Introduction

Reference:STFM Chapter 1
ETM Chapter 1
 An Overview of Financial
Management
 Role of financial management
 Goals of the corporation
 Issues of the new millenium
 What three questions do financial
leaders seek to answer?

 What causes a company to have a particular

stock value?
 How can managers make choices that add value
to their companies?
 How can managers ensure that their companies
don’t run out of cash while executing their plans?
 Corporate Financial Decisions

 Capital Structure Decisions

 Investment Decisions
 Financing Decisions
 Dividend Decisions
 Treasury Management
Factors that Affect Stock Price

 Amount of cash flows expected by

shareholders
 Timing of the cash flow stream
 Risk of the cash flows
 Treasury Management’s
Overall Objective

 Efficient utilization of cash in a manner

consistent with the overall strategic
objectives of the firm.
 Operating Cycle

1.
Acquire Materials
or Resources

4. 2.
Collect Payment Convert Materials to Goods
for Goods or Services Convert Resources to
Services

3.
Sell Goods
or Services
 Major Objectives of Treasury
Management

 Maintaining liquidity
 Optimizing cash resources
 Establishing and maintaining access to short-term financing
 Maintaining access to medium- and long-term financing (capital budgeting)
 Maintaining shareholder relations
 Managing risk
 Coordinating financial functions and sharing financial information
 Cash Flows and the
Timeline

Cash Concentration Cash

Inflows And Liquidity Outflows
Management
Flows
 Three Determinants of Cash
Flows
 Sales
– Current level
– Short-term growth rate in sales
– Long-term sustainable growth rate in sales

 Operating expenses
 Capital expenses
 Factors that Affect the Level and
Risk of Cash Flows

 Decisions made by financial managers:

– Investment decisions (product lines, production
processes, geographic market, use of technology,
marketing strategy)
– Financing decisions (choice of debt policy and
dividend policy)

 The external environment

 Cash Management
vs
Treasury Management

 Liquid assets vs financial assets

 Short term vs long term

 Functional vs strategic
 Functions and
Responsibilities of a
Treasury Manager

 System Design, Implementation, and Evaluation

 Funds Management
 Banking System Administration
 Forecasting
 Risk Management
 Financing
 Daily Cash Management

 Daily funds management  Banking system administration

– Prepare cash position  Liquidity management
worksheet  Forecasting
– Monitor cash balances  Systems design, implementation
– Mobilize funds and evaluation
– Research and reconcile  Financial risk management
exception items
– Coordinate finance
functions with A/R, A/P and
accounting
 Factors Affecting Treasury
Management Practices

 Banking Structure
 Mail System
 Payment Conventions
 Interest Rates
 Regulatory Environment
 Tax Status
 Risk Appetite
 IT Capabilities
 Treasury Linkages & Interfaces
Intracorporate Integration Intercorporate Integration

A/R Banks
Financial
Purchasing A/P Markets
A/P

External
Investment Treasury Pension Suppliers Treasury
Investment
Borrowing $ Mgt. Customers $ Mgrs.

Industry
General Internal External
Trade
Ledger Risk Audit Regulatory Auditors
Groups
Mgt. Agencies
 Key to Success for a
Treasury Manager

 Cooperation with other functions

 Differences Between the
U.S. and Other Countries

 Large number of banks

 Lack of nationwide banking
 Extensive use of mail for payment
 Bills paid by check
Bank and Treasury Management Prior
to 1950
 Cash Management Evolution
1950s

 First Lockbox
 The Accord and the Government Securities
Market
 Cash Management Evolution
1960’s

 Short Term Investment Vehicles

 Managing Banking Balances
 Lockbox Models
 Cash Management Evolution 1970s

 Remote Disbursement
 Controlled Disbursement
 Funds Concentration
 Bank Balance Reporting
 Electronic Payment
 Commercial Paper
 Cash Management Evolution 1980s

 DIDMCA of 1980
 Noon Presentment/Payor Services
 Electronic Commerce and Data
Interchange
 1980s Developments
(continued)

 Personal Computers
 Internalization of Financial Markets
 Bank Creditworthiness
 Cash Management Ethics
 Cash Management Evolution 1990’s

 Derivatives
 Electronic Payment of State and Federal
Taxes
 Interstate Banking
 Internet
 Financial Deregulation
 EMU
 Financial Management
Issues of the New Millenium

 Use of computers and electronic transfers

of information and value
 The globalization of business
 Financial Regulation ?
The Role of Working Capital

Sales

Inv A /R

Cash
 Objectives

 View firm as a system of cash flows

 How WC and depreciation create

disparities between profit and cash flow

 Management aspects of various WC

accounts
 The Cash Flow Timeline

Order
Order Order
Order Sale
Sale Cash
Cash
Placed
Placed Received
Received Received
Received
Accounts
Accounts Collection
Collection
<<Inventory
Inventory>> << Receivable
Receivable >> << Float
Float >>

Time
Time==>
==>
Accounts
Accounts Disbursement
Disbursement
<< Payable
Payable >> << Float
Float >>
Invoice
Invoice Payment
Payment Cash
Cash
Received
Received Sent
Sent Disbursed
Disbursed
 ...in the beginning

Balance
BalanceSheet
Sheet--June
June11

Cash
Cash $1,000
$1,000 Debt
Debt $$ 500
500
Common
CommonStock
Stock 500
500

Total
Total $1,000
$1,000 Total
Total $1,000
$1,000
 The Next Day, June 2

Balance
BalanceSheet
Sheet--June
June22
Purchase
PurchaseFixed
FixedAssets
Assetsand
andInventory
Inventory

Cash
Cash $$ 400
400 A/P
A/P $$ 300
300
Inventory
Inventory 300
300 Debt
Debt 500
500
Fixed
FixedAssets
Assets 600
600 Common
CommonStock
Stock 500
500

Total
Total $1,300
$1,300 Total
Total $1,300
$1,300
 End of June

Balance
BalanceSheet
Sheet--June
June30
30
Sale
Saleof
ofproduct,
product,incur
incuroperating
operatingexpenses,
expenses,
incur
incurdepreciation,
depreciation,and
andgenerate
generateprofit
profit

Cash
Cash $$ 325
325 A/P
A/P $$ 300
300
A/R
A/R 700
700 Accruals
Accruals 200
200
Inventory
Inventory 00 Debt
Debt 500
500
Fixed
FixedAssets
Assets 600
600 Common
CommonStock
Stock 500
500
(Accum
(AccumDepr)
Depr) (100)
(100) Retained
RetainedEarnings
Earnings 25
25
Total
Total $1,525
$1,525 Total
Total $1,525
$1,525
 July 1

Balance
BalanceSheet
Sheet--July
July11
Pay
Payoperating
operatingaccruals
accrualswith
withcash
cash

Cash
Cash $$ 125
125 A/P
A/P $$ 300
300
A/R
A/R 700
700 Accruals
Accruals 00
Inventory
Inventory 00 Debt
Debt 500
500
Fixed
FixedAssets
Assets 600
600 Common
CommonStock
Stock 500
500
(Accum
(AccumDepr)
Depr) (100)
(100) Retained
RetainedEarnings
Earnings 25
25
Total
Total $1,325
$1,325 Total
Total $1,325
$1,325
 July 15

Balance
BalanceSheet
Sheet--July
July15
15
Pay
Paypayables
payableswith
withcash
cash

Cash
Cash $$((175)
175) A/P
A/P $$ 00
A/R
A/R 700
700 Accruals
Accruals 00
Inventory
Inventory 00 Debt
Debt 500
500
Fixed
FixedAssets
Assets 600
600 Common
CommonStock
Stock 500
500
(Accum
(AccumDepr)
Depr) (100)
(100) Retained
RetainedEarnings
Earnings 25
25
Total
Total $1,025
$1,025 Total
Total $1,025
$1,025
 July 31

Balance
BalanceSheet
Sheet--July
July31
31
Collect
Collectaccounts
accountsreceivable
receivable

Cash
Cash $$ 525
525 A/P
A/P $$ 00
A/R
A/R 00 Accruals
Accruals 00
Inventory
Inventory 00 Debt
Debt 500
500
Fixed
FixedAssets
Assets 600
600 Common
CommonStock
Stock 500
500
(Accum
(AccumDepr)
Depr) (100)
(100) Retained
RetainedEarnings
Earnings 25
25
Total
Total $1,025
$1,025 Total
Total $1,025
$1,025
 Profit versus Cash Flow

 Question: Why did the firm end up with $125 in

additional cash while earning a profit of $25?
 Answer: Some expenses are not cash expenses.

 Question: Why did the firm run out of cash during

its operating cycle?
 Answer: The cash deficit was due to the differences
between the timing of cash disbursements and cash
receipts.
 Important Points

 The firm must manage its cost structure to

generate a profit

 WC accounts must be managed so that

liquidity is maintained.
 Relationship Between Accrual
Income and Cash Flow
Income Statement Adjustment Account Cash Flow Account

Sales - Change in accounts receivable = Cash collected

Cost of goods sold - Change in accounts payable

+ Change in inventory = Cash paid to suppliers

Operating expenses - Change in operating accruals

+ Depreciation = Cash paid for
operating expenses

Interest - Change in accrued interest = Cash paid to creditors

Taxes - Change in accrued taxes

- Change in deferred taxes = Cash paid for taxes
_________________ ___________________
Net Profit Operating Cash Flow
 Managing the Cash Cycle

 Managing Inventory

 Managing Receivables

 Managing Payables

 Electronic Commerce
 Managing Inventory

 JIT

 Trade-offs between:

– stock out costs

– cost of excess inventory

– ordering costs
 Managing Receivables

 Who should receive credit and how much?

 Credit terms

 Monitoring the outstanding balance

 Speeding up the receipt of payments

through lockboxes
 Managing Payables

 Search for terms that match with cash

receipts

 Timing of payment

 Controlled disbursement
 Electronic Commerce

 Revolutionizing management of cash cycle

 Proprietary systems

 Impact of Internet
 How Much WC is Enough

 One view
– optimal level is zero
– WC is an idle resource
– Provides little value
 How much in resources to commit?
– Why inventory?
– Why receivables and payables?
– Why short-term investments?
How Management of Working
Capital is Changing

Exhibit 1-6
Working Capital Requirements as a Percent of Sales

35%
30%
25%
Percent of Sales

20% Dell
15% Apple
10% Compaq
5% Gateway
0%
-5% 1994 1995 1996 1997 1998 1999 2000 2001 2002
-10%
Years