Managing Cash Flow : Question 1

1. 
   

 

1. What does short-term financial planning involve?

Short-term financial planning usually involves projecting monthly financial statements and concentrating on a venture's cash needs. Most initial business plans contain monthly projected (pro forma) financial statements for at least one year, and sometimes for two or more years. These short-horizon forecasts directly address whether a venture is expected to generate—or otherwise obtain—the required cash to meet its coming obligations.

2. Provide a description of the financing cost implications associated with a venture’s need for additional funds.

The cost of obtaining additional funds may be explicit, such as additional interest expense associated with debt. Interest expense shows up directly on the projected income statement and, in turn, impacts the AFN shown on the balance sheet. In contrast, added “costs” associated with obtaining equity capital from venture capitalist and other investors are based on the expected rates of return the investors receive when they exit their investments. These implicit costs do not show up on the projected financial statements.

3. What is meant by a cash budget? Describe how a cash budget is prepared. 

A cash budget is a financial tool showing the inflows and outflows of the firm’s cash balance over a period of time. It is calculated by determining all of the cash-basis expenses and revenues the firm has over a period of time to find out how cash is being built and burned. 

4. Besides the cash budget, what additional financial statements are projected monthly in conjunction with short-term financial planning?

Additional statements that can be prepared on a monthly basis to provide a clear financial picture of the firm include the income statement, balance sheet and a statement of cash flows. 

5. What is meant by a venture’s operating cycle?

A venture’s operating cycle is the time it takes to purchase raw materials, assemble a product, book a sale, and collect on it.

6. Describe the cash conversion cycle (C3 ).

The cash conversion cycle is the operating cycle less the days of short-term credit extended by suppliers, employees and government (the purchase-to-payment cycle).

7. What are the three components of the cash conversion cycle (C3 )? How is each component calculated?
The three components of the cash conversion cycle are inventory-to-sale conversion period, sales-tocash conversion period, and purchase-to-payment conversion period. The inventory-to-sale conversion period is calculated by dividing average inventories by the venture’s average daily cost of goods sold. The sale-to-cash conversion period is calculated by dividing the average receivables by the net sales per day. The purchase-to-payment conversion period is calculated by dividing the sum of average payables and accrued liabilities by the venture’s cost of goods sold per day.

8. Briefly explain how changes in the conversion times of the components of the C3 can be interpreted.

A lengthening of the inventory-to-sale conversion period indicates less efficient inventory management. A lengthening of the sale-to-cash conversion period indicates less efficient collections or management of receivables. A decrease in the purchase-to-payment period indicates a less efficient use of the credit provided by suppliers, employees and the government. 

9. From the Headlines – Sustainable Northwest: Describe Sustainable Northwest’s short-term inflows and outflows of cash. What would you expect to be the main ingredients of each part of the cash conversion cycle?

Sustainable Northwest is a nonprofit organization with a for-profit wholesale lumberyard called Sustainable Northwest Wood which supports its nonprofit parent’s objectives. The wholesale lumberyard provides raw materials gathered by selective harvesting to small lumber mills for processing, with the processed products then being sold to home builders, suppliers of green building products, etc. The inventory-to-sale conversion period would involve gathering raw wood, processing the raw wood into finished products, and carrying the finished products until sales are made. Credit terms may need to be extended to home builders and other customers, who in turn may need to give credit to their retail customers. Thus, Northwest Wood is likely to incur a sale-to-cash conversion period. Furthermore, given that Northwest Wood is a wholesale lumber yard, any purchase-to-payment conversion period to offset the length of the venture’s operating cycle would have to come from the owners of the forests from which the trees are harvested.