Please enable JavaScript.
Coggle requires JavaScript to display documents.
Chapter 27) S-T Financial Planning (Working-Capital Management (Current…
Chapter 27) S-T Financial Planning
It is important for companies to forecast their cash flows to determine their S-T financing needs
Working-Capital Management
Current Assets
Cash, marketable securities, inventory, account receivable
Long-term Assets
Equipment, building, land
Risk-Return Trade-off
Current assets earn low return, but help reduce the
risk of illiquidity
Current Liabilities
Short-term notes, accrued expenses, account payable
Long Term Debt & Equity
Bonds, preferred stock, common stock
Risk-Return Trade-off
Current liabilities are less expensive, but increase the
risk of illiquidity
Forecasting S-T Financing Needs
Firms require S-H financing for
Positive cash flow stock
Assume during the first quarter of 2013, Springfield announces a deal where it will be the exclusive supplier to a new major customer, leading to an overall
sales increase
of 20% for the firm
An extra $1 million in capital expenditure - also required during the first quarter to
increase production capacity
Sales growth will also affect Springfield required working capital
Negative cash flow shocks
A company will encounter circumstance in which cash flows are temporarily negative for an unexpected reason, creating a
short-term financing needs
Seasonalities
When sales - concentrated during a few months sources & uses of cash are also likely to be seasonal
Matching Principle
States that a firm's
S-T needs
should be
financed with S-T debt & L-T needs
should be financed with
L-T sources of funds
Also known as
Tenure Matching
Permanent Working Capital
The amount that a firm must keep invested in its S-T assets to support its continuing operation
Matching principle suggests that the firm should finance this permanent investment in working capital with L-T sources of funds
The minimum amount of all current assets that is required at all times
To ensure a minimum level of uninterrupted business operation
Temporary Working Capital
Difference between the actual level of S-T working capital needs & its permanent working capital requirements
Matching principle suggest that the firm should finance this temporary investment in working capital with
S-T sources of funds
It varies with the
volume of operation
, it fluctuates with the
scale of operation
Additional working capital required from time to time
over & above
the
permanent/fixed working capital
Production/ sales fluctuates & resulting in different working capital need. Seasons & off-season
As season vary, temporary working capital requirement moves up & down
Can be financed through S-T funds - current liabilities