Financial Management

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Chapter 10 Working-Capital Management and
Short-term Financing
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Working-Capital Management

• Current Assets
• Cash, marketable securities, inventory, accounts
  receivable.
• Long-Term Assets
• Equipment, buildings, land.
• Which earn higher rates of return?
• Which help avoid risk of illiquidity?

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Working-Capital Management

• Current Assets
• Cash, marketable securities, inventory, accounts
  receivable.
• Long-Term Assets
• Equipment, buildings, land.
• Risk-Return Trade-off
• Current assets earn low returns, but help
  reduce the risk of illiquidity.

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Working-Capital Management

• Current Liabilities
• Short-term notes, accrued expenses, accounts
  payable.
• Long-Term Debt and Equity
• Bonds, preferred stock, common stock.
• Which are more expensive for the firm?
• Which help avoid risk of illiquidity?

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Working-Capital Management

• Current Liabilities
• Short-term notes, accrued expenses, accounts
  payable.
• Long-Term Debt and Equity
• Bonds, preferred stock, common stock.
• Risk-Return Trade-off
• Current liabilities are less expensive, but
  increase the risk of illiquidity.

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• Balance Sheet
• Current Assets Current Liabilities
• Fixed Assets Long-Term Debt
• Preferred Stock
• Common Stock
• To illustrate, lets finance all current assets
  with current liabilities,

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• Balance Sheet
• Current Assets Current Liabilities
• Fixed Assets Long-Term Debt
• Preferred Stock
• Common Stock
• To illustrate, lets finance all current assets
  with current liabilities,

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• Balance Sheet
• Current Assets Current Liabilities
• Fixed Assets Long-Term Debt
• Preferred Stock
• Common Stock
• To illustrate, lets finance all current assets
  with current liabilities, and finance all fixed
  assets with long-term financing.

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• Balance Sheet
• Current Assets Current Liabilities
• Fixed Assets Long-Term Debt
• Preferred Stock
• Common Stock
• To illustrate, lets finance all current assets
  with current liabilities, and finance all fixed
  assets with long-term financing.

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• Balance Sheet
• Current Assets Current Liabilities
• Fixed Assets Long-Term Debt
• Preferred Stock
• Common Stock

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• Balance Sheet
• Current Assets Current Liabilities
• Fixed Assets Long-Term Debt
• Preferred Stock
• Common Stock
• Suppose we use long-term financing to finance
  some of our current assets.

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• Balance Sheet
• Current Assets Current Liabilities
• Fixed Assets Long-Term Debt
• Preferred Stock
• Common Stock
• Suppose we use long-term financing to finance
  some of our current assets.

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• Balance Sheet
• Current Assets Current Liabilities
• Fixed Assets Long-Term Debt
• Preferred Stock
• Common Stock
• Suppose we use long-term financing to finance
  some of our current assets.
• This strategy would be less risky, but more
  expensive!

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• Balance Sheet
• Current Assets Current Liabilities
• Fixed Assets Long-Term Debt
• Preferred Stock
• Common Stock

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• Balance Sheet
• Current Assets Current Liabilities
• Fixed Assets Long-Term Debt
• Preferred Stock
• Common Stock
• Suppose we use current liabilities to finance
  some of our fixed assets.

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• Balance Sheet
• Current Assets Current Liabilities
• Fixed Assets Long-Term Debt
• Preferred Stock
• Common Stock
• Suppose we use current liabilities to finance
  some of our fixed assets.

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• Balance Sheet
• Current Assets Current Liabilities
• Fixed Assets Long-Term Debt
• Preferred Stock
• Common Stock
• Suppose we use current liabilities to finance
  some of our fixed assets.
• This strategy would be less expensive, but more
  risky!

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The Hedging Principle

• Permanent Assets (those held gt 1 year)
• Should be financed with permanent and spontaneous
  sources of financing.
• Temporary Assets (those held lt 1 year)
• Should be financed with temporary sources of
  financing.

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• Balance Sheet
• Temporary
• Current Assets

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• Balance Sheet
• Temporary Temporary
• Current Assets Short-term financing

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• Balance Sheet
• Temporary Temporary
• Current Assets Short-term financing
• Permanent
• Fixed Assets

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• Balance Sheet
• Temporary Temporary
• Current Assets Short-term financing
• Permanent Permanent
• Fixed Assets Financing
• and
• Spontaneous
• Financing

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The Hedging Principle

• Permanent Financing
• Intermediate-term loans, long-term debt,
  preferred stock, common stock.
• Spontaneous Financing
• Accounts payable that arise spontaneously in
  day-to-day operations (trade credit, wages
  payable, accrued interest and taxes).
• Short-term financing
• Unsecured bank loans, commercial paper, loans
  secured by A/R or inventory.

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Cost of Short-Term Credit

• Interest principal x rate x time
• Example Borrow 10,000 at 8.5 for 9 months.
• Interest 10,000 x .085 x 3/4 year
• 637.50

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Cost of Short-Term Credit

• We can use this simple relationship
• Interest principal x rate x time
• to solve for rate, and get the

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Cost of Short-Term Credit

• We can use this simple relationship
• Interest principal x rate x time
• to solve for rate, and get the
• Annual Percentage Rate (APR)

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Cost of Short-Term Credit

• We can use this simple relationship
• Interest principal x rate x time
• to solve for rate, and get the
• Annual Percentage Rate (APR)
• interest 1
• principal time

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Cost of Short-Term Credit
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Cost of Short-Term Credit

• interest
  1
• principal time

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Cost of Short-Term Credit

• interest
  1
• principal time
• Example If you pay 637.50 in interest on
  10,000 principal for 9 months

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Cost of Short-Term Credit

• interest
  1
• principal time
• Example If you pay 637.50 in interest on
  10,000 principal for 9 months
• APR 637.50/10,000 x 1/.75 .085
• 8.5 APR

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Cost of Short-Term Credit

• Annual Percentage Yield (APY) is similar to APR,
  except that it accounts for compound interest

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Cost of Short-Term Credit

• Annual Percentage Yield (APY) is similar to APR,
  except that it accounts for compound interest
• i m
• m

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Cost of Short-Term Credit

• Annual Percentage Yield (APY) is similar to APR,
  except that it accounts for compound interest
• i m
• m
• i the nominal rate of interest
• m the of compounding periods per year

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Cost of Short-Term Credit

• What is the (APY) of a 9 loan with monthly
  payments?
• APY ( 1 ( .09 / 12 ) 12 -1 ) .0938
• 9.38

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Sources of Short-term Credit

• Unsecured

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Sources of Short-term Credit

• Unsecured
• Accrued wages and taxes.

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Sources of Short-term Credit

• Unsecured
• Accrued wages and taxes.
• Trade credit.

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Sources of Short-term Credit

• Unsecured
• Accrued wages and taxes.
• Trade credit.
• Bank credit.

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Sources of Short-term Credit

• Unsecured
• Accrued wages and taxes.
• Trade credit.
• Bank credit.
• Commercial paper.

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Sources of Short-term Credit

• Unsecured
• Accrued wages and taxes.
• Trade credit.
• Bank credit.
• Commercial paper.
• Secured

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Sources of Short-term Credit

• Unsecured
• Accrued wages and taxes.
• Trade credit.
• Bank credit.
• Commercial paper.
• Secured
• Accounts receivable loans.

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Sources of Short-term Credit

• Unsecured
• Accrued wages and taxes.
• Trade credit.
• Bank credit.
• Commercial paper.
• Secured
• Accounts receivable loans.
• Inventory loans.