Short-Term Financial Management

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chapter 12

• Short-Term Financial Management

Lonni Steven Wilson, Medaille College
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Key Chapter Objectives

• Understand the definition of net working capital
  and see how it is calculated.
• Discuss cash management by sport businesses,
  including how much cash to hold.
• Understand what is involved in the efficient
  collection and disbursement of cash.
• Identify issues that arise as businesses engage
  in collections management, the conversion of
  accounts receivable to cash.

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Key Terms

• net working capitalAs discussed earlier, net
  working capital equals current assets minus
  current liabilities.
• short-term financial managementCenters on
  current assets and current liabilities, which
  generate inflows or outflows of cash to or from a
  business within one year or less.
• accounts receivableUnpaid bills for goods and
  services that have been sold to customers.
• current assetsCash and other assets that are
  expected to be converted to cash within one year.

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Accounts Receivable

• As shown in table 12.1 (see next slide), accounts
  receivable are an extremely important current
  asset.
• Typically, accounts receivable have the largest
  value relative to other current assets.

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Table 12.1 from the Text
Current assets () Current assets () Current liabilities () Current liabilities ()
Cash 265.5 Short-term debt 138.3
Marketable securities 198.8 Accounts payable 436.4
Accounts receivable 633.9 Accrued income taxes 65.1
Inventories 569.7 Current payments due on long-term debt 103.7
Other current assets 311.3 Other current liabilities 723.2
Total 1,979.2 Total 1,466.7
All numbers are in billions
From U.S. Department of Commerce, Bureau of the
Census, Quarterly Financial Report for
Manufacturing, Mining and Trade Corporations
2006 Quarter 2.
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Types of Current Assets

• Cash
• Marketable securities
• Accounts receivable
• Inventories
• Prepaid expenses
• Other types of current assets

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Types of Current Liabilities

• Short-term debt
• Accounts payable
• Accrued income taxes
• Current payments on long-term debt
• Accrued liabilities
• Unearned or deferred credits
• Other types of current liabilities

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Cash Management Decisions

• How much cash to hold
• How best to replenish cash (marketable securities
  versus borrowing)
• How to achieve efficient collection and
  disbursement of cash
• Why hold cash?
• The reason for holding cash (despite the fact
  that it doesnt earn interest) is the need for
  liquidity (i.e., having an asset on hand for
  immediate transactions).

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Key Terms

• payment floatChecks written by the firm and not
  yet cleared.
• availability floatChecks received by the firm
  and deposited but not yet cleared.
• net floatThe net effect of checks in the process
  of collection (payment-availability float).

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The Benefit of Float

• Interest is earned on available balance from the
  bank while payment float occurs (assuming the
  business has an interest-earning account with the
  bank).
• The financial managers true concern is with
  available balance rather than ledger balance.

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Methods of Reducing Float

• Concentration banking Making payments to a local
  office as opposed to corporate headquarters.
  Reduces mail time local checks reduce processing
  time.
• Lockbox system Sending payments to a post office
  box (regional collection point) a bank collects
  and deposits the payments on behalf of the
  company.
• (continued)

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Methods of Reducing Float (continued)

• Disbursements Having regional banking accounts
  whereby suppliers in that region have
  disbursement checks written to them from a
  relatively close bank. Note This system can also
  be used to increase float if, for example,
  companies use banks in remote locations such as
  Helena, Montana, or Pierre, South Dakota, which
  would then mean it would take suppliers extra
  days to receive and cash checks.
• Electronic funds transfers Reducing the use of
  paper checks, thereby speeding up collections and
  reducing availability float.

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Credit Management

• The terms of credit become important in
  determining the amount of accounts receivable
  appearing on the balance sheet.
• 1/10/30 Customers receive a 1 discount for
  paying within 10 days.
• 2/10/30 Customers receive a 2 discount for
  paying within 10 days.
• If customers have a poor credit record
• COD (cash on delivery)
• CBD (cash before delivery)

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Average Daily Sales Outstanding

• SMCs annual sales are 4 million.
• Therefore, its average daily sales 4,000,000 /
  365 days 10,959 per day.
• The average daily sales outstanding is equal to
  the average daily sales divided by current
  accounts receivable.
• Assume that accounts receivable equal 186,300.
• The average daily sales outstanding therefore
  equals 186,300 / 10,959 17 days.
• This means that when making a purchase, the
  average SMC customer pays in 17 days.

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Aging Report

• An aging report tabulates receivables by
  accounts ages.
• Table 12.2 Sample Aging Report
• (continued)

Age of account Percent of total accounts receivable
0 to 30 days 60
31 to 60 days 15
61 to 90 days 15
90 to 120 days 6
121 days plus 4
Total 100
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Aging Report (continued)

• An aging report can provide more detailed
  information.
• Note that in table 12.1, a significant number of
  customers are past due (40 of accounts are
  outstanding more than 30 days).
• Any company that displays a report like the one
  shown in table 12.2 has serious collections
  problems and should be reviewing its collections
  policies.

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Questions for In-Class Discussion

1. How should a business monitor collections
   activity?
2. How has the advent of greater volumes of
   electronic funds transfers affected the
   accumulation of float by a business?