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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Dr. Del Hawley
Quarterly Sales ($ in millions)
1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002
YearQuarterly Sales for Hershey Foods (1992 – 2002)
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
Companies can adopt the following strategies to fund long-term needs and seasonal fluctuations of sales:
Cash conversion cycle
time = 0
Sell finished goodson account
Purchase rawmaterials on account
Average Age of Inventory
Average Collection Period
Cash Conversion Cycle
TimeThe Cash Conversion Cycle
Cost 1 cash is collected from sale
Cost 2 *
(cost of holding too little of operating asset)
Cash and marketable securities
Opportunity cost of funds
Illiquidity and solvency costs
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
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 financingCost Tradeoffs in Working Capital Accounts
If a company decides to offer trade credit, it must:
Credit selection techniques
Five C’s of Credit
Credit scoringAccounts Receivable Management
Framework for in-depth credit analysis that is typically used for high-dollar credit requests:
Uses statistically-derived weights for key credit characteristics to predict whether a credit applicant will pay the requested credit in a timely fashion.
Financial cash is collected from saleand Credit Characteristics
Score(0 to 100)(1)
Weighted Score[(1) X (2)](3)
Years at address
Years on job
83.25Credit Scoring of a Consumer Credit Application by WEG Oil
Credit standards relaxed
Credit standards tightened
Marginal profit from margin), but higher costs from additional A/R and additional bad debt expense.
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
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
Cost of marginal margin), but higher costs from additional A/R and additional bad debt expense.investment in A/RCost 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.
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 = $3,114Cost 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
Techniques for credit monitoring
Average collection period: the average number of days credit sales are outstandingCredit Monitoring
Aging of accounts receivable: schedule that indicates the portions of total A/R balance outstanding
Payment pattern: determine if customers are paying according to stated credit terms the normal timing within which a firm’s customers pay their accounts
Cash manager responsible for
Mail floatCash 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
Bank account analysis statementCash Position Management
Cash position management: collection, concentration, and disbursement of funds on a daily basis
Smaller companies set target cash balance for their checking accounts.
Field-banking system activity in firms’ accounts.
Primary objective: speeding up collections
Collection systems: function of the nature of the business
Perform cost-benefit analysis to determine if lockbox system worth using
Depository transfer checks float.
Automated clearinghouse debit transfers
Wire transfersFunds Transfer Mechanisms
Accounts payable functionsAccounts 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.
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.