ChapterOutline 27 1TracingCashandNetWorkingCapital27 2DefiningCashinTermsofOtherElements27 3TheOperatingCycleandtheCashCycle27 4SomeAspectsofShort TermFinancialPolicy27 5CashBudgeting27 6TheShort TermFinancialPlan27 7Summary Conclusions ExecutiveSummary Wearesolidlyintothethirdgreatquestionofcorporatefinance TheBalance SheetModeloftheFirm CurrentAssets FixedAssets1Tangible2Intangible Shareholders Equity CurrentLiabilities Long TermDebt Whatlong terminvestmentsshouldthefirmengagein TheCapitalBudgetingDecision TheBalance SheetModeloftheFirm Howcanthefirmraisethemoneyfortherequiredinvestments TheCapitalStructureDecision CurrentAssets FixedAssets1Tangible2Intangible Shareholders Equity CurrentLiabilities Long TermDebt TheBalance SheetModeloftheFirm Howmuchshort termcashflowdoesacompanyneedtopayitsbills TheNetWorkingCapitalInvestmentDecision NetWorkingCapital CurrentAssets FixedAssets1Tangible2Intangible Shareholders Equity CurrentLiabilities Long TermDebt 27 1TracingCashandNetWorkingCapital CurrentAssetsarecashandotherassetsthatareexpectedtobeconvertedtocashwiththeyear CashMarketablesecuritiesAccountsreceivableInventoryCurrentLiabilitiesareobligationsthatareexpectedtorequirecashpaymentwithintheyear AccountspayableAccruedwagesTaxes 27 2DefiningCashinTermsofOtherElements 27 2DefiningCashinTermsofOtherElements Anincreaseinlong termdebtandorequityleadstoanincreaseincash asdoesadecreaseinfixedassetsoradecreaseinthenon cashcomponentsofnetworkingcapital TheSourcesandUsesofCashStatementfollowsfromthisreasoning 27 3TheOperatingCycleandtheCashCycle Time Accountspayableperiod Operatingcycle Cashreceived Finishedgoodssold Firmreceivesinvoice Cashpaidformaterials 27 3TheOperatingCycleandtheCashCycle Inpractice theinventoryperiod theaccountsreceivableperiod andtheaccountspayableperiodaremeasuredbydaysininventory daysinreceivablesanddaysinpayables 27 4SomeAspectsofShort TermFinancialPolicy Therearetwoelementsofthepolicythatafirmadoptsforshort termfinance TheSizeoftheFirm sInvestmentinCurrentAssetsUsuallymeasuredrelativetothefirm sleveloftotaloperatingrevenues FlexibleRestrictiveAlternativeFinancingPoliciesforCurrentAssetsUsuallymeasuredastheproportionofshort termdebttolong termdebt FlexibleRestrictive TheSizeoftheInvestmentinCurrentAssets Aflexiblepolicyshort termfinancepolicywouldmaintainahighratioofcurrentassetstosales Keepinglargecashbalancesandinvestmentsinmarketablesecurities Largeinvestmentsininventory Liberalcreditterms Arestrictiveshort termfinancepolicywouldmaintainalowratioofcurrentassetstosales Keepinglowcashbalances noinvestmentinmarketablesecurities Makingsmallinvestmentsininventory Allowingnocreditsales thusnoaccountsreceivable CarryingCostsandShortageCosts InvestmentinCurrentAssets Carryingcosts Totalcostsofholdingcurrentassets AppropriateFlexiblePolicy InvestmentinCurrentAssets Carryingcosts Totalcostsofholdingcurrentassets WhenaRestrictivePolicyisAppropriate InvestmentinCurrentAssets Carryingcosts Totalcostsofholdingcurrentassets AlternativeFinancingPoliciesforCurrentAssets Aflexibleshort termfinancepolicymeanslowproportionofshort termdebtrelativetolong termfinancing Arestrictiveshort termfinancepolicymeanshighproportionofshort termdebtrelativetolong termfinancing AlternativeFinancingPoliciesforCurrentAssets Inanidealworld short termassetsarealwaysfinancedwithshort termdebtandlong termassetsarealwaysfinancedwithlong termdebt Inthisworld networkingcapitalisalwayszero FinancingPolicyforanIdealizedEconomy Currentassets Short termdebt Grainelevatoroperatorsbuycropsafterharvest storethem andsellthemduringtheyear Inventoryisfinancedwithshort termdebt Networkingcapitalisalwayszero 27 5CashBudgeting Acashbudgetisaprimarytoolofshort tunfinancialplanning Theideaissimple Recordtheestimatesofcashreceiptsanddisbursements CashReceiptsArisefromsales butweneedtoestimatewhenweactuallycollect CashOutflowPaymentsofAccountsPayableWages Taxes andotherExpensesCapitalExpendituresLong TermFinancialPlanning 27 5CashBudgeting Thecashbalancetellsthemanagerwhatborrowingisrequiredorwhatlendingwillbepossibleintheshortrun 27 6TheShort TermFinancialPlan Themostcommonwaytofinanceatemporarycashdeficittoarrangeashort termloan UnsecuredLoansLineofcreditdownatthebankSecuredLoansAccountsreceivablefinancingcaneeitherassignedorfactored Inventoryloansuseinventoryascollateral OtherSourcesBanker sacceptancesCommercialpaper 27 7Summary Conclusions Thischapterintroducesthemanagementofshort termfinance Weexaminetheshort termusesandsourcesofcashastheyappearonthefirm sfinancialstatements Weseehowcurrentassetsandcurrentliabilitiesariseintheshort termoperatingactivitiesandthecashcycleofthefirm Fromanaccountingperspective short termfinanceinvolvesnetworkingcapital 27 7Summary Conclusions Managingshort termcashflowsinvolvestheminimizationofcosts Thetwomajorcostsare Carryingcosts theinterestandrelatedcostsincurredbyoverinvestinginshort termassetssuchascashShortagecosts thecostofrunningoutofshort termassets Theobjectiveofmanagingshort termfinanceandshort termfin