Finance 7311

1
Finance 7311

• Lecture 2a
• Cash Flow Management

2
Cash Flow Definitions

• Pay attention to the Definition
• Operating Cash Flow
• EBITDA EBIT Dep/Amort
• or, EBIT(1 t) Dep/Amort
• Value Line NI Dep/Amort
• Free Cash Flow EBIT(1 t) Dep/Amort
• - Change in NWC
• - Capital Spending

3
Cash Flow Definitions

• Free Cash Flow EBIT(1 t) Dep/Amort
• - Change in NWC
• - Capital Spending
• Note This definition explicitly accounts for the
  cash needed for reinvestment back into the firm,
  either NWC or Fixed Assets

4
Operating Cycle

• Consider a company that buys on credit,
  manufactures a product, and then sells on credit

Cash Received
Sale
Purchase inventory
5
Operating Cycle

• Operating cycle
• Inventory Period Accts. Rec. Period
• Days Sales in Inv Days Sales O/S
• Note this measure is in total days

6
Cash Cycle

• Consider a company that buys on credit,
  manufactures a product, and then sells on credit

Cash Cycle
Cash Received
Sale
Purchase inventory
Pay for inventory
7
Cash Cycle

• Cash cycle
• Inv. Period A/ R Per. A/P Period
• Days Sales in Inv DSO Days Pay
• Note this measure is in total days

8
Cash Cycle

• Intuitively the gap between payment of cash and
  the receipt of cash is the cash cycle
• The larger the gap, the more working capital that
  must be financed (see FCF definition for example)

9
Cash Cycle Example

• Days sales inventory (DSI) 40.5
• Days payable 40
• DSO 35
• Annual revenues 50 million
• Gross profit 30
• Cost of debt 6

10
Cash Cycle Example

• Cash cycle Days Sales Inv DSO Days pay
• Cash cycle 40.5 35 40 35.5 Days

11
Cash Cycle Example

• Consider the savings from reducing the gap by 1
  day
• Daily revenue 50 million/365 136,986
• Daily COS .7 x 136,986 95,890
• Savings 95,890 x .06 5,753

12
To Reduce Cash Cycle

• Why do we want to reduce cash cycle?
• Reduce Inventory just in time
• Collect A/R faster
• Slow payment of A/P

13
Reduce Inventory

• Pros
• Reduce financing needs/costs
• Perhaps avoid economic loss
• Cons
• Lost sales

14
Reduce Accounts Receivable

• Pros
• Reduce financing need/costs
• Perhaps avoid economic loss (w/o)
• Cons
• Lost sales
• What about a discount for early payment?

15
Early Payment Discount

• Consider 2/10, net 30 terms 100 sale
• Can receive 98 in 10 days,or 100 in 30 days
• R 100/98 -1 x (365/20) 37.24

20 days
98
100
16
Delay Accounts Payable

• Pros
• Reduce financing need/cost
• Costs
• Give up discounts for early payment
• Harm reputation worse terms later

17
Amazon.com Example 07

• Revenue 14.8B
• COS 11.5B
• Inv 1.2B
• A/R .85B
• A/P 3.7B
• Days inventory 38.1
• DSO 21
• Days payable 117.4
• Cash cycle 38.1 21 117.4 -58.3
• Daily COS 31.5 million
• 31.5 million x 58.3 1.8B million free financing

18
Total Asset Requirement Over Time
Seasonal Variation

Total Asset Needs
Fixed Assets Perm. WC
Time
19
Flexible Financing Policy
Long-Term Financing
Marketable Securities

Total Asset Needs
Seasonal Variation
Fixed Assets Perm. WC
Time
20
Restrictive Financing Policy
Short-Term Borrowing
Seasonal Variation

Total Asset Needs
Long-Term Financing Fixed Assets, Perm. WC
Time