Asset & Liabilities Management Chapter 1

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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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ISBN:


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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


Purchase Fixed Assets and Inventory

Cash $ 400 A/P $ 300

Inventory 300 Debt 500

Fixed Assets 600 Common Stock 500



7/21Copyright 2005 by Thomson Learning, Inc.

End of June


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




July 1

Balance Sheet - July 1

Pay operating accruals with cash

Cash $ 125 A/P $ 300

A/R 700 Accruals 0






July 15


Pay payables with cash

Cash $ ( 175) A/P $ 0

A/R 700 Accruals 0






July 31


Collect accounts receivable

Cash $ 525 A/P $ 0

A/R 0 Accruals 0






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.



Important Points

The firm must manage its cost structure togenerate a profit

WC accounts must be managed so that liquidity ismaintained.



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



Managing the Cash Cycle

Managing Inventory

Managing Receivables

Managing Payables

Electronic Commerce



Managing Inventory

JIT

Trade-offs between:

stock out costs

cost of excess inventory

ordering costs



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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Copyright 2005 by Thomson Learning Inc

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.

Asset & Liabilities Management Chapter 1

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