WORKING CAPITAL

MANAGEMENT
Factor vs Reverse Factor

Factor: Supplier sends invoices to

factor

RF: Buyer chooses invoices that he

wants to be aid ear!ier b" the factor
and then, supplier chooses which
of invoices he needs to be aid

RF# strong $%"er and &an"

smaller' or deendent' Suppliers in
need of financing

RF tar(eted at b%"ers who !i)e to (et

!on(er a"&ent ter&s fro& their
s%!iers or disco%nts for ear!ier
a"&ents*

Discount RF-Bank discounts suppliers receivables before their

payment date and the Customer repays the liability to Banks account
on the receivables' payment date.
-Customer can get longer payment terms from his suppliers

Maturity RF:Bank repays the Customers liability to his supplier on

the payment date
-Customers repays the debt in the additional financing period, specified
in the agreement
Benefits for the suppliers:
Bank takes over risk of default on payment of receivables by the
Customer,
Financing ahead of payment date or on payment date at the latest,
Financing without the need to examine credit capacity of the supplier
and the need for him to establish additional collateral
+efinition

Wor)in( Caita!#
+ed%ct what "o%

OWE others ,C%rrent

Liabi!ities- from the s%&
tota! of what "o% HAE
and

!hat you ARE OWE"

,C%rrent Assets-
!
What is Wor)in( Caita! .

/%ant%& of cash a b%siness re0%ires

for r%nnin( da" to da" b%siness
oerations

Financin( conversion of Raw &ateria!

into finished (oods 1 receivin(
roceeds of sa!e thereof in case of
&an%fact%rin( %nits

Stoc#ing of (oods 1 rea!i2ation of

sa!e roceeds in case of Tradin(
%nits
Finance 3 T"es 1
Re0%ire&ents
Wor)in( Caita! Mar(in

Shareholder4s
Contrib%tion

Cash profits earned

during the "ear

Cash reserves of
previous "ears

$ong term loans

WORKING CAPITAL
MANAGEMENT
Net Wor)in( Caita! 5 C%rrent Assets 6 C%rrent
Liabi!ities
Assets Liabilities
Cash 10 Accounts Payable 30
Accounts Receivable 20 Short-term Bank Loan 20
nventory !0 Current Liabilities "0
Current Assets #0 Lon$-term Loan 20
%i&e' Assets 30 Sharehol'ers ()uity 30
Total Assets 100 Total Liabilities and Shareholders Equity 100
*ou$+s *istributors nc,
*ecember 31- 2012
Balance Sheet
"
%urrent Assets
Reresent those assets that wi!! be t%rned into cash within
a

"
e
a
r
fro& the ba!ance date in the nor&a! co%rse of $%siness*
e
*
(
'

Inventories

7toc) of Raw &ateria!

Wor) in Pro(ress

7toc) of Finished Goods

7%ndr" +ebtors

7hort Ter& Loans 1 Advances

Cash 1 Cash E0%iva!ent

An" other ite& d%e within 8 "ear ,Preaid E9enses'

Advance Ta9 etc* -
#
%urrent $ia&ilities
Represent those o&ligations !hich are
repaya&le !ithin a year' e'g',

7%ndr" creditors

Interest accr%ed b%t not d%e

Provisions

Lon( ter& !oan rea"&ent

insta!&ents d%e within 8 "ear

$an) borrowin( for wor)in( caita!

An" other ite& d%e within 8 "ear

Wor)in( caita! re0%ire&ents 6
W:;
peratin! Cycle
I&ortant e0%ations

Operating C"c!e 5
,(nventory :o!din( <
Receivab!e collection-
eriod

%ash C"c!e5
Operating %ycle )
Accounts *aya&le period
Operating cycle
peratin! cycle " R # $ # F # D C
$ % $a& material storage period
' % 'ork in progress holding period
F % Finished goods storage period
( % (ebtors collection period
C % Credit period availed
Oeratin( C"c!e F!ow
)he operating cycle is the time period from the arrival of stock
until receipt of cash. )he cash cycle begins when cash is paid for
materials and ends &hen cash is collected from receivables.
Oeratin( C"c!e for a
Man%fact%rin( Fir&
Cash Conversion C"c!e for a
Man%fact%rin( Fir&
*urchase of $a&
+aterials
%ale on
Credit
Cash $eceived
From Credit ,ale
&nventory
Conversion 'eriod
(vera!e
Collection 'eriod
peratin! Cycle
Cash Conversion Cycle
'ayable
Deferral *eriod
Cash -utlay
MANAGEMENT OF CA7:
CON=ER7ION C;CLE
Cash Conversion C"c!e 5 ,Oeratin( C"c!e- 6
,Acco%nts Pa"ab!e +eferra! Period-
8* Oeratin( C"c!e 5 The ti&e between orderin( of
raw &ateria!s and receivin( cash fro& credit sa!es
>* Inventor" conversion eriod 5 ti&e re0%ired to
order' rod%ce and se!! fina! rod%cts on credit
?* Avera(e co!!ection eriod 5 ti&e re0%ired to
co!!ect cash fro& credit sa!es
@* Acco%nts a"ab!e deferra! eriod 5 ti&e fir& is
ab!e to de!a" a"&ent for raw &ateria!s' wa(es
and other acco%nts
A* Cash conversion c"c!e 5 ti&e between a"&ents
for raw &ateria!s and !abo%r and cash co!!ection
fro& sa!es
OPERATING AN+ CA7: C;CLE7 FOR +OBG47
+I7TRI$BTOR7 INC*
,In this e9a&!e' we %se avera(e ba!ance b%t co%!d a!so %se
"ear6end fi(%res for inventor"' acco%nts receivab!e and acco%nts
a"ab!e-
8* Inventor" Conversion Period
6 Ass%&e that be(innin( of "ear inventor"
ba!ance was C?D and cost of (oods so!d was
C?AD
days
Sold Goods of Cost
entory AverageInv
# . ./ ./#
.#! 0
1
2 "! .! 30
./#

+

OPERATING AN+ CA7: C;CLE7 FOR
+OBG47 +I7TRI$BTOR7 INC*
>* Receivab!es Conversion Period or Avera(e Co!!ection
Period
6 Ass%&e 8DDE of sa!es are on credit
6 Ass%&e that be(innin( of "ear acco%nts
receivab!e was C>D and sa!es was CADD
days
Sales Credit
ceivables Average
1# . 4 ./#
#!! 0
1
2 .! 1! 30
./#
$e

+

OPERATING AN+ CA7: C;CLE7 FOR
+OBG47 +I7TRI$BTOR7 INC*
?* Pa"ab!es +eferra! Period
6 ass%&e be(innin( of
;ear acco%nts a"ab!e was
C>D
@* Oeratin( C"c!e
5 Inventor" Conversion Period <
Receivab!es Conversion Period
5 ?F*AD da"s < 8G*>A da"s
5 A@*>A da"s
A* Cash C"c!e 5 Oeratin( C"c!e 6 Acco%nts
Pa"ab!e +eferra! Period
5 A@*>A da"s 3 >F*DH da"s
5 >G*8G da"s
days
Sold Goods of Cost
Payables Accounts Average
!5 . 1/ ./#
.#! 0
1
2 .! 1! 30
./#

+

+otal %ost
Carr"in(
Cost
7horta(e
Cost
%urrent Asset
,Optimal-
Carr"in(
costs
and
shorta(e
costs
Goa!s of WORKING CAPITAL
MANAGEMENT
8* 7ti&%!ate sa!es b" offerin( c%sto&ers
credit ,acco%nts receivab!e- and read"
(oods for sa!e ,inventor"- Increase
Profits
>* Mini&i2e costs b" ba!ancin( rod%ction and
sa!es !eve!s thro%(h inventor" Increase
Profits
?* 7ec%re !ow cost financin( Increase Profits
@* Reach above ? (oa!s b%t never r%n o%t of
cash b" havin( eno%(h cash and
&ar)etab!e sec%rities on hand andIor b"
!i&itin( %se of short6ter& debt
Iss%es to 7t%d"#
WORKING CAPITAL
MANAGEMENT
8* What t"es and a&o%nts of c%rrent assets
sho%!d a fir& ho!d.
>* What t"es and a&o%nts of short6ter&
financin( sho%!d a fir& e&!o".
?* :ow do fir&s ens%re the" have eno%(h
cash to &eet on6(oin( ob!i(ations.
@* :ow do fir&s forecast their cash needs.
Wor)in( Caita! Po!icies and the
C%rrent Ratio

C%rrent Ratio is a &eas%re of the e9tent to

which c%rrent Assets are financed b"
c%rrent !iabi!ities

C%rrent Ratio 5 C%rrent Assets I C%rrent

Liabi!ities

+o%(4s +istrib%tors has a c%rrent ratio of

HDIAD or 8*@

A c%rrent ratio of 8*@D &eans that for ever"

C8*@D of c%rrent assets there is one do!!ar
of c%rrent !iabi!ities
Ris) Ret%rn ,Li0%idit"
Profitabi!it"- Trade6off# C%rrent
Assets
Bs +, .67%.!!
+,
Ris) Ret%rn Trade6off#
C%rrent Liabi!ities
interest
.!!8/!!
Wor)in( Caita! Po!icies
,Re!ative to Ind%str"-
'orking
Capital
*olicy
9evels of
Current
:ssets
;o&
Current
:ssets are
Financed
Current
$atio
-perating
and Cash
Cycles
)rade-off
Bet&een
*rofitability
and $isk
Conservative ;igh 'ith
9ong-term
(ebt and
<=uity
;igher
than
>ndustry
:verage
9onger
than
>ndustry
:verage
9o&er
*rofits ?
9o&er $isk
:ggressive 9o& 'ith
,hort-term
(ebt
9o&er
than
>ndustry
:verage
,horter
than
>ndustry
:verage
;igher
*rofits ?
;igher $isk
Profitabi!it" vs Ris) Trade6off6A!ternative Financin(
7trate(ies ,8-
Profitabi!it" vs Ris) Trade6off6A!ternative Financin(
7trate(ies,>-
Profitabi!it" vs Ris) Trade6off6
A!ternative Financin(
7trate(ies ,?-
:ow a Conservative Wor)in( Caita! Po!ic"
Lowers Profitabi!it" and Ris)
,=ice6versa for A((ressive Po!ic"-
>mpact ;igher 9evel
of Cash and
+arketable
,ecurities
;igher 9evel
of :ccounts
$eceivable
;igher
9evel of
>nventory
9ess ,hort-term
(ebt ?@reater
9ong-term
9iabilities and
<=uities
9o&er
$eturn
9i=uid assets
earn lo&er
returns than
less li=uid
assets
@reater cost
of financing
and possibly
more &rite-
offs.
;igher
carrying
costs and
higher
obsolescenc
e
'ith up&ard-
sloping yield curve,
interest costs are
higher. <=uity
costs are normally
higher
9ess
$isk
9ess $isk
Because Cash
is $eadily
:vailable
'ont miss a
potentially
profitable
sale.
Fe&er
,tock-outs
9ess short-term
debt payments to
meet.
Wor)in( Caita! Levera(e
,WCL-

WCL5E chan(e in ROI.E chan(e in

%urrent Asset
i'e' sensitivity of RO( ,earning po!er-
to change in %A
RO(/EB(+.+A
If %A is reduced &y 0 %A ,0 %A.%A-, 1
increase in RO(/
23,EB(+.+A40 %A-4
,EB(+.+A-5.EB(+.+A6/0%A.+A40%A
W%$/,0 %A.+A40 %A-.,0
%A.%A-/%A.+A40%A
If %A is increased, W%$/ %A.+A70%A
Wor)in( Caita! Po!icies
Bnderstandin( Li0%idit"

To %nderstand how we!! a co&an" can

&eet its on(oin( cash ob!i(ations ,its
!i0%idit"-' "o% need to %nderstand
whether the fir& is %sin( or (eneratin(
cash f!ow

To he! "o% %nderstand the nat%re of

cash f!ows' "o% need to )now how to
deve!o and interret a state&ent of
cash f!ows

$efore deve!oin( a state&ent of cash

f!ows' !et %s review how the ba!ance
sheet and inco&e state&ents are
created
7%&&ar"

Wor)in( Caita! 5 7hort6ter& Assets

3 7hort6ter& !iabi!ities

Cash Conversion C"c!e

.
Oeratin( c"c!e
.
Cash c"c!e

Po!icies
.
A((ressive
.
Conservative
7tate&ent of Cash F!ows
Bnderstandin( Cash F!ows
O%t!ine

Prearation of ba!ance
sheet and inco&e
state&ent fro&
transactions

7tate&ent of Cash F!ows

Prearin( Pro For&a# 7%!e&entar"
Review of Financia! 7tate&ent
Prearation

A ba!ance sheet is a Jsna shotK of a

co&an"4s affairsL it shows what the
co&an" owns ,its assets-' what it owes
,its !iabi!ities- and how &%ch shareho!ders
have invested in the fir& ,e0%it"-

Assets 5 Liabi!ities < E0%it"

An inco&e state&ent shows how &%ch the

co&an" se!!s ,its reven%e-' what it costs
to oerate the b%siness ,its e9enses- and
how &%ch is !eft over for shareho!ders
,rofit-
Prearation of the $a!ance 7heet and
Inco&e 7tate&ent# A ste6b"6ste
e9a&!e
Ste/ 10 nitial nvestment in Business
Sylvia invests 120-000 in her ne2 business- a clothin$ retailer-
name' Sylvia+s Satins, 3he 4irm establishes an over'ra4t
4acility 2ith a bank 4or 120-000,
Sylvia+s Satins Balance Sheet 5%i$ures in 000+s6
Assets Liabilities
Cash 120 7ver'ra4t 10
Sharehol'ers ()uity
Current Assets 120 Common Shares 20
3otal Assets 120 3otal Liabilities an' Sharehol'ers+ ()uity 120
Prearation of the $a!ance 7heet and
Inco&e 7tate&ent# A ste6b"6ste
e9a&!e
Ste/ 20 Accountin$ 4or Set-u/ costs o4 business
Sylvia s/en's 1"-000 to /ay 4or le$al 4ees
4or settin$ u/ business
Sylvia+s Satins Balance Sheet 5%i$ures in 000+s6
Assets Liabilities
Cash 11" 7ver'ra4t 10

Sharehol'ers ()uity
Current Assets 11" Common Shares 20
ntan$ibles "
3otal Assets 120 3otal Liabilities an' Sharehol'ers+ ()uity 120
Prearation of the $a!ance 7heet and
Inco&e 7tate&ent# A ste6b"6ste
e9a&!e
Ste/ 30 Accountin$ %or leasehol' im/rovements
Sylvia enters into a lease an' s/en's 1"-000 on leasehol' im/rovements
Sylvia+s Satins Balance Sheet 5%i$ures in 000+s6
Assets Liabilities
Cash 110 7ver'ra4t 10

Sharehol'ers ()uity
Current Assets 110 Common Shares 20
Leasehol' m/rovement "
ntan$ibles "
3otal Assets $20 3otal Liabilities an' Sharehol'ers+ ()uity 120
Prearation of the $a!ance 7heet and
Inco&e 7tate&ent# A ste6b"6ste
e9a&!e
Ste/ !0 Accountin$ 4or 4i&e' asset /urchase
Sylvia buys e)ui/ment 4or 110-000,
Sylvia+s Satins Balance Sheet 5%i$ures in 000+s6
Assets Liabilities
Cash 10 7ver'ra4t 10

Sharehol'ers ()uity
Current Assets 10 Common Shares 20
()ui/ment 10
Leasehol' m/rovement "
ntan$ibles "
3otal Assets $20 3otal Liabilities an' Sharehol'ers+ ()uity 120
Prearation of the $a!ance 7heet and
Inco&e 7tate&ent# A ste6b"6ste
e9a&!e
Ste/ "0 Accountin$ 4or /urchase o4 inventory
Sylvia+s 4irm buys 180-000 o4 shirts 4rom a su//lier on cre'it
Sylvia+s Satins Balance Sheet 5%i$ures in 000+s6
Assets Liabilities
Cash 10 7ver'ra4t 10
Accounts Payable 80
nventory 80
Sharehol'ers ()uity
Current Assets 80 Common Shares 20
()ui/ment 10
Leasehol' m/rovement "
ntan$ibles "
3otal Assets 190 3otal Liabilities an' Sharehol'ers+ ()uity 190
Prearation of the $a!ance 7heet
and Inco&e 7tate&ent# A ste6b"6
ste e9a&!e
Ste/ 80 Accountin$ 4or sales
Sylvia+s 4irm sells 130-000 o4 inventory 4or 1!0-000 on cre'it
Sylvia+s Satins Balance Sheet 5%i$ures in 000+s6
Assets Liabilities
Cash 10 7ver'ra4t 10
Accounts Receivable !0 Accounts Payable 80
nventory 30
Sharehol'ers ()uity
Current Assets 1#0 Common Shares 20
()ui/ment 10 Retaine' (arnin$s 110
Leasehol' m/rovement "
ntan$ibles "
3otal Assets 1:0 3otal Liabilities an' Sharehol'ers+ ()uity 1:0
ncome Statement o4 Sylvia+s Satins
Revenue 1!0
Cost o4 ;oo's Sol' 30
;ross <ar$in 110
Prearation of the $a!ance 7heet
and Inco&e 7tate&ent# A ste6b"6
ste e9a&!e
Ste/ #0 Accountin$ 4or /ayments to su//liers
Sylvia /ays o44 120-000 o4 /ayables
Sylvia+s Satins Balance Sheet 5=C7<( S3A3(<(=3 >=C?A=;(*6
Assets Liabilities
Cash 10 7ver'ra4t 120
Accounts Receivable !0 Accounts Payable !0
nventory 30
Sharehol'ers ()uity
Current Assets 1#0 Common Shares 20
()ui/ment 10 Retaine' (arnin$s 10
Leasehol' m/rovement "
ntan$ibles "
3otal Assets 1:0 3otal Liabilities an' Sharehol'ers+ ()uity 1:0
Prearation of the $a!ance 7heet
and Inco&e 7tate&ent# A ste6b"6
ste e9a&!e
Ste/ 90 Account 4or collection o4 accounts receivable
Sylvia receives 110-000 o4 cash 4rom customers in collectin$ accounts receivable
Sylvia+s Satins Balance Sheet 5=C7<( S3A3(<(=3 >=C?A=;(*6
Assets Liabilities
Cash 10 7ver'ra4t 110
Accounts Receivable 30 Accounts Payable !0
nventory 30
Sharehol'ers ()uity
Current Assets 180 Common Shares 20
()ui/ment 10 Retaine' (arnin$s 10
Leasehol' m/rovement "
ntan$ibles "
3otal Assets 190 3otal Liabilities an' Sharehol'ers+ ()uity 190
Prearation of the $a!ance 7heet
and Inco&e 7tate&ent# A ste6b"6
ste e9a&!e
Ste/ :0 Account 4or /ayment o4 interest
Com/any s char$e' 11-000 o4 interest an' bank char$es relate' to over'ra4t,
Sylvia+s Satins Balance Sheet 5%i$ures in 000+s6
Assets Liabilities
Cash 10 7ver'ra4t 111,0
Accounts Receivable 30 Accounts Payable !0
nventory 30
Sharehol'ers ()uity
Current Assets 180 Common Shares 20
()ui/ment 10 Retaine' (arnin$s :
Leasehol' m/rovement "
ntan$ibles "
3otal Assets 190,0 3otal Liabilities an' Sharehol'ers+ ()uity 190,0
Sylvia Satin+s ncome Statement
Revenue 1!0,0
Cost o4 ;oo's Sol' 30,0
;ross <ar$in 110,0
nterest 1,0
=et ncome Be4ore 3a& 1:,0
Prearation of the $a!ance 7heet
and Inco&e 7tate&ent# A ste6b"6
ste e9a&!e
Ste/ 100 Account 4or 'e/reciation an' amorti@ation
Com/any 'e/reciates e)ui/ment on strai$ht-line basis over " years 5use4ul li4e
o4 e)ui/ment6 an' over 10 years 5lease term6 4or leasehol' im/rovements
Sylvia+s Satins Balance Sheet 5%i$ures in 000+s6
Assets Liabilities
Cash 10 7ver'ra4t 111
Accounts Receivable 30 Accounts Payable !0
nventory 30
Current Assets 180 Sharehol'ers ()uity
()ui/ment 9 Common Shares 20
Leasehol' m/rovement !," Retaine' (arnin$s 8,"
ntan$ibles "
3otal Assets 1##," 3otal Liabilities an' Sharehol'ers+ ()uity 1##,"
Sylvia Satin+s ncome Statement
Revenue 1!0,0
Cost o4 ;oo's Sol' 30,0
;ross <ar$in 110,0
nterest 1,0
*e/reciation 2,0
Amorti@ation 0,"
=et ncome Be4ore 3a& 18,"
Prearation of the $a!ance 7heet
and Inco&e 7tate&ent# A ste6b"6
ste e9a&!e Ste/ 110 Accountin$ 4or 3a&es
3he income ta& rate is !0A, Be 2ill i$nore 'e4erre' ta&es,
Com/any 2on+t /ay ta&es until a4ter year en',
Sylvia+s Satins Balance Sheet 5%i$ures in 000+s6
Assets Liabilities
Cash 10 7ver'ra4t 111,0
Accounts Receivable 30 Accounts Payable !0
nventory 30 3a&es Payable 2,8

Current Assets 180
()ui/ment 9 Common Shares 20
Leasehol' m/rovement !," Retaine' (arnin$s 13,:
ntan$ibles "
3otal Assets 1##," 3otal Liabilities an' Sharehol'ers+ ()uity 1##,"
Sylvia Satin+s ncome Statement
Revenue 1!0,0
Cost o4 ;oo's Sol' 30,0
;ross <ar$in 110,0
nterest 1,0
*e/reciation 2,0
Amorti@ation 0,"
=et ncome Be4ore 3a& 18,"
3a&es 2,8
=et ncome A4ter 3a& 13,:
I&ortance of Cash F!ows# Li0%idit"

A!tho%(h 7"!via4s fir& is rofitab!e' it is

i&ortant to %nderstand how it was ab!e to
(enerate eno%(h cash to &eet its
ob!i(ations* In other words' how !i0%id is
7"!via4s 7atins.

Li0%idit" is a critica! asect of a co&an"4s

financia! erfor&ance* The a"ro!! &%st be
&et* $efore a fir& can (et a !oan fro& a
ban) or credit fro& a s%!ier' it &%st
show itse!f to be !i0%id*

To assess !i0%idit"' we need to %nderstand

the factors affectin( fir&4s on6(oin( abi!it"
to (enerate cash*
7tate&ent of Cash F!ows
7a!es
6 Cost of Goods 7o!d
6 7e!!in(' Genera! and Ad&inistration E9enses Net
Income
6 Interest
6 Inco&e Ta9es
<Non6cash e9enses e*(*dereciation
5 Cash Flows From Operating Activities
6 Increase in Acco%nts Receivab!e
6 Increase in Inventor" Change in Net Working
Capital
< Increase in Acco%nts Pa"ab!e
6 P%rchases of Fi9ed Assets Net Capital
Expenditures
< 7a!es of Fi9ed Assets
6 Pa"&ents to Owners of $%siness
5 Cash Generated (Used) By Business Available
for epayment of !ebts
7tate&ent of Cash F!ows
for 7"!via4s 7atins
Sales 1!0,0
- Cost o4 ;oo's Sol' 30,0
C ;ross Pro4it 110,0
- Sellin$- ;eneral an' A'ministration (&/enses 2,"
- nterest 1,0
- ncome 3a&es 2,8
C=et ncome 13,:
D =on-cash (&/enses 5'e/reciation- amorti@ation6 12,"
CCash %lo2s 4rom 7/eratin$ Activities 18,!
- ncrease in Accounts Receivable 130,0
- ncrease in nventory 30,0
D ncrease in Accounts Payable an' other Payables !2,8
- Purchases o4 %i&e' Assets an' other Ca/ital (&/en'itures 20,0
D Sales o4 %i&e' Assets 0,0
- Payments to 72ners o4 Business 7ther than Salary 0,0
Cash ;enerate' 5>se'6 By Business Available 4or Re/ayment o4 *ebts -131,0
Financin( Cash F!ow +eficiencies

If 7"!via4s 7atins %sed % C?8'DDD

cash in its on6(oin( oerations' how
was this financed.
Oenin( Cash $a!ance
C>D'DDD
Less# Cash Bsed
C?8'DDD
Cash 7%r!%s ,+eficienc"- 6
C88'DDD

+eficienc" was financed b" ban)

overdraft
Cash F!ow +rivers
E!even Ke" Cash F!ow +rivers
Re!ationshi with Cash F!ow
8* 7a!es Growth Bs%a!!" ne(ative
>* Gross Mar(in E ,Gross ProfitI7a!es-
ositive
?* 7e!!in(' Genera! and Ad&inistration
,7GA- as E of 7a!es ne(ative
@* Interest E9ense
ne(ative
A* Non6cash E9enses ositive
F* Inco&e Ta9 Rate
ne(ative
H* Avera(e Co!!ection Period ,ACP- ne(ative
G* Inventor" Conversion Period
ne(ative
M* Acco%nts Pa"ab!e Period ositive
8D* Net Caita! E9endit%res ne(ative
88* Owner4s Withdrawa!s fro& Fir& ne(ative
Re!ationshi of E9enses to
Cash F!ow

Co&anies with hi(her rofit &ar(ins

,fir&s with !ow cost of (oods so!d and !ow
7GA as E of sa!es- (enerate &ore cash

Converse!"' fir&s that inc%r !osses

(enera!!" %se % cash and wi!! enco%nter
rob!e&s rea"in( !oans if !osses are not
ste&&ed* LOAN7 7:OBL+ NOT $E
GRANTE+ TO FBN+ 7B7TAINE+ LO77E7
OF $ORROWER7*

7i(nificant non6cash e9enses rovide

so&e re!ief b%t on!" where re(%!ar
caita! e9endit%res are not re0%ired
Re!ationshi of Avera(e Co!!ection
Period to Cash F!ow
Avera(e Co!!ection Period ,ACP- is ca!c%!ated as#
Acco%nts Receivab!e
7a!esI?FA

In case of 7"!via4s 7atins' ACP is C?DI,C@DI?FA- or >H@

da"s
One can esti&ate Acco%nts Receivab!e as#
7a!es N ACP
?FA
If sa!es do%b!e to CGD and ACP re&ains %nchan(ed' then
Acco%nts Receivab!e wo%!d a!so do%b!e i*e* ,CGDN>H@-I?FA
5 CFD
If ACP decreases in ha!f to 8?H da"s' endin( Acco%nts
Receivab!e wo%!d e0%a! ,C@DN8?H-I?FA 5 C8A and fir&
wo%!d (enerate C8A &ore cash in the "ear
Re!ationshi of Inventor" Conversion
Period to Cash F!ow
Inventor" Conversion Period is ca!c%!ated as#
Inventor"
Cost of Goods 7o!dI?FA
In case of 7"!via4s 7atins' Inventor" Conversion Period is
C?DI,C?DI?FA- or ?FA da"s
One can esti&ate Inventor" as#
Cost of Goods 7o!d N Inventor" Conversion Period
?FA
If cost of (oods so!d do%b!es to CFD and Inventor"
Conversion Period re&ains %nchan(ed' then Inventor"
wo%!d a!so do%b!e i*e* ,CFDN?FA-I?FA 5 CFD
If Inventor" Conversion Period decreases in ha!f to 8G?
da"s' endin( inventor" wo%!d e0%a! ,C?DN8G?-I?FA 5 C8A
and fir& wo%!d (enerate C8A &ore cash in the "ear
Re!ationshi of Acco%nts Pa"ab!e
Period to Cash F!ow
Pa"ab!es +eferra! Period
5 ,Pa"ab!es-I,Cost of Goods 7o!d < Other Oeratin( E9enses- O
?FA
In case of 7"!via4s 7atins' Pa"ab!es +eferra! Period is
,C@D-I,C?DI?FA- or @GH da"s
One can esti&ate Acco%nts Pa"ab!e as#
Cost of Goods 7o!d N Acco%nts Pa"ab!e Period
?FA
If cost of (oods do%b!es and Pa"ab!es +eferra! Period
re&ains %nchan(ed' then Acco%nts Pa"ab!e wo%!d a!so
do%b!e i*e* ,CFDN@GH-I?FA 5 CGD
If co&an" a"s its s%!iers in ha!f the ti&e' endin(
acco%nts a"ab!e wo%!d e0%a! ,C?DN>@?-I?FA 5 C>D and
fir& wo%!d %se % C>D &ore cash in the "ear
Re!ationshi of 7a!es Growth to Cash
F!ow

If a co&an" is se!!in( on credit' an increase

in sa!es %s%a!!" %ses % cash as the fir&
b%"sIb%i!ds &ore inventor"' se!!s it and then
has to wait to (et aid b" its c%sto&ers i*e*
there is an increase in both inventor" and
acco%nts receivab!e*

Even for fir&s that strict!" se!! on a cash

basis' an increase in sa!es sti!! &eans that it
needs to increase its inventor"*

In &ost cases' the cash re0%ired to b%i!d6%

inventor" and receivab!es &ore than offsets
a"ab!es increase as we!! as the increased
cash f!ow fro& oerations

I&act of +o%b!in( of 7a!es of 7"!via4s 7atins on Cash
F!ow of Fir&
Sales 190,0
- Cost o4 ;oo's Sol' 80,0
C ;ross Pro4it 120,0
- Sellin$- ;eneral an' A'ministration (&/enses 5S;A6 2,"
- nterest 3,0
- ncome 3a&es ",9
C=et ncome 19,#
D =on-cash (&/enses 5'e/reciation- amorti@ation6 12,"
CCash %lo2s 4rom 7/eratin$ Activities 111,2
- ncrease in Accounts Receivable 180,0
- ncrease in nventory 80,0
D ncrease in Accounts Payable 5inclu'es 3a&es Payables6 9",9
- Purchases o4 %i&e' Assets an' other Ca/ital (&/en'itures 20,0
D Sales o4 %i&e' Assets 0,0
- Payments to 72ners o4 Business 7ther than Salary 0,0
Cash ;enerate' 5>se'6 By Business Available 4or Re/ayment o4 *ebts -1!3,0
,ales, gross profit, :?$, inventory, payables all double ? ,@: and non-cash
eApenses dont increase &ith sales ? interest increases to 0. &ith more
borro&ing ? income taAes e=ual "!6 of 301!-1.#-..!2 or 0#.4
Re!ationshi of 7a!es Growth to Cash
F!ow

With increased sa!es' 7"!via4s 7atins wo%!d

increase its rofit fro& C?'MDD to CG'HDD b%t
e9erience an increase in cash o%tf!ow fro&
6C?8'DDD to 6C@?'DDD and therefore end the
"ear with a hi(her ban) overdraft

7it%ation wo%!d be worse where fir&

e9eriences s%bstantia! (rowth and is
caita! intensive i*e* it needs &ore caita!
e9endit%res to faci!itate e9ansion

These e9endit%res !ace (reater ress%re

on the cash f!ow of the fir&

Re!ationshi of Profitabi!it" and
Li0%idit"

Most often' c!ients who strive to be &ore

rofitab!e %s%a!!" i&rove their !i0%idit" as
hi(her rofit &ar(ins and better cost
contro!s enhance cash f!ows

F%rther&ore' a &ore rofitab!e b%siness

&a)es it easier for the fir& to attract other
so%rces of credit as we!! as o%tside e0%it"

:owever' as shown in the !ast e9a&!e'

so&eti&es fir&s see) to e9and their
b%sinesses to increase or at !east reserve
rofitabi!it"* This %ts the c!ient4s desire for
rofitabi!it" at odds with the need to
&aintain !i0%idit"
Re!ationshi of Caita!
E9endit%res and Li0%idit"

Most fir&s eriodica!!" need to &a)e

s%bstantia! caita! e9endit%res' at the ver"
!east to &aintain their oerations or to )ee
% with the co&etition
.
Grocer" stores need to re!ace free2ers
.
Fashion retai!ers need new fi9t%res
.
+e!iver" fir&s need to re!ace vans

These e9endit%res !ace a heav" drain on

cash f!ow and conse0%ent!"#
.
C!ients sho%!d e9tend !ife of their fi9ed assets
thro%(h reventative &aintenance
.
C!ients sho%!d ac0%ire assets with stron(
warranties and ins%rance rotection
Re!ationshi of Caita!
E9endit%res and Li0%idit"

Financin( of Caita! E9endit%res sho%!d

be str%ct%red so that the eriod of the
rea"&ent of rincia! &atches the !ife
of the asset
.
Ter& financin( or !ease arran(e&ent for
e0%i&ent
.
Lon(6ter& &ort(a(e for rea! estate

E9cessive %se of short6ter& debt creates

too &%ch de&and on cash f!ows in the
eriod when the asset is first ac0%ired
Identif"in( Trends in Cash F!ow
+rivers# Case of a co&an" !osin( to
co&etition 2000 2001 2002 Possible Concern 5*irect m/act on Cash %lo26
Sales ;ro2th "A -:A -10A Losin$ sales to com/etition
;ross <ar$in A 30A 2:A 2#A Lo2er mar$ins because o4 more com/etition
S;A A 19A 20A 21A Costs mainly 4i&e' -- increase as A o4 sales
nterest (&/ense 11-000 11-200 11-!00 <ore borro2in$ increases interest /ai'
ncome 3a& Rate 3"A 3"A 0A (44ective rate 4alls as losses increase
Avera$e Collection Perio' !" 'ays !: 'ays "2 'ays <ore cre'it-seekin$ customers
nventory Conversion Perio' 3! 'ays 39 'ays !" 'ays >nsol' inventory buil's
Accounts Payable Perio' 3" 'ays !3 'ays "3 'ays ;reater reliance on su//lier cre'it
=et Ca/ital (&/en'itures 12-000 1-000 800 *ecrease' sales lessens nee' 4or CAP(E
72ner+s Bith'ra2als 4rom %irm 2"-000 3"-000 !0-000 72ner tries to /reserve /ersonal 2ealth
'ossible %teps to &mprove Cash Flows:
)imit owner*s withdrawals from firm
Review profitability of product mix
Review possible cost-cuttin! measures
More Closely Monitor (+R, &nventory and 'ayables )evels
Identif"in( Trends in Cash F!ow +rivers#
Case of a co&an" e9andin( sa!es at
e9ense of !ower (ross rofit &ar(ins
2000 2001 2002 Possible Concern 5*irect m/act on Cash %lo26
Sales ;ro2th "A 10A 1"A A$$ressively sellin$
;ross <ar$in A 30A 29A 2"A Lo2er /rices to attract customers
S;A A 19A 1#A 18A Costs mainly 4i&e' -- 'ecrease as A o4 sales
nterest (&/ense 11-000 11-200 11-!00 Bi$$er over'ra4t increases interest /ai'
ncome 3a& Rate 3"A 3"A 3"A
Avera$e Collection Perio' !" 'ays !: 'ays "2 'ays (asier cre'it to attract customers
nventory Conversion Perio' 3! 'ays 33 'ays 32 'ays nventory moves 4aster
Accounts Payable Perio' 3" 'ays !3 'ays "3 'ays ;reater reliance on su//lier cre'it
=et Ca/ital (&/en'itures 12-000 2"-000 3"-000 (&/ansion re)uires increase in CAP(E
72ner+s Bith'ra2als 4rom %irm 2"-000 30-000 3"-000 72ner thinks bi$$er 4irm
entitles him to bi$$er com/ensation
'ossible %teps to &mprove Cash Flows:
9imit o&ners &ithdra&als from firm
$evie& profitability of eApansion plans
+ore Closely +onitor :?$ and *ayables 9evels
>ncrease use of term debt or other long-term financing e.g. e=uity

7i(ns of Li0%idit" Prob!e&s

+ec!ine in dai!" or wee)!" cash inf!ows

Profitabi!it" and Oeratin( Cash F!ow 70%ee2e

66 Increased costs that the fir& is %nab!e to ass
on to c%sto&ers

Bne9ected b%i!d6% of Acco%nts Receivab!e

Bne9ected b%i!d6% of Inventor"

+ec!ine in fir&4s net wor)in( caita!' c%rrent

ratio or an increase in its short6ter& and tota!
debt ratios ,7hort6ter& +ebtI Tota! Assets and
Tota! +ebtI Tota! Assets-
Cash $%d(ets 1 Pro For&a
7tate&ents
Forecastin( Cash F!ows
O%t!ine

Wh" forecast cash f!ows.

Cash b%d(et

Pro For&a
.
Inco&e 7tate&ent
.
$a!ance 7heet

Percent of sa!es &ethod

Mana(in( Li0%idit" and the Need to
Forecast Cash F!ows

Co&anies need to !an for their cash needs to

ens%re the" have s%fficient cash to#
.
Meet on6(oin( ob!i(ations s%ch as the a"ro!!
.
Meet contin(encies s%ch as an increased need for
wor)in( caita! ,sensitivit" ana!"sis is esecia!!"
i&ortant-
. $e ab!e to invest when attractive oort%nities arise

The" need to roPect a cash b%d(et that

forecasts cash inf!ows and o%tf!ows on a
&onth!" basis*

Cash b%d(etin( is esecia!!" i&ortant in

seasona! and (rowin( b%sinesses*

Cash b%d(ets sho%!d tie in with ro for&a

inco&e state&ents and ba!ance sheets*
Prearin( Co&rehensive Pro
For&a Financia! 7tate&ents
,ales Forecast *roduction Forecast
Cash Flo& Forecast
*ro Forma >ncome
,tatement
*ro Forma Balance ,heet
,ales, production and cash flo& forecasts are usually done on
a monthly basis &hereas pro forma income and balance sheets
are done an annual basis
EOAMPLE OF CA7: $B+GET AN+
PRO FORMA FINANCIAL 7TATEMENT7
8ey Assumptions for 9adget %ompany
,Startup Business-
Sales

Month!" sa!es of 8D'DDD %nits

First &onth of sa!es is Febr%ar" >DD?

$ased on contract with distrib%tor

Cash $%d(et

AIR 6 Q sa!es co!!ected within one6&onth

fo!!owin( sa!e and the other Q co!!ected two
&onths fo!!owin( sa!e
Cash Co!!ections fro&
7a!es
Month January February March April
Sales of ad!et
Co"pany
10 11"-900 11"-900 11"-900
Cash #nflo$s fro"
A% Collection&
'urin! Month
After Sale
1#:00 1#:00
'urin! 2nd Month
After Sale
1#:00
Total Collections 0 0 1#-:00 11"-900
Bey :ssumptions: Company &ill sell !,!!! units a month 70.#4 each.
;alf of accounts receivable &ill be collected one month after sale.
;alf of accounts receivable &ill be collected t&o months after sale.
Cash Co!!ections and Acco%nts
Receivab!e
Month (ctober )o*e"ber 'ece"ber Total for
+ear
Sales of ad!et
Co"pany
11"-900 11"-900 11"-900 11#3-900
Cash #nflo$s fro"
A% Collection&
'urin! Month
After Sale
1#:00 1#:00 1#:00 1#:-000
'urin! 2nd Month
After Sale
1#:00 1#:00 1#:00 1#1-100
Total Collections 11"-900 11"-900 11"-900 11"0-100
Bey :ssumptions: Company sold 05.,4!! of goods but received only 0#!,!!.
)he difference of 01.,5!! represents the increase in accounts receivable during
year. -f the 01.,5!! in accounts receivable at year end, (ecember sales represent
0#,4!! and half of Covember sales represent 05,D!!.
Cash Pa"&ents to
7%!iers
Month January February March April
,urchases of
ad!et Co"pany
110-000 110-000 110-000 110-000
Cash ,ay"ent to
Suppliers
$-0.000 $-0.000 $-0.000
Bey :ssumptions: Company &ill purchase one month in advance of sales.
- +onth-end inventory &ill e=ual the current months purchases.
<ach unit costs 0.!! to purchase.
,upplier &ill be paid one month after purchase.
Cash Pa"&ents and Acco%nts
Pa"&ents
Month (ctober )o*e"ber 'ece"ber Total for
+ear
,urchases of
ad!et Co"pany
110-000 110-000 110-000 1120-000
Cash ,ay"ents to
Suppliers
$-0.000 $-0.000 $-0.000 $--0.000
Bey :ssumptions: Company purchased 01!,!!! of goods but paid for only
0!,!!! by year end.
)he difference of 0!,!!! represents the increase in accounts payable during year.
)he 0!,!!! accounts payable at year end is for (ecember purchases.
Forecastin( Cash F!ow6
sreadsheet
Ke" Ass%&tions for Gad(et Co&an"
%ash Budget

Genera! and ad&inistration costs 5

C?'HAD er &onth

Interest is char(ed on revio%s &onth4s

!oan ba!ance at an ann%a! rate of 8>E*
The &onth!" rate is 8>EI8> or 8E*

C8D'DDD oenin( cash ba!ance

*ro Forma (ncome Statement

+ereciation 5 C>AD er &onth

no accr%a! is &ade for interest e9ense

at "ear end
Cash $%d(et
Month January February March April
Total Collections 0 0 1#-:00 11"-900
Cash (utflo$s&
Cash ,ay"ent to
Suppliers
$-0.000 $-0.000 $-0.000
eneral E/penses 13-#"0 13-#"0 13-#"0 13-#"0
#nterest E/pense 0 0 01 -23
Total Cash (utflo$s 13-#"0 113-#"0 113-92" 113-99!
=et 7/eratin$ Cash %lo2 513-#"06 5113-#"06 51"-:2"6 11-:18
Be$innin$ Cash Balance
5Borro2in$6
110-000 18-2"0 51#-"006 5113-!2"6
(n'in$ Cash Balance
5Borro2in$6
18-2"0 51#-"006 5113-!2"6 5111-"0:6
Cash $%d(et
Month (ctober )o*e"ber 'ece"ber Total for
+ear
Total Collections 11"-900 11"-900 11"-900 11"0-100
Cash (utflo$s&
Cash ,ay"ent to
Suppliers
$-0.000 $-0.000 $-0.000 $--0.000
eneral E/penses 13-#"0 13-#"0 13-#"0 1!"-000
#nterest E/pense -4 0 0 404
Total Cash (utflo$s 113-#88 113-#"0 113-#"0 11""-808
=et 7/eratin$ Cash
%lo2
2-03! 2-0"0 2-0"0 5"-"086
Be$innin$ Cash
Balance 5Borro2in$6
51-83:6 13:! 12-!!! 110-000
(n'in$ Cash Balance
5Borro2in$6
13:! 12-!!! 1!-!:! 1!-!:!
R an Feb Mar Ari! Ma" R %ne R %!"
7a!es Forecast 8A'GDD 8A'GDD 8A'GDD 8A'GDD 8A'GDD 8A'GDD
Cash I nf!ows Fro& Co!!ections H'MDD 8A'GDD 8A'GDD 8A'GDD 8A'GDD
P%rchases Fro& 7%!iers 8D'DDD 8D'DDD 8D'DDD 8D'DDD 8D'DDD 8D'DDD 8D'DDD
Cash O%tf!ows to 7%!iers 8D'DDD 8D'DDD 8D'DDD 8D'DDD 8D'DDD 8D'DDD
Genera! 1 Ad&in E9enses ?'HAD ?'HAD ?'HAD ?'HAD ?'HAD ?'HAD ?'HAD
+ereciation >AD >AD >AD >AD >AD >AD >AD
I nterest D D HA 8?@ 88A MF HF
Ta9es D D D D D D D
Net Cash F!ow 6?'HAD 68?'HAD 6A'M>A 8'M8F 8'M?A 8'MA@ 8'MH@
$e(innin( of Month Cash 8D'DDD F'>AD 6H'ADD 68?'@>A 688'ADM 6M'AH@ 6H'F>D
End of Month Cash F'>AD 6H'ADD 68?'@>A 688'ADM 6M'AH@ 6H'F>D 6A'F@F
D >DD> R an Feb Mar Ari! Ma" R %ne R %!"
7a!es D D 8A'GDD 8A'GDD 8A'GDD 8A'GDD 8A'GDD 8A'GDD
Cost of Goods 7o!d D D 8D'DDD 8D'DDD 8D'DDD 8D'DDD 8D'DDD 8D'DDD
Gross Mar(in D D A'GDD A'GDD A'GDD A'GDD A'GDD A'GDD
Genera! 7a!es 1 Ad&inistrative E9enses D ?'HAD ?'HAD ?'HAD ?'HAD ?'HAD ?'HAD ?'HAD
+ereciation D >AD >AD >AD >AD >AD >AD >AD
I nterest E9enses D D D HA 8?@ 88A MF HF
Profit $efore Ta9es D 6@'DDD 8'GDD 8'H>A 8'FFF 8'FGA 8'HD@ 8'H>@
Ta9es D D D D D D D D
Profit After Ta9es D 6@'DDD 8'GDD 8'H>A 8'FFF 8'FGA 8'HD@ 8'H>@
>DD>
R an Feb Mar Ari! Ma" R %ne R %!"
Cash 8DDDD F'>AD D D D D D D
Acco%nts Receivab!e D D 8A'GDD >?'HDD >?'HDD >?'HDD >?'HDD >?'HDD
I nventor" D 8D'DDD 8D'DDD 8D'DDD 8D'DDD 8D'DDD 8D'DDD 8D'DDD
8DDDD 8F'>AD >A'GDD ??'HDD ??'HDD ??'HDD ??'HDD ??'HDD
Net Fi9ed Assets >GADD >G'>AD >G'DDD >H'HAD >H'ADD >H'>AD >H'DDD >F'HAD
Tota! Assets ?GADD @@'ADD A?'GDD F8'@AD F8'>DD FD'MAD FD'HDD FD'@AD
Acco%nts Pa"ab!e D 8D'DDD 8D'DDD 8D'DDD 8D'DDD 8D'DDD 8D'DDD 8D'DDD
$an) Loan D D H'ADD 8?'@>A 88'ADM M'AH@ H'F>D A'F@F
D 8D'DDD 8H'ADD >?'@>A >8'ADM 8M'AH@ 8H'F>D 8A'F@F
7hareho!ders4 E0%it" ?GADD ?@'ADD ?F'?DD ?G'D>A ?M'FM8 @8'?HF @?'DGD @@'GD@
?G'ADD @@'ADD A?'GDD F8'@AD F8'>DD FD'MAD FD'HDD FD'@AD
A%( 7et* Oct Nov +ec >DD?
7a!es Forecast 8A'GDD 8A'GDD 8A'GDD 8A'GDD 8A'GDD 8H?'GDD
Cash I nf!ows Fro& Co!!ections 8A'GDD 8A'GDD 8A'GDD 8A'GDD 8A'GDD 8AD'8DD
P%rchases Fro& 7%!iers 8D'DDD 8D'DDD 8D'DDD 8D'DDD 8D'DDD 8>D'DDD
Cash O%tf!ows to 7%!iers 8D'DDD 8D'DDD 8D'DDD 8D'DDD 8D'DDD 88D'DDD
Genera! 1 Ad&in E9enses ?'HAD ?'HAD ?'HAD ?'HAD ?'HAD @A'DDD
+ereciation >AD >AD >AD >AD >AD ?'DDD
I nterest AF ?H 8F D D FDF
Ta9es D D D D D D
Net Cash F!ow 8'MM@ >'D8? >'D?@ >'DAD >'DAD 6A'ADF
$e(innin( of Month Cash 6A'F@F 6?'FA? 68'F?M ?M@ >'@@@
End of Month Cash 6?'FA? 68'F?M ?M@ >'@@@ @'@M@
D >DD> A%( 7et* Oct Nov +ec >DD?
7a!es D 8A'GDD 8A'GDD 8A'GDD 8A'GDD 8A'GDD 8H?'GDD
Cost of Goods 7o!d D 8D'DDD 8D'DDD 8D'DDD 8D'DDD 8D'DDD 88D'DDD
Gross Mar(in D A'GDD A'GDD A'GDD A'GDD A'GDD F?'GDD
Genera! 7a!es 1 Ad&inistrative E9enses D ?'HAD ?'HAD ?'HAD ?'HAD ?'HAD @A'DDD
+ereciation D >AD >AD >AD >AD >AD ?'DDD
I nterest E9enses D AF ?H 8F D D FDF
Profit $efore Ta9es D 8'H@@ 8'HF? 8'HG@ 8'GDD 8'GDD 8A'8M@
Ta9es D D D D D D D
Profit After Ta9es D 8'H@@ 8'HF? 8'HG@ 8'GDD 8'GDD 8A'8M@
>DD>
A%( 7et* Oct Nov +ec >DD?
Cash 8DDDD D D ?M@ >'@@@ @'@M@ @'@M@
Acco%nts Receivab!e D >?'HDD >?'HDD >?'HDD >?'HDD >?'HDD >?'HDD
I nventor" D 8D'DDD 8D'DDD 8D'DDD 8D'DDD 8D'DDD 8D'DDD
8DDDD ??'HDD ??'HDD ?@'DM@ ?F'8@@ ?G'8M@ ?G'8M@
Net Fi9ed Assets >GADD >F'ADD >F'>AD >F'DDD >A'HAD >A'ADD >A'ADD
Tota! Assets ?GADD FD'>DD AM'MAD FD'DM@ F8'GM@ F?'FM@ F?'FM@
Acco%nts Pa"ab!e D 8D'DDD 8D'DDD 8D'DDD 8D'DDD 8D'DDD 8D'DDD
$an) Loan D ?'FA? 8'F?M D D D D
D 8?'FA? 88'F?M 8D'DDD 8D'DDD 8D'DDD 8D'DDD
7hareho!ders4 E0%it" ?GADD @F'A@H @G'?88 AD'DM@ A8'GM@ A?'FM@ A?'FM@
?G'ADD FD'>DD AM'MAD FD'DM@ F8'GM@ F?'FM@ F?'FM@
Gad(et Co&an"# ProPected Inco&e 7tate&ent
for ;ear Ended +ece&ber ?8' >DD?
7a!es
C 8H?'GDD
Cost of Goods 7o!d#
P%rchases 8>D'DDD
Less# Endin( Inventor" 8D'DDD
88D'DDD
Gross Profit F?'GDD
Genera! E9enses @A'DDD
+ereciation ?'DDD
Interest FDF
@G'FDF
Net Profit C8A'8M@
Gad(et Co&an"# Pro For&a
$a!ance 7heet +ece&ber ?8'
>DD?
Actual ,ro5ected Actual ,ro5ected
2002 2002 2002 2002
Current Assets Liabilities
Cash 110-000 !-!:! Accounts ,ayable 10 110-000
Accounts %ecei*able 0 23-#00 6an7 #ndebtedness 0 0
#n*entory 0 10-000 10 110-000
110-000 139-1:!
Equip"ent Shareholders Equity
Cost 129-"00 129-"00 Co""on Stoc7 139-"00 139-"00
Less& Accu"8 'ep8 0 3-000 %etained Earnin!s 0 1"-1:!
129-"00 12"-"00 139-"00 1"3-8:!
Total Liabilities and
Total Assets 139-"00 183-8:! Shareholders Equity 139-"00 183-8:!
E of 7a!es Method# Pro For&a Mode!
In(redients
7a!es Forecast

+rives the &ode!

Pro For&a 7tate&ents

The o%t%t s%&&ari2in( different

roPections
Asset Re0%ire&ents

Invest&ent needed to s%ort sa!es

(rowth
Financia! Re0%ire&ents

+ebt and dividend o!icies

The JP!%(KK

+esi(nated so%rce,s- of e9terna! financin(

Econo&ic Ass%&tions

7tate of the econo&"' interest rates'

inf!ation
:istorica! Financia! 7tate&ents for 7t*
+i!bert Phar&ace%tica!s
>ncome ,tatement
,ales 0#!!
Costs 1.# "56 of ,ales
(epreciation 1! 1!6 of Cet FiAed :ssets
>nterest "! !6 of last periods (ebt
)aAable >ncome !#
)aAes ./ ."6 of )aAable >ncome
Cet >ncome 0/D
$etained 01.
(ividends 0"/ /56 of Cet >ncome
Balance ,heet
Current assets 0"!! )otal (ebt 0"#!
Cet fiAed assets /!! -&ners <=uity ##!
)otal :ssets 0,!!! )otal 9iabilities 0,!!!
S Tota! Assets are
>DDE of sa!es* ,C> of
assets for ever" C8 of
sa!es*-
S Fi9ed assets are
FDE of tota! assets'
or 8>DE of sa!es*
Pro For&a Financia! 7tate&ents Bsin(
E of 7a!es Method
S Ass%&e that sa!es (row b" >DE to CFDD
>ncome ,tatement
,ales 0/!!
Costs 141 "56 of ,ales
(epreciation n.a. 1!6 of Cet FiAed :ssets
>nterest n.a. !6 of last periods (ebt
)aAable >ncome n.a.
)aAes n.a. ."6 of )aAable >ncome
Cet >ncome n.a.
$etained n.a.
(ividends n.a. /56 of Cet >ncome
Balance ,heet
Current assets 0"4! )otal (ebt n.a.
Cet fiAed asset 51! -&ners <=uity n.a.
)otal :ssets 0,1!! )otal 9iabilities 0,1!!
S Fir&s needs C> of
assets for ever" C8 of
sa!es*
S Fi9ed assets are FDE
of tota! assets*
Fi!!in( in the $!an)s
+ereciation
. Fir& needs C> of assets for ever" C8 of sa!es ,tota! asset t%rnover is
D*A or tota! assets are >DDE of sa!es-
Tota! Assets &%st rise to C8'>DD to s%ort CFDD of sa!es
Fi9ed Assets are FDE of Tota! Assets
C%rrent Assets are @DE of Tota! Assets
+ereciation is >DE of Fi9ed Assets
+ereciation 5 D*> N ,D*F N C8'>DD- 5 C8@@
This dereciation ca!c%!ation wron(' b%t c!ose and si&!eT
. 7ho%!d ca!c%!ate dereciation as E of additions to (ross fi9ed
assets !%s E of !ast "ear4s net*
Interest
. $ased on the !ast end6of6eriod +ebt !eve! ,short and !on(6ter&-*
. Interest 5 D*8 N C@AD 5 @A
Pro For&a Financia! 7tate&ents Bsin(
E of 7a!es Method
>ncome ,tatement
,ales 0/!!
Costs 141 "56 of ,ales
(epreciation "" 1!6 of Cet FiAed :ssets
>nterest "# !6 of last periods (ebt
)aAable >ncome 1D
)aAes "" ."6 of )aAable >ncome
Cet >ncome 4#
$etained 014
(ividends 0#5 /56 of Cet >ncome
Balance ,heet
Current assets 0"4! )otal (ebt 0"#!
Cet fiAed assets 51! -&ners <=uity 5#!
)otal :ssets 0,1!! )otal 9iabilities 0,1!!
E0%it" is the
plug variab!e
Financia! P!annin(
E0%it" is the !%( variab!e*
E0%it" rises fro& CAAD to CHAD' b%t C>G of this is fro&
retained earnin(s*
The difference' C8H>' is additiona! e0%it" inco&e necessar" to
s%ort the increase in sa!es*
+ebt co%!d a!so be the !%(* Fir& co%!d borrow C8H> and +ebt
co%!d rise to CF>>*
If new caita! not avai!ab!e' then can4t finance sa!es increase*
Balance ,heet &ith (ebt as *9E@
Current assets 0"4! )otal (ebt 0/11
Cet fiAed assets 51! -&ners <=uity #54
)otal :ssets 0,1!! )otal 9iabilities 0,1!!
Cash 1 Mar)etab!e
7ec%rities
Overview of :ow Co&anies
Maintain Li0%idit"

$" ho!din( cash and &ar)etab!e

sec%rities

$" havin( read" access to so%rces of

financin(
.
Access to e0%it" ,not a!wa"s ossib!e or
attractive-
.
Access to debt thro%(h rior
co&&it&ents fro& !ender e*(* !ine of
credit
Criteria in 7e!ection of Mar)etab!e
7ec%rities
8* Li0%idit" 3 the sec%rit" sho%!d be eas" to se!!
before &at%rit" and the costs invo!ved in se!!in(
,transaction costs- sho%!d be &ini&a!
>* +efa%!t Ris) 3 when investin( in bonds' there
sho%!d be !itt!e chance the borrower wi!! not rea"
rincia! and interest ,%s%a!!" stic) with hi(h6(rade
borrowers-
?* Mar)et Ris) 3 there sho%!d be !itt!e ris) that the
sec%rit"4s rice wi!! decrease before &at%rit"
beca%se of chan(es in overa!! &ar)et conditions
,!eve!s of interest rates and stoc) &ar)et indices-L
this &eans that sec%rities are %s%a!!" short6ter&'
fi9ed inco&e sec%rities ,not !on(6ter& bonds and
not e0%ities-
@* Attractive Ret%rn 3 fir&s wi!! accet &ore of the
above three ris)s in order to hi(her ret%rn
A* Ta9 I&!ications 3 ret%rn is considered on after6ta9
basis
Criteria in 7e!ection of Mar)etab!e
7ec%rities
9i=uidity (efault $isk +arket $isk Field
3Feb. ", 1!!.2
)-bills ;ighest 9o&est
?obligation of
Federal
@overnment
9o&est 1.416 3.-month
t-bill2
Bankers
:cceptance
;igh 9o& ?
guaranteed
by a bank
9o& 1.456 3highest
rated2
Commercial
*aper
;igh to
+edium
9o& to
+edium ?
depends on
risk of
corporate
borro&er
9o& to +edium ?
corporate
borro&er may be
affected by stock
market conditions
1.456 3highest
rated2
Field is higher
on lo&er rated
paper
Other 7hort6ter& Invest&ents
Bsed for Li0%idit" P%roses

Overni(ht !oans ,!ar(e fir&s !end &one"

on an overni(ht basis-

Certificates of +eosits ,interest6bearin(

rather than disco%nt instr%&ents iss%ed b"
ban)s and tr%st co&anies-

Ne(otiab!e Certificates of +eosit ,can be

so!d before &at%rit" in &ar)et-

Mone" Mar)et M%t%a! F%nd ,oo! of short6

ter& &one" &ar)et instr%&ents-
Effective Interest Rate on a
7hort6ter& +isco%nt
Instr%&ent

Effective rate over !ife of

instr%&ent

Effective ann%a! interest rate

+ a t u r i t y * r i c e C u r r e n t * r i c e
C u r r e n t * r i c e

_
,

_
,

1
]
1

+ a t u r i t y * r i c e C u r r e n t * r i c e
C u r r e n t * r i c e
. / #
( a y s t o + a t u r i t y
Effective Interest Rate on a
7hort6ter& +isco%nt
Instr%&ent

E9a&!e of effective ann%a!

interest rate ca!c%!ation

T6bi!! has MD da"s to &at%rit"L

&at%rit" rice is C8'DDD b%t it
c%rrent!" se!!s for CMMD

! ! !
" / 6 +

_
,

1
]
1

0 D D !
0 D D !
. / #
D !
,
.
Aro9i&ate Ann%a! ;ie!d
7hort6ter& +isco%nt
Instr%&ent
0 0 D D !
0 D D ! D !
. / #
,
.
! ! !
" ! 6

_
,
X
+ a t u r i t y * r i c e C u r r e n t * r i c e
C u r r e n t * r i c e ( a y s t o + a t u r i t y
. / #

_
,
X
>n the case of t-bills, the approAimate yield is referred to as the bond
e=uivalent yield. )he bond e=uivalent yield on the D!-day t-bill is
sho&n belo&.
Acco%nts Receivab!e
O%t!ine

Ter&s

E9tendin( Credit to New Acco%nts

A C4s of credit

Monitorin( Acco%nts Receivab!e

thro%(h A(in( of Acco%nts
Acco%nts Receivab!e
+ecisions

Ke" +ecisions to Ma)e

8* Ter&s and conditions of credit sa!es
>* Credit ana!"sis
?* Credit decision* Whether to e9tend
credit to a c%sto&er.
@* Co!!ection o!ic"
Acco%nts Receivab!e and Credit
Ter&s

Ter&s and conditions of credit

decisions
.
No ter&s 3 cash on de!iver"
.
T"ica! Credit Ter&s 3 >I8D net ?DL
this &eans that a"&ent is d%e ?D
da"s fo!!owin( date of invoice and
if c%sto&er a"s b" da" 8D' heIshe
receives a >E disco%nt off invoiced
rice ,an incentive to &a)e
c%sto&ers a" ear!"-
Acco%nts Receivab!e and
Choice of Credit Ter&s

Choice of Credit Ter&s

.
A !on(er net ter& &eans

More sa!es and (ross rofit

$%t it a!so &eans'

:i(her bad debt

Increased credit deart&ent costs

(iven need to chec) new a!icants

Increased invest&ent in acco%nts

receivab!e and otentia!!" inventor"
Acco%nts Receivab!e and Credit
Ana!"sis

E9a&!e of I&act of E9tendin( Credit to a New 7et

of C%sto&ers
.
The new set of c%sto&ers co%!d increase sa!es b"
CFD'DDD* The (ross rofit &ar(in is >AE and bad
debt is esti&ated to be ?E* Credit deart&ent
costs are e9ected to be C?'DDD ann%a!!"* The
avera(e co!!ection eriod is e9ected to be @
&onths* Given an inco&e ta9 rate of @DE' what is
the after6ta9 rate of ret%rn on rovidin( credit to
the new set of c%sto&ers.
Chan(e in after6ta9 rofit 5 ,CFD'DDDN,>AE6?E- 3
?'DDD-N,86D*@D-
5 CF'8>D
Invest&ent needed 5 CFD'DDDN@I8>N,86>AE-5C8A'DDD
Rate of ret%rn 5 CF'8>DIC8A'DDD 5 @D*GE
The after6ta9 rate of ret%rn on rovidin( credit to the
new set of c%sto&ers is @D*GDE

E9ercise U8

A new set of c%sto&ers co%!d increase

sa!es b" C8DD'DDD* The (ross rofit &ar(in
is 8DE and bad debt is esti&ated to be
AE* Additiona! credit deart&ent costs are
e9ected to be C?'DDD ann%a!!"* The
avera(e co!!ection eriod is e9ected to be
? &onths* Given an inco&e ta9 rate of
@DE' what is the after6ta9 rate of ret%rn on
rovidin( credit to the new set of
c%sto&ers.
7o!%tion

Chan(e in after6ta9 rofit

5 ,C8DD'DDDN,D*8D 6 D*DA- 3
?'DDD-N,86D*@D-
5 C8'>DD

Invest&ent 5
C8DD'DDDN?I8>N,86*8D-5C>>'ADD

Rate of ret%rn 5 C8'>DDIC>>'ADD 5

A*?E

The after6ta9 rate of ret%rn on

rovidin( credit to the new set of
c%sto&ers is A*?E
E9ercise U>

;o% have been aroached b" "o%r

sa!es staff abo%t se!!in( C8DD'DDD of
(oods on credit to a new c%sto&er* The
cost of (oods so!d on "o%r fir&4s
rod%cts is GDE* Credit deart&ent
costs are e9ected to be C>'DDD
ann%a!!" to hand!e this acco%nt* The
avera(e co!!ection eriod is e9ected to
be ? &onths* The inco&e ta9 rate is
>DE* If "o% want to earn a 8AE after6
ta9 rate of ret%rn on rovidin( credit to
the new c%sto&er' what wi!! be the
&a9i&%& bad debt e9ense that can be
to!erated.
7o!%tion
Let $+ be bad debt e9ense as E of sa!es
Gross Mar(in 5 8DDE 6GDE 5>DE*
Chan(e in after6ta9 rofit 5 ,C8DD'DDDN,>DE6$+- 3>'DDD-N,86D*>D-
Invest&ent needed 5 C8DD'DDDN?I8>N,GDE-5C>D'DDD
We need to so!ve for $+ with e0%ation'
Rate of ret%rn 5 ,,C8DD'DDDN,>DE6$+- 3>'DDD-N,86D*>D--IC>D'ADD
5 8AE
,,C8DD'DDDN,>DE6$+- 3>'DDD-N,86D*>D--5C?'DHA
,C8DD'DDDN,>DE6$+- 3>'DDD-5 C?'G@@
C8DD'DDDN,>DE6$+-5CA'G@@
>DE6$+5A*G@@E
$+58@*8AFE
The &a9i&%& bad debt e9ense is 8@*8AFE
T:E A C47 OF CRE+IT ANAL;7I7
Character of wner+Mana!er
Capacity to Repay

Financial Forecast

Business 'lan

&ncome or 'rofits
Collateral

)i-uidation .alue

/nforceability

)i-uidity
Credit Conditions

(bility to (ccess 0ew

Financin!

Credit Checks

1erms of )oan
Capital

(de-uate (mount of
)on!-1erm Funds
/specially /-uity
7C:E+BLE OF AGE OF
RECEI=A$LE7
A(e +a"s A&o%nt ,DDD- Percent of Tota!
D 3 ?D C>DD @F*A8E
?8 3 FD 8AD ?@*GGE
F8 3 MD AD 88*F?E
Over MD ?D F*MGE
Tota! C@?D 8DDE

Trade6off $etween Non6Co!!ection and 7trin(ent and
E9ensive Co!!ection Methods as we!! as Loss of C%sto&er
Goodwi!!
Inventor"
Financia! Overview of
Inventor" Mana(e&ent

$enefits of Increased Inventor"

.
0%antit" disco%nts for %rchasin(
.
avoids stoc) o%ts
.
!essens orderin( costs

Costs of Increased Inventor"

.
:i(her carr"in( costs ,Financin('
stora(e' ins%rance' etc*-
.
Potentia! obso!escence
7hort6Ter& Financin(
O%t!ine

7e!ection Criteria

Covenants

Effective Ann%a! Rate of $orrowin(

Instr%&ents
.
Line of Credit

Cost of Trade Credit

7hort6ter& Financin(
7o%rces
A c c o u n t s
P a y a b l e
R e $ u l a r
n t e r e s t
* i s c o u n t
n t e r e s t
F a r i a b l e - R a t e
n t e r e s t
3 e r m
L o a n
R e $ u l a r
n t e r e s t
F a r i a b l e - R a t e
n t e r e s t
L i n e o 4
C r e ' i t
B a n k
L o a n s
C o m m e r c i a l
P a / e r
% a c t o r i n $
Criteria in 7e!ectin( 7hort6ter&
Finance

Lowest effective net cost considerin(

.
interest
.
fees
.
offsettin( benefits in red%ced
ad&inistrative costs
.
net a&o%nt borrowed

F!e9ibi!it" of Rea"&ent Ter&s

A&o%nt of Credit Avai!ab!e

Conditions of Credit e*(* co!!atera!'

covenants etc*
C$<(>)
*:CB:@<
>nterest
$ate
Fees

:pplication

:dministration
Covenants
Collateral
,tructure >ncluding
$epayment ,chedule
@uarantees

*ersonal

$elated Company

)hird *arty
:mount
PRIVATE & CONFIDENTIAL
=ictoria Main Office
8>>A +o%(!as 7treet
=ictoria' $*C*
=GW >EF

$an) of Montrea! is !eased to offer the fo!!owin( !ines of credit to

%on and s%bPect to the fo!!owin( ter&s and conditions*

$oan +ypes
A!! !oans are a"ab!e on de&and' s%bPect to eriodic review b" the $an) not !ess
fre0%ent!" than ann%a!!"' %n!ess otherwise indicated*
(nterest Rates
For the %rose of this Offer' WPri&e RateW is the f!oatin( ann%a! rate of interest
estab!ished fro& ti&e to ti&e b" the $an) of Montrea! as the base rate it wi!! %se
to deter&ine rates of interest on Canadian do!!ar !oans to c%sto&ers in Canada
and desi(nated as Pri&e Rate* Pri&e Rate is c%rrent!" F*>AE
$oan Structure
8- First $an) Cash Mana(e&ent Acco%nt ,FCMA- C>'HAD'DDD*
cont4d

7ete&ber Gth' 8MM>

P%rose# Oeratin( assistance*
Interest Rate# Pri&e !%s 8I@E
Rea"&ent# Interest on!"' a"ab!e &onth!"* E9act do!!ar borrowin(*
Above oeratin( !ine inc!%des#
Ma9i&%& C8DD'DDD Letter of Credit faci!it" to cover eriodic i&ort of food
st%ffs*
Ma9i&%& C>AD'DDD overdraft faci!it" to cover eriodic sett!e&ent of B*7*
a"ab!es*
Mar(in Conditions#
S Oeratin( advances contained within FF*FE e!i(ib!e acco%nts receivab!e ,FD
da"s and %nder- !%s ADE inventor" at cost as indicated b" &onth!" si(ned
Inventor" +ec!arations' E!i(ib!e receivab!es to inc!%de c%rrent ?DIFD da" acco%nts
that have for&a! rea"&ent ro(ra& estab!ished for an" over F8 da" a"&ents*
Esti&ate of Priorit" Pa"ab!es to be rovided on &onth!" Inventor" +ec!aration*
7econdar" Mar(in
S Oeratin( advances are not to e9ceed e!i(ib!e receivab!es*
cont4d
Infor&ation Re0%ire&ents#
Month!" a(ed Acco%nt Receivab!e Listin(s' Inventor" and Acco%nt Pa"ab!e
+ec!arations si(ned b" co&an" 7i(nin( Officer*
$" October 8A
th
' 8MM> X In6ho%se $a!ance 7heet and Inco&e 7tate&ents as at
R%!" ?8st' 8MM>*
>- Co&&ercia! Mort(a(e C8'MMD'DDD* ,Aro9* $a!ance-
P%rose# Refinance e9istin( Co&&ercia! Mort(a(e C8'FH8'DDD with
additiona! C?>M'DDD to rea" +e&and Loan' Non6Revo!vin( C?DD'DDD ba!ance
C>M'DDD to co&an" c%rrent acco%nt*
Interest Rate# 88*DDE' ? ;ear Ter& d%e October 8st' 8MM@ ,>A "ear
a&orti2ation-*
Rea"&ent# Month!" b!ended a"&ents C8M'?DD' >A "ear a&orti2ation*
Security ; Already (n *lace
X +ebent%re sec%rit" rovidin( overa!! Fi9ed Char(e C?'ADD'DDD over roert"
and vario%s co&an" owned vehic!esIe0%i&ent a!on( with F!oatin( Char(e
over a!! other co&an" assets*
+ebent%re Restrictive Covenants#
Not to dec!are or a" dividends witho%t $an) arova!*
Co&an" not to rovide G%arantee to an" other financia! instit%tion witho%t
$an) arova!*
contd

X 7tandard Mort(a(e C!a%se FireIA!! Peri!s Ins%rance*

X Assi(n&ent of $oo) +ebts*
X 7%bro(ation of shareho!der !oans si(ned b"
X 7%bro(ation of !oan b" :o!din(s Ltd*
X Cororate Letter of Bnderta)in( re# Financia! Test Covenants ,To be re!aced 6
re!ace&ent !etter attached-*
X First Co&&ercia! Mort(a(e C>'DDD'DDD rovidin( Fi9ed Char(e over =ictoria
wareho%se co&!e9' inc!%din( char(e over co&an"Ys freeho!d and !easeho!d
interest in the s%bPect roert"*
X Genera! Assi(n&ent of Rents*
X Priorit" A(ree&ent over e9istin( $an) of Montrea! +ebent%re char(es*
Security ; +o Be O&tained
X Revised Cororate Letter of Bnderta)in(' detai!ed as fo!!ows#
8- Maintain debtIe0%it" ratio &a9i&%& >*HA#8 as deter&ined b" Fisca! 8MM? "ear
end Financia! 7tate&ents with e0%it" defined as 7hareho!der Loans' Retained
Earnin(s and net ta9 $on%s Pa"ab!e*

cont4d

>- Achieve Wor)in( Caita! ratio &ini&%& 8*>A#8* ,C%rrent !iabi!ities to e9c!%de
+irectors Wa(es after ta9-*
?- Restrict Ann%a! Caita! E9endit%res to C8'ADD'DDD as detai!ed in Contro!!er
reared Fisca! 8MM? Caita! E9endit%re 7%&&ar"*
P!ease note Caita! E9endit%res at C8'ADD'DDD !eve! are aroved in rinci!e in
that the $an) wi!! be reviewin( the anticiated and res%!tant financin(
re0%ire&ents with "o% in the near f%t%re*
X Revised FCMA A(ree&ent*
X Ins%rance Waiver*
Given the sca!e and co&!e9it" of co&an" financia! oerations' we wo%!d
areciate the oort%nit" to revisit the need for rovision of Ann%a! A%dited "ear
end Financia! 7tate&ents*
cont4d
E9a&!e of T"ica! $an) Loan
Covenants for C!ose!" :e!d Co&an"

Gordon Man%fact%rin( is 8DDE owned b" 7a&

Gordon

Mini&%& C%rrent Ratio of 8*>A to ens%re

!i0%idit"

Mini&%& AdP%sted Net Worth of C> &i!!ion to

ens%re so!venc"

AdP%sted Net Worth e0%a!s

7hareho!ders E0%it" fro& $a!ance 7heet !%s
Loans fro& 7hareho!derIRe!ated Co&anies
!ess Loans to 7hareho!derIRe!ated Co&anies
!ess Goodwi!!
Effective Ann%a! Cost of
7hort6ter& Financia!
Instr%&ent

Effective before ta9 rate over !ife

of instr%&ent

Effective before6ta9 ann%a! interest

rate
> n t e r e s t F e e s , a v i n g s
C e t : m o u n t B o r r o & e d
+

_
,

> n t e r e s t F e e s , a v i n g s
C e t : m o u n t B o r r o & e d

. / #
( a y s t o + a t u r i t y
+
+

_
,

1
]
1

Effective Ann%a! Interest Rate on
Re(%!ar Interest Ter& Loan

E9a&!e# A ban) char(es a AE ann%a! re(%!ar

interest rate on a C8DD'DDD M86da" ter& !oan*
There is an ann%a! fee of 8E*
7o!%tion#
Interest aid is AEN C8DD'DDDNM8I?FA or C8'>@H
Fee is 8ENC8DD'DDDNM8I?FA or C>@M
Net a&o%nt borrowed is C8DD'DDD 3 8'DDD or
CMM'DDD
Effective ann%a! interest rate e0%a!s

!
! ! , ! ! !
% / . 1 6
. / #
D !
+
+

_
,

1
]
1

1 " 5 1 " D ,
Effective Ann%a! Interest Rate on
+isco%nt Interest Ter& Loan

E9a&!e# A ban) char(es a AE ann%a! disco%nt

interest rate on a C8DD'DDD M86da" ter& !oan*
There is an ann%a! fee of 8E*
7o!%tion#
Interest aid is AEN C8DD'DDDNM8I?FA or C8'>@H
Fee is 8ENC8DD'DDDNM8I?FA or C>@M
Net a&o%nt borrowed is C8DD'DDD 3 8'>@H or
CMG'HA?
Effective ann%a! interest rate e0%a!s

!
D 4 , 5 # .
% / . 1 D 6
. / #
D !
+
+

_
,

1
]
1

1 " 5 1 " D ,
Line of Credits

Bsed to finance seasona! f!%ct%ations in

wor)in( caita!*

Fir& can borrow % to a &a9i&%& !eve! over

a secified ti&e eriod*

Rea"&ent ob!i(ation varies ,e*(*' ?E of

rincia! er &onth-' a!tho%(h ba!ance &%st
be 2ero b" ter&ination of the !oan a(ree&ent*

$orrowin( fir& &a" withdraw as need

re0%ires % to a reset &a9i&%&*
.
Committed &eans ban) ob!i(ed ,written !oan
a(ree&ent- 66 fee on %n%sed ba!ance abo%t 8E*
,Commitment fee-
.
Uncommitted &eans ban) not ob!i(ed 66 no fee on
%n%sed ba!ance*

$an) %s%a!!" has otion to ter&inate*

Line of Credits

Ass%&e interest ca!c%!ated on avera(e

ba!ance of !oan %sed over eriod*

Ass%&e co&&it&ent fee ca!c%!ated

si&i!ar!"*
Ca!c%!atin( Effective Interest Rate
on Line of Credit
E9a&!e# A ban) char(es a AE interest rate on a C8DD'DDD
!ine of credit for a&o%nts %sed and a co&&it&ent fee of
8E for a&o%nts avai!ab!e b%t not %sed* The fee is
ca!c%!ated based on the avera(e %n%sed ba!ance d%rin(
the eriod* If avera(e !oan ba!ance was C@D'DDD for 8GD
da"s ' what was effective interest rate on !ine of credit.
7o!%tion#
Interest E9ense 5 AENC@D'DDDN8GDI?FA or CMGF
Co&&it&ent Fee 5 8ENFD'DDDN8GDI?FA or C>MF
Net A&o%nt $orrowed 5 C@D'DDD
Effective Ann%a! Interest Rate e0%a!s

!
" ! , ! ! !
% / . / 6
. / #
4 !
+
+

_
,

1
]
1

D 4 / 1 D /
E9ercise U8
E9a&!e# A 8>D6da" C>DD'DDD !ine of credit* The !ine of credit
wo%!d have an ann%a! interest rate of AE and an ann%a!
co&&it&ent fee of 8E of the %n%sed ba!ance* +%rin( the
first FD da"s the !oan is o%tstandin(' CAD'DDD wi!! be
borrowed* +%rin( the !ast FD da"s' C8AD'DDD wi!! be
borrowed*

Interest E9ense 5 AENCAD'DDDNFDI?FA <

AENC8AD'DDDNFDI?FA 5 C8'F@@
Co&&it&ent Fee 5 8ENC8AD'DDDNFDI?FA <
8ENCAD'DDDNFDI?FA 5 C?>M
Net A&o%nt $orrowed 5 CAD'DDDNFDI8>D < C8AD'DDDNFDI8>D
5 C8DD'DDD
Effective Ann%a! Interest Rate e0%a!s
/.16
!!! , !!
.1D /"" ,

1!
./#

1
]
1

+
+
E9ercise U>
E9a&!e# A 8GD6da" C?DD'DDD !ine of credit* The !ine of credit
wo%!d have an ann%a! interest rate of FE and an ann%a!
co&&it&ent fee of D*AE of the %n%sed ba!ance* +%rin( the
first 8DD da"s the !oan is o%tstandin(' C8DD'DDD wi!! be
borrowed* +%rin( the !ast GD da"s' C>AD'DDD wi!! be
borrowed*

Interest E9ense 5 FENC8DD'DDDN8DDI?FA <

FENC>AD'DDDNGDI?FA 5 C@'M?>
Co&&it&ent Fee 5 D*AENC>DD'DDDN8DDI?FA <
D*AENCAD'DDDNGDI?FA 5 C?>M
Net A&o%nt $orrowed 5 C8DD'DDDN8DDI8GD <
C>AD'DDDNGDI8GD 5 C8FF'FFH
Effective Ann%a! Interest Rate e0%a!s
/.#!6
//5 , //
.1D D.1 , "

4!
./#

1
]
1

+
+
Additiona! E9ercises

For additiona! e9ercises on

!ines of credit' tr" rob!e&s
>@*F and >@*H and +avis and
Pinches
Ca!c%!atin( Effective Cost of
+eferrin( Pa"&ent on Acco%nts
Pa"ab!e
E9a&!e# A co&an" has >I8D n@A ter&s with its s%!ier*
If the co&an" c%rrent!" a"s within 8D da"s and receives
the >E disco%nt' what is the effective ann%a! cost of
de!a"in( a"&ent %nti! da" @A.
7o!%tion#
Rather than a"in( MGE of face va!%e on da" 8D' co&an"
(ets to a" 8DDE of face va!%e on da" @A* This is
e0%iva!ent to borrowin( a disco%nt interest !oan e0%a! to
MGE of face va!%e on da" 8D and rea"in( !oan bac) on
da" @A*
Interest E9ense 5 >E ,disco%nt fore(one-
Net A&o%nt $orrowed# 5 MGE of face va!%e of a"ab!es
Effective Ann%a! Interest Rate e0%a!s

D 4 6
% 1 . . " # 6
. / #
" # - !
+

_
,

1
]
1

1 6
Factorin( Receivab!es

7e!!in( receivab!es to a factor ,Finance

co&an"- for disco%nted cash va!%e ,with
advance factorin(- witho%t reco%rse to the
se!!er ,borrower-

Factor bears ris) ,where no reco%rse- and

co!!ection e9enses

Fees are fair!" hi(h in factorin( arran(e&entsL

in &ost ind%stries' factorin( is one of the &ost
e9ensive &ethods of short6ter& borrowin(
Factorin(# E9a&!e

+on4t Pa" for One F%!! ;earT

7a!eserson screens c!ient for credit

e!i(ibi!it" with Citifinancia! on site %sin( Citi4s
in6store co&%ter s"ste&* Citi contro!s credit
0%a!it"* $ad ris)s are not offered credit*

Citi a"s Leon4s the disco%nted va!%e of the

%rchase rice i&&ediate!"*

Citi co!!ects f%!! a"&ent fro& c!ient at end of

"ear* If c!ient can4t a"' then Citi starts
char(in( interest*
Advanta(es of Factorin( Over
P!ed(in( of Acco%nts Receivab!es

A!!ows Co&anies to Avoid Credit

Chec)in(' $oo))eein( and Co!!ection
Costs

With Advance Factorin(' Fir&s can 7horten

Cash Conversion C"c!e

With Non6Reco%rse Factorin(' the Financia!

Instit%tion Absorbs $ad +ebt Losses
Effective Ann%a! Interest Rate of Advance
Factorin(
E9a&!e# A co&an" has C>DD'DDD or acco%nts receivab!e* A
finance co&an" char(es a 8E co&&ission on a!! receivab!es
factored* The finance co&an" wi!! !oan an a&o%nt e0%a! to HDE
of the receivab!es factored and wi!! char(e a 8>E ann%a! interest
rate on this a&o%nt* :owever' credit deart&ent costs wi!! be
red%ced b" CHAD a &onth* The avera(e co!!ection eriod is FD
da"s ,> &onths-* What is effective ann%a! cost of factorin(.
7o!%tion#
Fee is C>DD'DDDN8E or C>'DDD
Net a&o%nt borrowed is C>DD'DDDNHDE or C8@D'DDD
Ann%a! interest aid is 8>EN C>DD'DDDNHDENFDI?FA or C>'HF>
7avin(s over > &onths 5 CHADN> 5C8'ADD
Effective ann%a! interest rate e0%a!s

" ! , ! ! !
% # . ! " 6
. / #
/ !
+
+

_
,

1
]
1

1 5 / 1 1 ! ! ! # ! ! ,
O;Z Cor* c%rrent!" has &onth!" receivab!es of CG?'???*
It advance factors a!! receivab!es to $an)* Receivab!es
t"ica!!" co!!ected on >A
th
of &onth' so ter& 5 >A da"s*
$an) !ends HAE of receivab!es' char(es 8*AE co&&ission
and ?E above Pri&e ,Pri&e5FE-* O;Z Cor' saves C8'DDD
a &onth on boo)6)eein( and co!!ection e9enses* What
is the net cost to O;Z.
Co&&ission 5 D*D8A N G?'??? 5 C8'>AD
7avin(s 5 6C8'DDD
Interest 5 D*DMND*HANCG?'???N,>AI?FA- 5 C?GA*>H
Tota! 5 CF?A*>H
#.D6
0/1,"DD.5#
0/.#.15
k
1#
./#
<:$

,
_

+
E9ercise U8
$ea&scoe &onth!" receivab!es of C@DD'DDD* It advance
factors a!! receivab!es to $an)* Receivab!es t"ica!!"
co!!ected at the end of each &onth' so ter& 5 8 &onth*
$an) !ends HDE of receivab!es' char(es D*AE co&&ission
and >E above Pri&e ,Pri&e5ME-* $ea&scoe' saves
C8'DDD a &onth on boo)6)eein( and co!!ection e9enses*
What is the net cost.
Co&&ission 5 D*DDA N @DD'DDD 5 C>'DDD
7avin(s 5 6C8'DDD
Interest 5 ,D*DMI8>-ND*HN@DD'DDD 5 C>'AFH
Tota! 5 C?'AFH
/."6
014!,!!!
0.,#/5
k
1
<:$

,
_

+
E9ercise U>
Ratio Ana!"sis
O%t!ine

Ratios

+% Pont Ana!"sis
Ratio Ana!"sis
G
Financial ratios sho& relationships among financial statement
accounts.
G
>nvestors predict future earnings and dividends of firm in order
to value shares
G
Creditors predict likelihood of default by firm on claim
G
+anagement decides upon investment in short and long-term
asset and establish amount and type of credit financing
Ratio Ana!"sis
,teps:
)ype:
. (ecide on ratios that are appropriate
1. Calculate ratios
.. Compare ratios to industry norms
". <valuate reasons for discrepancies

from industry norms
#. >dentify trends in ratios over time
/. <valuate reasons for trends
5. >f discrepancies arose because of
underlying problems, evaluate
alternative solutions to problems.
>. 9i=uidity
>>. :sset +anagement $atios
>>>. (ebt +anagement $atios
>H. *rofitability $atios
H. +arket Halue $atios
&&2 (sset Mana!ement Ratios
- measures ho& effectively management is utiliIing the companys assets
1urnover Measures
2 >nventory EtiliIation % ,ales?>nventory
)oo JhighK )oo Jlo&K
- loss of profitable sales - obsolescence
from stock outs - &arehousing constraints
-costs from eAcessive - financing and insurance
reordering costs are eAcessive
12 :verage Collection *eriod % $eceivablesLLLL
:verage ,ales per (ay
)oo Jlo&K )oo JhighK
- loss of profitable sales from - bad debt
tight credit terms - financing costs
.2 FiAed :sset EtiliIation % ,ales?Cet FiAed :ssets
"2 )otal :sset EtiliIation % ,ales?)otal :ssets
&&&2 Debt Mana!ement 3)evera!e4 Ratios
- measures eAtent to &hich non-e=uity financing is used
2 )otal (ebt?)otal :ssets
12 )otal (ebt?)otal <=uity
.2 9ong-term (ebt?Common <=uity
- measures ability of company to meet fiAed financing charges &ith operating
income
2 )imes >nterest <arned
% <arnings Before >nterest and )aAes 3<B>)2
>nterest Charges
12 FiAed Charge Coverage $atio
)evera!e
- creditors &ill charge higher financing rates to firms &hich are highly
levered
2 @reater likelihood of bankruptcy because of added
interest costs
12 9oss of creditors upon li=uidation of firm is likely higher because
amount of debt increases but li=uidation value of assets does not.
.2 Common shareholders have smaller stake in firm that is financed by
debt rather than solely by e=uity - may lead them to misappropriate firm
assets or take eAcessive risks especially &here firm is nearing
bankruptcy.
if firms are too highly leveraged, they may be unable to obtain
financing from creditors.
(dvanta!es to %hareholders from )evera!e
2 leverage allo&s firms to eAperience higher returns in
JgoodK times 3but lo&er returns in JbadK times2 -
generally eApected <*, increases to compensate for
greater risk &ith higher leverage
12 eAisting shareholders can maintain control by
borro&ing debt rather than issuing ne& common shares
esp. important for shareholders &ho are also managers -
leverage buy outs
.2 taA advantages - interest charges are deductible from
taAable income &hile dividends are not
&.2 'rofitability Ratios
- measure combined effect of li=uidity, asset management and leverage on
operating results
2 @ross *rofit +argin on ,ales % @ross +argin?,ales
12 Cet *rofit +argin on ,ales % Cet >ncome :vailable to
Common ,hareholders? ,ales
.2 Basic <arning *o&er $atio % <B>)?)otal :ssets
"2 $eturn on )otal :ssets % Cet >ncome :vailable to
Common ,hareholders? )otal :ssets
#2 $eturn on <=uity % Cet >ncome?Common <=uity
- *rofitability analysis often focuses on means to improve the gross margin
through ne& pricing policies, changes in product lines and methods to reduce
the cost of goods sold.
.2 Market .alue Ratios
- measures the stock markets evaluation of li=uidity, asset
management, debt management and profitability
2 *rice <arnings $atio % *rice per share?<*,
12 +arket?Book $atio % ,tock *rice ?
Book Halue *er ,hare
Book Halue *er ,hare % ,hareholders
Common <=uity ? ,hares -utstanding
The +%ont e0%ation

9i!hli!hts relationship bet$een financial ratios

R7(
R7A
=et /ro4it
mar$in
Asset
turnover
&
&
1D 'ebtGe)uity
)he (u*ont ,ystem
1
]
1

1
]
1

Equity
ebt
! t turnover total asse in t m net profi "#E
nover asset tur in ! total t m net profi "#A
Assets
Sales
Sales
$et Income
Sales
Sales
Assets
$et Income
"#A
Assets
$et Income
"#A
Equity
ebt
"#A
Equity
Assets
"#A "#E
Equity
Assets
Assets
$et Income
Assets
Assets
Equity
$et Income
"#E
Equity
$et Income
"#E
arg
arg

(uto
'arts
Buildin!
Materials
5old and
'recious
Metals
Food and
Bevera!e
1echnolo!y 'ipelines
)i-uidity
Current 1./D .D/ !.5 1.5/ 1."5 !.5
Muick ./! .! D./5 .#5 .41 !.#
(sset
Mana!ement
(ays ,ales
-utstanding
"".5 #D.D 1.1 .#.D 5!./ "/.#
>nventory
)urnover
5.// .# 5.5/ .! .".#1 1/.11
9ong-term
:sset $atio
#.!. ..4" !.#D /."! D.4# !.4D
Debt
Mana!ement
)otal (ebt to
)otal :ssets
!..! !../ !.1# !."D !..# !./5
)imes >nterest
<arned
/1..5 4." 35/.!42 D.!! 1...# .D5
:verage >ndustry $atios
Avera(e Ind%str" Ratios ,Contin%ed-
(uto
'arts
Buildin!
Materials
5old and
'recious
Metals
Food and
Bevera!e
1echnolo!y 'ipelines

'rofitability


+argin 362


#.D/

#.15

351.52

#.D/

31.!2

#.!.

$eturn on
:ssets 362

4../

5.14

3D.#12

5./

!.!D

/.4

$eturn on
<=uity 362

".1D

.!/

31#./42

1.!D

3!.4.2

1.14


Market




:verage *?<

4.5

1D.4

#!.1

/.1

1/.!

#.

(ividend Field
362


.1"


!.5

!.1#

.51

!..D

".1!


,ource: >ndustry $eports 3Nuly #, DD42 )he Financial *ost
(atagroup.
Castone Case# Wor)in(
Caita! and Financia!
7tate&ent Ana!"sis
$ea&scoe Canada
Castone Case# Wor)in(
Caita! and Financia!
7tate&ent Ana!"sis
)he chart belo& sho&s the price of the stock of Beamscope, a
distributor of electronics products in Canada and ,outh
:merica, from DD5 to 1!!.
$ea&scoe4s Wor)in( Caita!
Mana(e&ent
$atio DD/ DD5 DD4 DDD 1!!!
Current .D. ./ .5! ..# .!
Muick ..4 .!/ .!/ !.#4 !.""
:verage Collection *eriod /1 4" 4! #" #!
(ays >nventory 1D "/ #. /" //
(ays *ayable #. 5 /D "5 "D
-perating Cycle D . .. 4 #
Cash Cycle .4 /! /" 5 /5
)hree maOor problems occurred &ith &orking capital in DD5-DD4:
. Company couldnt cope &ith gro&th in managing inventory P :$
1. Company didnt properly process goods returned from customers.
.. Company didnt have an ade=uate returns policies &ith suppliers.
$ea&scoe4s +ebt Mana(e&ent
$atio DD/ DD5 DD4 DDD 1!!!
)otal (ebt?)otal :ssets 0,!9 0,": 0,"# 0,#1 0,##
)otal (ebt?<=uity n.a. 0,!3 0,33 1,2: 1,3#
,hort-term (ebt?<=uity n,a, 0,23 0,19 1,0# 1,38
)imes >nterest <arned n.a. :,8: 9,"0 -",2! -2,82
>ncreased (ebt 9evels $elative )o <=uity
. >ncrease in :ccounts $eceivable and >nventory needed to be financed.
1. Company &rote off Encollectible :ccounts $eceivable and -vervalued
>nventory in DDD.
9o&er (ebt ,ervicing :bility because of higher interest and lo&er profits.
$ea&scoe4s Profitabi!it"
$atio DD/ DD5 DD4 DDD 1!!!
;ross Pro4it <ar$in :,9A :,8A :,2A 2,!A !,1A
=et Pro4it <ar$in 2,0A 1,"A 1,#A -3,!A -2,9A
,ales?)otal :ssets 3,8 2,3 2,! 2," 2,!
$eturn on :ssets 5.16 3,"A ".6 -4.#6 -8,#A
)otal :ssets?<=uity 1,:3 2,!" 2,3" 3,!1 !,3"
$eturn on <=uity ..D6 9,8A D./6 -1D.!6 -1D.6
Company became very unprofitable in DDD
. Both gross and net profit margins shrunk because of &riteoffs in that year.
1. (u*ont analysis reveals that the lack of operating profitability after DD4 is
maOor reason for lo& return.
Three Methods of Lendin(
,Tondon Co&&ittee- ,8-
>
nd
Method of Lendin( ,>-
%RE"(+ <O=(+OR(=9
ARRA=9E<E=+ ,%<A-
CM( data is a tool used by the bankers to assess the
re-uirement of workin! capital2 &t is divided into six parts:
Form & 'articulars of /xistin! 6 'roposed )imits
Form && peratin! %tatement
Form &&& (nalysis of Balance %heet
Form &. Comparative %tatement of Current (ssets 6
Current )iabilities
Form . Computation of M'BF
Form .& Funds Flow %tatement