Chapter 16 Short-Term Financial Planning

Line of credit

A formal (committed) or informal (non-committed) prearranged, short-term bank loan.

Accounts Receivable Financing

A secured short-term loan that involves either the assignment or factoring of receivables

Inventory Loans

A secured, short-term loan, to purchase inventory

Sources of cash

Activities that bring in cash

Uses of cash

Activities that decrease cash

Net Working Capital

Current Assets - Current Liabilities

Maturity Factoring

Factor forwards the money on an agreed upon future date.

Blanket inventory lien

Gives the lender a lien agains all the borrowers inventories.

Working Capital Management

How do we manage the day-to-day finances of the firm?

Field warehouse financing

In field warehouse financing, a public warehouse company (an independent company that specializes in inventory management) acts as a control agent to supervise the inventory for the lender.

Current assets

Items that can or will be converted into cash within one year Presented on the balance sheet in order of liquidity. A) Cash and cash equivalents B) Marketable securities C) Accounts receivables D) Inventories

Restrictive (aggressive) Short Term Financial Policy

Low ration of current assets to sales. High proportion of short-term debt relative to long term financing. 1. Keeping low cash balances and little investments in marketable securities 2. Making small investments in inventory 3. Allowing few or no credit sales, thereby minimizing accounts receivable.

Flexible (conservative) short term financial policy

Maintains a relatively high ratio of current assets to sales. Less short-term debt and more long-term debt. 1. Keeping large balances of cash and marketable securities 2. Making large investments in inventory 3. Granting liberal credit terms, which results in a high level of accounts receivables.

Conventional Factoring

Receivables are discounted and sold to the lender (the factor). Once it is sold, collection is the factor's problem and the factor assumes the full risk of default on bad accounts.

Relative interest rate

Short term interest rates are usually lower than long-term rates. This implies, that it is, on average, more costly to rely on long term borrowing as compared to short term borrowing.

Commercial paper

Short-term unsecured debt issued by large corporations. Short maturity ranging up to 270 days

revolving credit agreement

Similar to a line of credit except it is usually open for 2 or more years, whereas a line of credit would usually be renewed annually.

trade credit

Taking longer to pay bills (increasing accounts payable period) can increase cash on hand for the company. This amounts to borrowing from suppliers in the form of trade credit.

Cash Reserves

The flexible (conservative) financing policy implies surplus cash and little short=term borrowing. This policy reduces the probability that a firm will experience financial distress. Firms may not have to worry as much about meeting recurring short-term obligations. However, investments in cash and marketable securities are zero net present value investments at best.

Cash Cycle

The time between cash disbursement and cash collection The number of days that pass until we collect the cash from the sale, measured from when we actually pay for the inventory. = Operating Cycle - Accounts payable period.

Accounts payable cycle

The time between receipt of inventory and payment for it.

Accounts receivable period

The time between sale of inventory and collection of the receivable

Inventory Period

The time it takes to acquire and sell inventory

Operating Cycle

The time period between the acquisition of inventory and the collection of cash from receivables Operating Cycle = = Inventory Period + Accts Receivable Period Also = Accts Payable period + Cash Cycle

Cleanup period

To ensure a line of credit is used for short-term purposes, a borrower will sometimes be required to pay the line down to zero and keep it there for some period of the year, typically 60 days (called a cleanup period).

Stock out

To fail to meet customer demand due to inadequate supply

Committed Line of Credit

When a bank commits to lending a certain amount over a certain period of time. The firm usually pays a commitment fee to the bank.

Cash out

When a firm runs out of cash or marketable securities, it may have to borrow or default on an obligation.

cash budget

a forecast of cash receipts and disbursements for the next planning period

maturity hedging

a strategy where a firm tries to match the maturities of its assets and liabilities.

trust receipt

an instrument through which a bank retains title to goods until they are paid for. Also called floor planning, in reference to inventory on the showroom floor.

shortage costs

costs that fall with increases in the level of investment in current assets If a firm runs out of cash, it will be forced to sell marketable securities.

carrying costs

costs that rise with increases in the level of investment in current assets

Current liabilities

debts of a business that are generally paid within one year.

cash flow time line

graphical representation of the operating cycle and the cash cycle See page 522

unsecured loans

is a loan that does not require collateral from the borrower

Secured Loans

loans backed by collateral that the bank can claim if the borrowers do not repay them

Cash outflows

1. Payments of accounts payable. These are payments for goods or services rendered by suppliers. Generally, these payments will be made sometime after purchases. 2. Wages, Taxes, and other expenses. This category includes all other regular costs of doing business that require actual expenditures. (Depreciation is not included as it requires no cash outflow). 3. Capital expenditures. These are payments of cash for long-lived assets. 4. Long-term financing expenses. Includes interest payments on long-term debt outstanding and dividend payments.

2 Aspects of short term financial policy

1. The size of the firm;s investment in current assets. usually measured relative to the firms level of total operating revenues. 2. The financing of current assets. This is measured as the proportion of short-term debt (current liabilities) and long-term debt used to finance current assets.

2 kinds of shortage costs

1. Trading or order costs. Costs of placing an order for more cash or more inventory 1. Costs related to lack of safety reserves. These are costs of lost sales, lost customer goodwill, and disruption of production schedules.

Short Term Finance

1. What is a reasonable level of cash to keep on hand (in a bank) to pay bills? 2. How much should the firm borrow in the short term? 3. How much credit should be extended to customers.