in year: 365
Credit terms DiscountDiscount
period
Net
period
Nominal Effective
1/10, net 20 1% 10 20 36.87% 44.32%
1/10, net 30 1% 10 30 18.43% 20.13%
1/10, net 90 1% 10 90 4.61% 4.69%
2/10, net 20 2% 10 20 74.49% 109.05%
2/10, net 30 2% 10 30 37.24% 44.59%
3/15, net 45 3% 15 45 37.63% 44.86%
Traditional Bank Loan to Businesses
Simple Interest
Example: Borrow $10,000 for one year @ 5.25% simple interest, paid monthly.Amount borrowed $10,000.00
Stated annual rate 5.250%
Days per year 360
Stated rate per day: Nominal rate/Days per year 0.000145833
Interest cost per day (Daily rate x Amount borrowed) $1.46
Interest cost per 30-day month (Daily cost x 30) $43.75
1 0.02
365
Days credit out Discount period
3650.020
20
If a company allows its customers to pay after say 30 days, then it is extending 30 days of free credit. If it has
terms like 2/10, net 30, then it is extending 10 days of free credit and an additional 20 days of "non-free credit"
that has a cost equal to the 2% discount that is foregone. Firms should calculate the cost of the non-free
credit, compare it to the cost of funds from other sources such as banks, and then borrow from the source
with the lowest cost, other things equal.
Nominal cost of trade
Discount %
Example: 2/10, net 30
Effective cost of trade
Most short-term working capital bank loans to businesess are documented with a promissory note that
Cost of additional
credit
-
7/28/2019 Ch16 Tool Kit
12/18
Months per year 12
Effective interest rate per month (N=12,-PV,PMT,FV. Press I/Yr. Or use Rate function) 0.438%
Nominal interest rate per year. Nominal monthly rate x 12 5.25%
Effective interest rate per year. (1 + monthly rate)^12 1 5.38%
-
7/28/2019 Ch16 Tool Kit
13/18
Add-On Loan Rate
1-month 1-Year 2-Year
Amount borrowed $10,000.00 $10,000.00 $10,000.00
Stated annual rate 7.250% 7.250% 7.250%
Payments per year 12 12 12
Stated rate per month: Annual rate/12 0.604% 0.604% 0.604%
Months loan will be outstanding 1 12 24
Total interest: (Stated rate/month)(Borrowed)(no. of months) $60.42 $725.00 $1,450.00
Total loan: Amount borrowed + Total Interest $10,060.42 $10,725 $11,450.00
Monthly payment: Total loan / Months of loan $10,060.42 $893.75 $477.08
Rate/month: N=1,12, or 24, PV=-10000, PMT= varies. 0.604167% 1.093585% 1.112845%
Nominal APR = monthly rate 12 7.25% 13.12% 13.35%
EFF% = (1+monthly rate)^12 1 7.50% 13.94% 14.20%
Note that the nominal and effective interest rate increases as the term of the loan increases. More interest is
With a monthly payment add-on loan, the amount borrowed is multiplied by the stated interest rate to get the
If the loan is for more than a year, say 2 years, use the same procedures except use 24 rather than 12 for the
-
7/28/2019 Ch16 Tool Kit
14/18
SECTION 16.3SOLUTIONS TO SELF TEST
Inventory $20
Receivables $5
Payables $4
Sales $80
COGS $60
Inventory conversion period = 121.67
Average collection period = 22.81
Payables deferral period = 24.33
Cash conversion cycle = 120.15
A company has $20 million in inventory, $5 million in receivables, and $4 million in payables. Its
annual sales revenue is $80 million and its cost of goods sold is $60 million. What is its CCC?
-
7/28/2019 Ch16 Tool Kit
15/18
SECTION 16.7SOLUTIONS TO SELF TEST
Sales $20
Old inventory turnover ratio 2.0
New inventory turnover ratio 2.5
Old inventory = Sales/Inv. turnover $10.00
New inventory = Sales/Inv. turnover $8.00
Increase in available free cash flow $2.00
A company has $20 million in sales and an inventory turnover ratio of 2.0. If it can reduce its
inventory and improve its inventory turnover ratio to 2.5 with no loss in sales, by how much will FCF
increase?
-
7/28/2019 Ch16 Tool Kit
16/18
SECTION 16.8SOLUTIONS TO SELF TEST
Annual sales $730
DSO 35.0
Daily sales $2.00
Accounts receivables = DSO Daily Sales $70.00
A company has annual sales of $730 million. If its DSO is 35, what is its average accounts
receivables balance?
-
7/28/2019 Ch16 Tool Kit
17/18
SECTION 16.9SOLUTIONS TO SELF TEST
Discount 2%
Dicount period 12
Days credit is outsta 28
Nominal annual
cost of credit = Cost per period
0.0204 22.8125
46.6%
Effective annualcost of credit = (1 + Cost per period) ^ 1
1.0204 ^ 22.8125 1
1.5855 1
58.5%
Number of periods
per year
Number of periodsper year
A company has credit terms of 2/12 net 28. What is the nominal annual cost of
trade credit? The effective annual cost?
-
7/28/2019 Ch16 Tool Kit
18/18
SECTION 16.12SOLUTIONS TO SELF TEST
If a firm borrowed $500,000 at a rate of 10% simple interest with monthly interest
payments and a 365-day year, what would be the required interest payment for a 30-day
month?
Nominal rate 10%
Amount borrowed $500,000.00
Days/year 365
Rate/day = nominal rate / 365 = (fraction, not %) 0.000273973
Interest / month = Amount borrowed rate/day 30 = $4,109.59
If interest must be paid monthly, what would be the effective annual rate?
If interest had to be paid daily, the effective rate would be found as follows:
Effective rate = (1 + nom rate/365)^365 1.0 = 0.105155782 or 10.52%
However, interest must be paid monthly, so the effective rate is lower, found as follows:
Effective rate = (1 + nom rate/12)^12 1.0 = 0.104713067 or 10.47%
If this loan had been made on a 10% add-on basis, payable in 12 end-of-month
installments, what would be the monthly payments?
Find the total interest: 0.1 $500,000 = $50,000.00
Find the total amount of the loan: $500,000 + $50,000 = $550,000
Find the monthly payments: $550,000/12 = $45,833.33
What is the annual percentage rate?
APR: Find the rate that causes the PV of the monthly payment
stream to equal the amount borrowed. This is the nominal rate. 17.97%
What is the effective annual rate?
EFF%: =(1 + 0.1797/12)^12 1 =0.1953 or 19.53%paste function: =EFFECT(G37,12) 0.1953 or 19.53%
Simple interest loan
It would be easy to go wrong on this problem for two reasons. First, you must recognize that the monthly interest
payment will vary depending on how many days are in the month, and second, you must differentiate from daily
interest compounding and monthly compounding.
Add-on Loan