Short term financial management ch 1

short term financial management
refers to the utilization of the firms current assets and liabilities to maximize shareholder wealth
current accounts most pertinent to st fin. management
Working Capital aka

cash + equivalents,

Accounts payable

short term operating assets
short term operating liabilities
accounts payable
short term financial assets
cash and equivalents
benefits of cash + equivalents ( holdings)
-method of payment for daily transactions/new investments
provides buffer against lower than expected future cash flows
lower than expected future cash flows may stem from
decreased revenues exchange rate fluctuations and unexpected litigation costs etc
held primarily to reduce the potential for lost sales arising from product shortages
product shortages may occur due to
higher than expected customer demand and/or breakdowns in the supply chain or production process
cost of inventory include
reduced liquidity ( due to cash flow tied up in inventory
financing costs
fees for storage and insurance
supplier offers trade credit to a customer, receipt of goods/services occurs before payment rendered, extension of trade credi t may allow supplier to generate additional sales to financially constrained customers, + provides additional time to make and collect on the sale of their own products:
downside: creation of recievables which reduce cash flow and impose additional financing costs, extension of trade credit exposes the supplier to customer default risk
spontaneous source of ‘free’ financing
-early payment discount?
cost associated with maximizing the trade credit period lieu of taking the discount
overreliance on payables can prove detrimental to buyer if supplier cuts off future extensions on trade credit
firm liquidity
firms ability to
-pay it’s financial obligations when due, despite current economic conditions
-to strategically pursue capital investments when presented
liquidity is neccessary condition for
firm value to be maximized
asset liquidity
ease at which an asset can be sold at market value

less liquid assets can be quickly sold, but at a price lower than market value

liquid firms often hold
liquid assets
accounting concept
involves comparing Book value of assets to liabilities

if BV of assets exceeds liabilities then firm= solvent
b/c potential cash proceeds from sale of assets can be used to repay liabilities

if liabilities>B.V. of assets firm= insolvent
weakness: if asseets are sold the firm will be unable to produce which generates future revenues which are required for the firm to remain a going concern

reduced firm liquidity (ie illiquidity) may result in
reduced dividends to shareholders,
higher cost of capital
reduced capital invesment
firm liquidity metric
cash conversion cycle
cash conversion cycle
number of days it takes to typically move funds from inventory to receivables to cash
after accounting for payables period

shorter Conversion cycle implies that it takes less time to generate cash indicating improved liquidity
longer cycle must wait longer to receive cash inflows + must arrange for longer periods of nonspontaneous financing

affects firm value from time value of money

longer cash conversion cycle implies
longer wait to receive cash inflows
implies a higher degree of discounting
who manages the firms liquidity
the treasury department
cash management
includes the monitoring nad reporting of cash receipts and disbursements cash flow forecasting and using software specifically designed to provide information necessary for treasury management
raising external financing
investments in receivables and inventory often require additional funds.
common short term financing instruments include
commercial paper
lines of credit
bank notes
trade credit

Treasury department may also acquire long term financing through bank loans and security issuance.
in addition to ensuring access to capital treausry seeks to minimize short term borrowing costs

short term investment portfolio
when the firm holds excess cash treasury managers oversee the investment of these funds.
goal: preserve principal

generally consists of
low risk, low return money market securities
specific instruments inc. treasury bills repurchase agreements certificates of deposit and money market funds

primary goal of short term investment portfolio
to preserve principal
risk management
firms are exposed to a number of financial risks.
interest rate risk
foreign exchange rate
+ treasury must monitor operational risks
ex: natural disasters counterparty risk, _ fraud
reports directly to CFO
manages strategic aspects regarding overall firm liquidity

* important in evolving regulatory landscape + mounting uncertainties in foreign exchange rates/global trade

focuses on improving the generation of liquidity from internal operations and assessing cash flow risk and credit exposure

assistant treasurer
oversees day to day aspects of treasury management
cash managers
monitor daily cash receipts and disbursements and execute transactions ordered by the treasurer and assistant treasurer
it lowers tax liability
is reflective of utilization of fixed assets
is not a true cash outflow
reduces profit
does not reduce cash flow
accounts payable reflect
resources that can be utilized but have not been pay for
receivables represent
the dollar amount of sales that have yet to be collected
represent total amount of goods or services sold by firm throughout period in question.
always assume revenues are net of any early payment or trade credit discounts
variable costs required to produce the goods or services sold during the period

ex; raw materials, direct labor
often proportional to revenues

Gross profit
revenue- cogs
Operating expenses
-advertising expenditures
-research and development expenditures
leases etc
depreciation expense is on the income statement but it is not
an economic cost
represents the reduction in value of assets and serves as a tax shelter for firms that make capital investments

IRS allows firms to write off a portion of the capital investments book value over time in which investment is held

Earnings before interest and taxes EBIT
or operating income represents the earnings available to pay creditors taxes and shareholders

healthier firms tend to have higher levels of EBIT

interest expense
shows the annual borrowing cost. sources of debt that contribute to borrowing costs include line of credit mortgage loans and bonds
earnings before tax EBT
is EBIT – interest expense
represents taxable income
=EBT *.4
Net income NI

reflects overall profitability

cash flow is more crucial than this measure to corporate financial stability and liquidity

represents distributions of capital to shareholders

younger firms in growth industries are unlikely to pay dividends, such firms require internally generated funds to pursue growth strategies

change in RE retained earnings
increases in this result in an increase in equity financing available to the firm for the purchase of fixed assets or the accumulation of cash holdings
fixed assets
property, plant equipment and other capital intensive assets held by firm
S of CF: Operations section
captures effects of day to day operating activities

NI (overall profitability)
-Change AR
-Change INv
+ Change Accruals
+Change Acc Payable
= cash flow from __________

aka it’s
NI adjusted for depreciation, changes in AR Inv, Accruals, and accounts payable

S of CF: Investing
shows change sin cash flow attributable to the periodic changes in capital investment
-important to monitor in capital intensive industries
S of CF: Financing
reflects changes in financing choices made by management
managers can improve cash flows and liquidity by
growing sales while controlling costs
prudent investment in capital assets
maintaining access to external financing
spontaneously generated assets
spontaneously generated financing
sustainable growth rate
the maximum growth in revenues that a firm can achieve without enduring liquidity problems abscent a change in overall financial policy
higher revenues lead to liquidity problems because
increase asset base is commonly required to support higher revenues and additional funding is needed to finance a larger asset base
when cash flow is insufficient to support higher levels of assets then…
certain financial policies must be altered
asset turnover
net profit margin
dividend policy
capital structure
difficult to alter capital strucutre/dividend policies to meet objectives because -creditors often impose external restrictions on operations through financial covenants stipulated in loan contracts b. shareholders generally frown on dividend cuts