11.2 Lecture_22_Thurs_8_Oct

11.2 Lecture_22_Thurs_8_Oct - FINC 202 2009 Lecture 22:...

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Unformatted text preview: FINC 202 2009 Lecture 22: Cash Management + Accounts Payable Management 1 Management Financial Management sometimes called Financial “the art of managing the Balance Sheet” “the Assets Cash Debtors Inventory Investments Fixed Assets Liabilities and Equity Short­term debt Long­term debt Convertible debt Ordinary shares Preference shares 2 Cash doesn’t earn a profit, so why Cash should the firm hold it? should 1. 2. 3. 4. Transactions – must have some cash to operate. Precaution – “safety stock”. Reduced by line of credit and marketable securities. Compensating balances – for loans and/or services provided. Speculation – ________________________ _______________________________________. • This need is reduced by credit lines and marketable securities. 3 The goal of cash management To meet the above objectives, • • especially to have cash for transactions, yet not have any excess cash. To ___________________________ ________________________________, • and also needs for cash to meet other objectives. 4 Minimizing cash holdings Use a lockbox Insist on _______________________________ Synchronize inflows and outflows Use a remote disbursement account Reduce need for “safety stock” of cash by • • • Increasing forecast accuracy Holding marketable securities Negotiating a line of credit At a personal level this would be ______________ _________________________________________ 5 Cash budget Forecasts cash inflows, outflows, and ending cash balances. Used to plan loans needed or funds available to invest. Can be ___________________________. • Monthly for annual planning and daily for actual cash management. 6 SKI’s cash budget: For January and February Net Cash Inflows Jan Collections Purchases Wages Rent Total payments Net CF $67,651.95 44,603.75 6,690.56 2,500.00 $53,794.31 $13,857.64 Feb $62,755.40 36,472.65 5,470.90 2,500.00 $44,443.55 $18,311.85 7 SKI’s cash budget (con’t) Net Cash Inflows Jan Feb Cash at start if no borrowing $ 3,000.00 $16,857.64 Net CF 13,857.64 18,311.85 Cumulative cash 16,857.64 35,169.49 Less: target cash 1,500.00 Surplus $15,357.64 1,500.00 $33,669.49 8 How could bad debts be worked into the How cash budget? cash Collections would be reduced by the amount of the bad debt losses. For example, if the firm had 3% bad debt losses, collections would _______ _______________________________ Lower collections would lead to higher borrowing requirements. 9 Analyze SKI’s forecasted cash budget Cash holdings will exceed the target balance for each month, except for October and November. cash. Cash budget indicates the company is holding too much SKI could improve its EVA by • • either ____________________________________, or by _____________________________________. 10 Why might SKI want to maintain a relatively high Why amount of cash? amount If sales turn out to be considerably less than expected, SKI could face a cash shortfall. A company may choose to hold large amounts of cash • • if it does ___________________________________ __________________________________________, or if it is very conservative. The cash may be used, in part, to fund future investments. 11 Short-term Financing This topic breaks into: 1. 2. Accounts Payable Management A general overview of what we have been calling “Notes Payable” 12 General Introduction Short­term finance is liability originally scheduled for repayment within 1 year Two mains types of short­term finance: • Spontaneous Accruals, trade credit Accounts Payable Management Policy fits here ______________________________________ Negotiated Bank loans, bank bills, promissory notes, secured financing 13 • Spontaneous Financing Accruals • • • Expenses incurred but not paid Accrued wages, taxes Represent free­financing _____________________________ 14 Accounts payable/Trade credit • • • • Deferred payment of purchases ______________________________ Credit reputation suffers if payment delayed beyond due date Prompt payment discount usually offered 15 Should firm take prompt payment discount ? Firm has choice between • • Paying (100­D)% of invoice at end of discount period (DP) Paying 100% of invoice at end of net period (NP) Date of Sale DP DP NP 16 The Value of Taking a Supplier’s The Discount (1) Discount Cost of forgoing cash discount calculated in annual terms: • Nominal Interest Cost: ICNOMINAL = _________________ D% 360 ICNOMINAL = × 100% − D% NP − DP 17 Example: A firm is offered terms of 2/10, net 30. Should the firm take the discount if its overdraft rate is 16% per annum? • The alternative is not to pay its accounts payable till day 30 After which they _______________________ _____________________________________ 18 Insert solution to Discount Example here IC NOMINAL 2% 360 = 100% − 2% 30 −10 = 36.73% where 36.73% > 16% Therefore use OD to claim discount The 36.73% is the opportunity cost of foregoing the discount and thus paying a higher price for the goods bought on credit 19 The IC is a valuation of the cost of credit The in the net period in Alternatively we can view the same problem in terms of calculating: the interest rate “r” • • Where we know a Future Value and a Present Value Where the FV is price paid at day 30 And PV is price paid if payment is made on day 10 And ________________________________ 20 Problem 1 Gopher Ltd is offered terms of 1/10, net 30. (a) Should the firm take the discount if it could put it on an overdraft at 21% per annum or delay payment till Day 30? (b) What if the terms were 1/15, net 30? (c) What if the terms were 2/10, net 30, but Gopher believes it can get away with not paying till the end of day 45? 21 Solution 1 (a) 22 Solution 1 (b) 23 Solution 1 (c) 24 Comment on Nominal Interest Cost {360 / (NP­DP)} converts: • • Periodic interest rate to Nominal But this actually understates the true cost… Hence… 25 The Value of Taking a Supplier’s The Discount (2) Discount • Effective Interest Cost (EIC) method: Better than Nominal 360 NP − DP D% EIC = 1 + 100% − D% −1 Rule: ___________________________________ 26 Example 2: EIC treatment of same problem A firm is offered terms of 2/10, net 30. its (a) Should the firm take the discount if overdraft rate is 16% per annum • Calculated daily (360­day year) (b) What if the firm has an overdraft rate of 16% and chooses not to pay its accounts payable till day 30? 27 Solution to Discount Example 2 (a) EICDISCOUNT 2% = 1 + 100% − 2% = 43.86% 360 360 30 −10 −1 EICOD 0.16 = 1 + 360 = 17.35% −1 43.86% > 17.35% Therefore use OD to claim discount 28 Problem 2: Gopher Ltd’s EIC Gopher Ltd (as in Problem 1) is offered terms of 1/10, net 30. Using the EIC calculation: (a) Should the firm take the discount if it could put it on an overdraft at 21% per annum or delay payment till Day 30? (b) What if the terms were 1/15, net 30? (c) What if the terms were 2/10, net 30, but Gopher believes it can get away with not paying till the end of day 45? 29 Solution 2 (a) 30 Solution 2 (b) 31 Solution 2 (c) 32 Free v costly trade credit Firm should: • • Always take the free component (i.e. 10 days) of trade credit _________________________________ _________________________________ 33 Simple Income Statement Example Simple (with nonsense ad hoc figures) (with With Discount taken and Short­term debt Discount received is greater than interest on short­term debt Sales 200 Less Purchases 100 Add Discount Rec. 2 EBIT 102 Less Interest 1 EBT 101 Less tax @ 40% 40.4 NPAT 60.6 Trade Credit Relied upon and No discount Taken Sales 200 Less Purchases 100 Add Discount Rec. 0 EBIT 100 Less Interest 0 EBT 100 Less tax @ 40% 40 NPAT 60 34 ...
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