Chapte

r 18

Short-Term Finance and

Planning

18-1
McGraw-Hill/Irwin

Copyright 2013 by The McGraw-Hill Companies, Inc. All rights reserved.

Chapter Outline
Tracing Cash and Net Working Capital
The Operating Cycle and the Cash
Cycle
The Cash Budget

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Overarching
Principles
Much of this
chapter is about
timing:
Keep the money
you have as long
as you can;

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Get the money

owed you as soon
as you can.

Sources and Uses of

Cash
Balance sheet identity
(rearranged):
NWC + fixed assets = long-term
debt + equity
NWC = cash + other CA CL

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Cash = long-term debt + equity +

CL
CA other than cash fixed

Sources and Uses of

Cash
Sources of Cash:
Increasing long-term debt, equity, or
current liabilities
Decreasing current assets other than
cash, or fixed assets

Uses of Cash:
Decreasing long-term debt, equity, or
current liabilities

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Increasing current assets other than

cash, or fixed assets

The Operating Cycle

Operating cycle time between

purchasing the inventory and collecting

the cash from sale of the inventory
Inventory period time required to

purchase and sell the inventory

Accounts receivable period (ARP) time
required to collect on credit sales

Operating cycle = Inventory Period +

ARP
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Cash Cycle
Cash cycle
Amount of time we finance our inventory
Difference between when we receive cash
from the sale and when we have to pay for
the inventory
Accounts payable period (APP) time

between purchase of inventory and

payment for the inventory
Cash Cycle = Operating
Cycle APP
Operating cycle = Inventory Period
+ ARP

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Cash Cycle = Inventory Period + ARP

APP

Operating and Cash

Cycles

Cash Cycle = Operating

Cycle APP
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Cash Cycle = Inventory Period + ARP

APP

Example Information
Inventory:
Beginning = 200,000
Ending = 300,000

Accounts Receivable:
Beginning = 160,000
Ending = 200,000

Accounts Payable:
Beginning = 75,000
Ending = 100,000

Net sales = 1,150,000

Cost of Goods sold = 820,000
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Example Solution
Operating Cycle
Inventory period
Average inventory = (200,000+300,000)/2 = 250,000
Inventory turnover = COGS/AvgInv) = 820,000 / 250,000 =

3.28 times
Inventory period = 365/ Inv.TO = 365 / 3.28 = 111 days
Receivables period

Average receivables = (160,000+200,000)/2 = 180,000

Receivables turnover = Sales/Avg.Rec = 1,150,000 / 180,000 =

6.39 times
Receivables period = 365 / 6.39 = 57 days

Operating cycle = 111 + 57 = 168 days

Payables Period
Average payables = (75,000+100,000)/2 = 87,500
Payables turnover = COGS/Av.Payables = 820,000 / 87,500 =
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9.37 times
Payables period = 365 / 9.37 = 39 days

Cash Cycle

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Solution Interpretation

So what does all this mean for the firm?

It has to finance its inventory for 129 days, that is,

operate without cash inflows for 129 days (more than

four months!)
If it wants to reduce its financing needs, it needs to
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look carefully at its receivables and inventory periods

they both seem extensive.

Cash Budget
Forecast of cash inflows and

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outflows over the next short-term

planning period
Primary tool in short-term financial
planning
Helps determine when the firm
should experience cash surpluses
and when it will need to borrow to
cover working-capital
requirements
Allows a company to plan ahead
and begin the search for financing

Example: Cash Budget

Information
Pet Treats, Inc. specializes in gourmet pet treats and
receives all income from sales
Sales estimates (in $millions)

Q1 = 500; Q2 = 600; Q3 = 650; Q4 = 800; Q1 next year =

550

Accounts receivable:

Beginning receivables = $250

Average collection period (ACP) = 30 days

Accounts payable

Purchases = 50% of next quarters sales

Beginning payables = 125
Accounts payable period (APP) is 45 days

Other expenses
Wages, taxes, and other expense are 30% of sales
Interest and dividend payments are $50
A major capital expenditure of $200 is expected in
the second quarter

18-14 The initial cash balance is $80, and

The company maintains a minimum balance of $50

Example: Cash
Budget Cash
Collections
ACP = 30 days; this implies that
2/3 of sales are collected in the quarter made
Remaining 1/3 are collected the following

quarter
Beginning receivables of $250 will be

collected in the first quarter

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Example: Cash Budget

Cash Disbursements
Payables period is 45 days, so half of the

purchases will be paid for each quarter and

the remaining will be paid the following
quarter
Beginning payables = $125

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Flow and Cash

Balance

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So how will the company survive these

deficits?

Terminology
Net Working Capital (NWC)
Sources and Uses of Cash
Operating Cycle
Cash Cycle
Cash Budget

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Formulas
Operating cycle = inventory
period + accounts receivable
period
Cash cycle = Operating cycle
accounts payable period

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What are the most

important topics of
this chapter?

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1. Bring cash into the organization

and dispersing it efficiently is the
focus of working capital
management.
2. The timing of cash is the key to
insure we have sufficient funds to
pay our bills on time.
3. The cash budget forecasts future
cash needs.
4. The operating cycle and the cash
cycle work together to
demonstrate how much time it