Introduction to Corporate Finance

Ross et al.: Fundamentals

of Corporate Finance, Sixth

Edition, Alternate Edition

VII. Short−Term Financial

Planning and Management

19. Short−Term Finance
    and Planning

© The McGraw−Hill^683

Companies, 2002

choose quarters for convenience and also because a quarter is a common short-term

business planning period. (Note that, throughout this example, all figures are in millions

of dollars.)

All of Fun Toys’s cash inflows come from the sale of toys. Cash budgeting for Fun

Toys must therefore start with a sales forecast for the coming year, by quarter:

Note that these are predicted sales, so there is forecasting risk here, and actual sales

could be more or less. Fun Toys started the year with accounts receivable equal to $120.

Fun Toys has a 45-day receivables, or average collection, period. This means that

half of the sales in a given quarter will be collected the following quarter. This happens

because sales made during the first 45 days of a quarter will be collected in that quarter,

whereas sales made in the second 45 days will be collected in the next quarter. Note that

we are assuming that each quarter has 90 days, so the 45-day collection period is the

same as a half-quarter collection period.

Based on the sales forecasts, we now need to estimate Fun Toys’s projected cash col-

lections. First, any receivables that we have at the beginning of a quarter will be col-

lected within 45 days, so all of them will be collected sometime during the quarter.

Second, as we discussed, any sales made in the first half of the quarter will be collected,

so total cash collections are:

Cash collections Beginning accounts receivable 1/2 Sales [19.6]

For example, in the first quarter, cash collections would be the beginning receivables of

$120 plus half of sales, 1/2 $200 $100, for a total of $220.

Because beginning receivables are all collected along with half of sales, ending re-

ceivables for a particular quarter will be the other half of sales. First-quarter sales are

projected at $200, so ending receivables will be $100. This will be the beginning re-

ceivables in the second quarter. Cash collections in the second quarter will thus be $100

plus half of the projected $300 in sales, or $250 total.

Continuing this process, we can summarize Fun Toys’s projected cash collections as

shown in Table 19.3.

In Table 19.3, collections are shown as the only source of cash. Of course, this need

not be the case. Other sources of cash could include asset sales, investment income, and

receipts from planned long-term financing.

Q1 Q2 Q3 Q4

Sales (in millions) $200 $300 $250 $400

656 PART SEVEN Short-Term Financial Planning and Management

See the Finance Tools
section of
http://business.lycos.com
for several useful
templates including a
cash flow budget.

TABLE 19.3

Cash Collection for Fun

Toys (in Millions)

Q1 Q2 Q3 Q4

Beginning receivables $120 $100 $150 $125

Sales 200 300 250 400

Cash collections 220 250 275 325

Ending receivables 100 150 125 200

Collections Beginning receivables 1/2 Sales

Ending receivables Beginning receivables Sales 
Collections

1/2 Sales