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.
Dr. Del Hawley
Companies can adopt the following strategies to fund long-term needs and seasonal fluctuations of sales:
Time from the beginning of the production to the time when cash is collected from sale
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 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
Character: The applicant’s record of meeting past obligations; desire to repay debt if able to do so
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.
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
Increase in sales and profits (if positive contribution margin), but higher costs from additional A/R and additional bad debt expense.
Credit standards relaxed
Credit standards tightened
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
Turnover of account receivable (TOAR)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.
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
The ongoing review of a firm’s accounts receivable to determine if customers are paying according to stated credit terms
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: 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 provides report to its customers to show recent activity in firms’ accounts.
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.
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
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.