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Short-Term Financial Management. Dr. Del Hawley MBA 622. 1,400. 1,200. 1,000. Quarterly Sales ($ in millions). 800. 600. 400. 200. Quarterly Sales. 0. 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002. Year.

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Short term financial management l.jpg

Short-Term Financial Management

Dr. Del Hawley

MBA 622

Quarterly sales for hershey foods 1992 2002 l.jpg




Quarterly Sales ($ in millions)





Quarterly Sales


1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002


Quarterly Sales for Hershey Foods (1992 – 2002)

Financing strategies available to hershey l.jpg






Total Assets($ in millions)



Hershey’s Current Assets Matching Strategy Conservative Strategy Aggressive Strategy




1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002

Quarters (1992-2002)

Financing Strategies Available to Hershey

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Conservative strategy

  • Use long-term financing to cover both permanent assets and temporary assets.

Aggressive strategy

  • Use short-term financing to fund both seasonal peaks and part of long-term growth in sales and assets.

Matching strategy

  • Finance permanent assets with long-term funding sources and temporary asset requirement with short-term financing.

Short-Term Financing Strategies

Companies can adopt the following strategies to fund long-term needs and seasonal fluctuations of sales:

The cash conversion cycle l.jpg

Operating cycle

Cash conversion cycle

  • Operating cycle less the average payment period on accounts payable

time = 0

Operating cycle

Sell finished goodson account

Purchase rawmaterials on account

Collect accountsreceivable

Average Age of Inventory

Average Collection Period

Average paymentperiod

Payment mailed

Cash Conversion Cycle


The Cash Conversion Cycle

Cost tradeoffs in working capital accounts l.jpg

Cost 1 cash is collected from sale

(holding cost)

Cost 2 *

(cost of holding too little of operating asset)

Operating Assets

Cash and marketable securities

Opportunity cost of funds

Illiquidity and solvency costs

Accounts receivable

Cost of investment in accounts receivable and bad debts

Opportunity cost of lost sales due to overly restrictive credit policy and/or terms


Carrying cost of inventory, including financing, ware housing, obsolescence costs, etc.

Order and setup costs associated with replenishment and production of finished goods

Short-Term Financing

Accounts payable, accruals, and notes payable

Cost of reduced liquidity caused by increasing current liabilities

Financing costs resulting from the use of less expensive short-term financing rather than more expensive long-term debt and equity financing

Cost Tradeoffs in Working Capital Accounts

Accounts receivable management l.jpg

  • Determine its credit standards. cash is collected from sale

  • Set the credit terms.

  • Develop collection policy.

  • Monitor its A/R on both individual and aggregate basis.

If a company decides to offer trade credit, it must:

  • Apply techniques to determine which customers should receive credit.

  • Use internal and external sources to gather information relevant to the decision to extend credit to specific customers.

  • Take into account variable costs of the products sold on credit.

Credit standards

Credit selection techniques

Five C’s of Credit

Credit scoring

Accounts Receivable Management

Five c s of credit l.jpg

  • Character: cash is collected from sale The applicant’s record of meeting past obligations; desire to repay debt if able to do so

  • Capacity: The applicant’s ability to repay the requested credit

  • Capital: The financial strength of the applicant as reflected by its ownership position

  • Collateral: The amount of assets the applicant has available for use in securing the credit

  • Conditions: Refers to current general and industry-specific economic conditions

Five C’s of Credit

Framework for in-depth credit analysis that is typically used for high-dollar credit requests:

Credit scoring l.jpg

  • An example… cash is collected from sale

  • WEG Oil uses credit scoring to make credit decisions. WEG Oil decision rule is:

    • Credit Score > 75: extend standard credit terms

    • 65 < Credit Score < 75: extend limited credit (convert to standard credit terms after 1 year if account is properly maintained)

    • Credit Score < 65: reject application

Credit Scoring

Uses statistically-derived weights for key credit characteristics to predict whether a credit applicant will pay the requested credit in a timely fashion.

  • Used with high volume/small dollar credit requests

  • Most commonly used by large credit card operations, such as banks, oil companies, and department stores.

Credit scoring of a consumer credit application by weg oil l.jpg

Financial cash is collected from saleand Credit Characteristics

Score(0 to 100)(1)

Predetermined Weight(2)

Weighted Score[(1) X (2)](3)

Credit references




Home ownership




Income range




Payment history




Years at address




Years on job






Credit Scoring of a Consumer Credit Application by WEG Oil

Changing credit standards l.jpg

Credit standards relaxed

Credit standards tightened

  • Reduced investment in A/R and lower bad debt, but lower sales and profit.

  • An example…YMC wants to evaluate the effects of a relaxation of its credit standards:

  • YMC sells CD organizers for $12/unit. All sales are on credit. YMC expects to sell 140,000 units next year.

  • Variable costs are $8/unit and fixed costs are $200,000 per year.

  • The change in credit standards will result in:

    • 5% increase in sales; average collection period will increase from 30 to 45 days; increase in bad debt from 1% to 2%.

Changing Credit Standards

Effects of changes in credit standards for ymc l.jpg

Marginal profit from margin), but higher costs from additional A/R and additional bad debt expense.

increased sales

Cost of marginal

investment in A/R

Average investment inaccounts receivable (AIAR)

Effects of Changes in Credit Standards for YMC

Additional profit contribution from sales

Cost of the marginal investment in accounts receivables

  • To compute additional investment, use the following equations:

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Total variable cost of annual sales (TVC) margin), but higher costs from additional A/R and additional bad debt expense.

Turnover of account receivable (TOAR)

Cost of the marginal investment in accounts receivables

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Cost of marginal margin), but higher costs from additional A/R and additional bad debt expense.investment in A/R

Cost of the marginal investment in accounts receivables

Compute additional investment and, assuming a required return of 12%, compute cost of marginal investment in A/R.

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Cost of marginal bad debt expense margin), but higher costs from additional A/R and additional bad debt expense.

Marginal profit from increased sales

Cost of marginalbad debts

Net profit for the credit decision

Cost of marginalinvestment in A/R




= $28,000 - $6,406 - $18,480 = $3,114

Cost of Marginal Bad Debt Expense

3. Cost of marginal bad debt expense

Subtract the current level of bad debt expense (BDECURRENT) from the expected level of bad debt expense (BDEPROPOSED).

4. Net profit for the credit decision

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Credit monitoring

Techniques for credit monitoring

  • Average collection period

  • Aging of accounts receivable

  • Payment pattern monitoring

Average collection period: the average number of days credit sales are outstanding

Credit Monitoring

Aging of accounts receivable: schedule that indicates the portions of total A/R balance outstanding

Credit monitoring18 l.jpg

Payment pattern: determine if customers are paying according to stated credit terms the normal timing within which a firm’s customers pay their accounts

  • Percentage of monthly sales collected the following month

  • Should be constant over time; if payment pattern changes, the firm should review its credit policies

  • An example…

  • DJM Manufacturing determined that:

    • 20% of sales collected in the month of sales, 50% in the next month and 30% two months after the sale.

  • Can use payment pattern to construct cash receipts from the cash budget:

    • If January sales are $400,000, DJM expects to collect $80,000 in January, $200,000 in February, and $120,000 in March.

Credit Monitoring

Cash management l.jpg

  • Cash management determine if customers are paying according to stated credit terms

  • Financial relationships with banks

  • Cash flow forecasting

  • Investing and borrowing

  • Development and maintenance of information systems for cash management

Cash manager responsible for


Processing float

Availability float

Clearing float

Mail float

Cash Management

Cash management: the collection, concentration, and disbursement of funds

Float: funds that have been sent by the payer but not yet usable funds to the company

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Bank account analysis statement

Cash Position Management

Cash position management: collection, concentration, and disbursement of funds on a daily basis

  • Management of short-term investing if the company has a surplus of funds and borrowing arrangements if company has a temporary deficit of funds

Smaller companies set target cash balance for their checking accounts.

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Field-banking system activity in firms’ accounts.

  • Collections are made over the counter (retail) or at a collection office (utilities).

Mail-based system

  • Mail payments are processed at companies’ collection centers.

Electronic payments

  • Becoming increasingly popular because they offer advantages to both parties.


Primary objective: speeding up collections

Collection systems: function of the nature of the business

Collections22 l.jpg

Lockbox system

  • FVR = float value reduction in dollars

  • ra = cost of capital

  • LC = annual operating cost of the lockbox system


Perform cost-benefit analysis to determine if lockbox system worth using

Funds transfer mechanisms l.jpg

Depository transfer checks float.

  • Unsigned check drawn on one of the firm’s bank accounts and deposited in another of the firm’s bank accounts

  • Preauthorized electronic withdrawal from the payer’s account

  • Settle accounts among participating banks. Individual accounts are settled by respective bank balance adjustments.

  • Transfers clear in one day.

Automated clearinghouse debit transfers

  • Electronic communication that, via bookkeeping entries, removes funds from the payer’s bank and deposits the funds in the payee’s bank.

  • Expensive: used only for high-dollar payments

  • Fedwire: primary wire transfer system in US

Wire transfers

Funds Transfer Mechanisms

Accounts payable management l.jpg

Accounts payable functions

Accounts Payable Management

Management of time from purchase of raw materials until payment is placed in the mail

Decide between centralized or decentralized payables and payments systems

If supplier offers cash discounts, analyze the best alternative between paying at the end of credit period and taking the discount.

Disbursements products and methods l.jpg
Disbursements Products and Methods paid.

  • Zero-balance accounts (ZBAs): disbursements accounts that always have end-of-day balance of zero

    • Allows the firm to maximize the use of float on each check, without altering the float time of its suppliers

    • Keeps all cash in interest-bearing accounts

  • Controlled disbursement: Bank provides early notification of checks presented against a company’s account every day.

    • Federal Reserve Bank makes two presentments of checks to be cleared each day for most large cash management banks.

  • Positive pay: Company transmits to the bank a check-issued file to the bank when checks are issued.

    • Check-issued file includes check number and amount of each item.

    • Used for fraud prevention

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Developments in Accounts Payable and Disbursements paid.

  • Integrated (comprehensive) accounts payable: outsourcing of accounts payable or disbursements operations

  • Purchasing/procurement cards: increased use of credit cards for low-dollar indirect purchases

  • Imaging services: Both sides of the check, as well as remittance information, is converted into digital images.

    • Useful when incorporated with positive pay services

  • Fraud prevention in disbursements: fraud prevention measures:

    • Written policies and procedures for creating and disbursing checks; separating duties (approval, signing, reconciliation)

    • Using safety features on checks; setting maximum dollar limits and/or requiring multiple signatures

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Short-Term Financial Management paid.

Length of cash conversion cycle determines the amount of resources the firm must invest in its operations.

Cost trade-offs apply to managing cash and marketable securities, account receivable, inventory and account payable.

Objective for account receivable: collect accounts as quickly as possible without losing sales.

Objective for accounts payable: pay accounts as slowly as possible without damaging firm’s credit.