6.- Minimum Cash and Other Elements in the NFO

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En provenance du cours de IESE Business School

Operational Finance: Finance for Managers

305 notes

IESE Business School

Operational Finance: Finance for Managers

305 notes

Cours 2 sur 5 dans Specialization Foundations of Management

When it comes to numbers, there is always more than meets the eye. In operational finance, you will learn how to read the “story” that the balance sheet and income statement tells about the company’s operations. The insights you gain from this “financial story” will then become a tool for short-term decision-making at the top management level relating to current assets, current liabilities and the management of working capital. Finally, by the end of the course you will understand the financial consequences of managerial decisions on operations, marketing, etc.

À partir de la leçon

Week 4: Negative NFO and DuPont Analysis

In this final week, we will introduce the final pieces of the puzzle to give you a complete overview of operational finance. We’ll discuss tools like sensitivity analysis that will help you consider the potential outcome of a decision given different variables. In this session we will also look at other crucial concerns for the firm and its shareholders like sustainable growth and ROE (Return On Equity) plus revisit NFO (Need of Funds for Operations) and other topics. Objectives: By the end of this session, you should have a complete overview of the key aspects of operational finance. You will also understand what tools financial professionals use in order to make decisions to strengthen a company’s position.

Course Conclusion & Congratulations0:55

1.- Recap from Week 37:11

2.- Recap from Week 3 (Part 2)3:55

3.- Sensitivity Analysis7:33

4.- Sensitivity Analysis (Part 2)5:54

5.- An Example of Sustainable Growth6:03

6.- Minimum Cash and Other Elements in the NFO7:37

7.- Seasonal Companies6:54

8.- Building up the ROE (Part 1)3:57

9.- Building up the ROE (Part 2)5:20

10.- Building up the ROE (Part 3)4:57

11.- Blind Financial Statements5:02

12.- Blind Financial Statements (Part2)3:34

13.- Blind Financial Statements (Part 3)7:19

14.- Brief Recap2:42

15.- Course Conclusions6:46

Rencontrer les enseignants

Miguel Antón
Associate Professor
Financial Management

[MUSIC]

Now so far so good.

You might think well Miguel today you are going really fast.

Now, what would happened is that by the last three weeks you've been

following slowly what I'm saying, because I'm repeating some of the concepts.

Now, you are more familiar with that.

So, if you need it, just pause it and repeat the video again, it should be okay.

Now, for simplicity, in the last few weeks, we've look at the definition of

the NFO in a very simple fashion, receivables plus inventory minus payables.

But when you take a real balance sheet of a company that is pretty long,

you will say, well, there are many things that I even don't know where to put.

Let's think to a few of them, for example, Minimum Cash For Operations and Taxes.

So if we move on to that, you may have realized that in the poly panel case

there is credit, and we saw from the forecast

that if the liabilities are bigger than the assets, then you have extra cash.

And if the assets are bigger than the liabilities, you have need of credit.

So, you might wonder why if you have in need of credit,

you still have some cash in your asset side.

In the example, of Polypanel do you see here.

Well did I mentioned this at all the other day, but look at the past

it turns out that there is something in the cash in Polypanel there is one, eight,

six and six and then the credit is growing from 100 to 310.

Now that cash on the top we have assumed is zero in the future.

But actually, it is not zero, right?

So what is this cash about?

Well, it is very simple.

We call it minimum cash for operations.

To every company in developed financial markets or

economies Tend to have minimum cash almost zero right.

The reason is very simple.

Cash produces almost no return, it produces zero interest rate.

So, the lower the cash the better, because this It's like wasting a resource.

You could put it to something that is profitable.

Now, it turns out that some small companies in developed countries or

even bigger companies in developing

economies actually need some cash for operations.

This is analogous to you and me, for example, you use a credit card.

Right?

We have a credit card use it for some purchases, right?

But at the same time you have a wallet and in the wallet,

you normally have some cash for coffee or for the bus, right?

So that cash that you have in the wallet 10 or 20 Euros,

whatever it is, that is what we call minimum cash for operations.

Now, analogous to another operational ratios, the minimum cash for

operations also would have days of cash in the sense

that you can compute how many days of cash you have in your balance sheet.

Now, it turns out that this minimum cash should go into the NFO.

It's a need of a cash, a need for operations.

NFO would be minimum cash for

operations plus receivables plus inventory minus payables.

Payables.

And then as I was saying before you can have days of cash, but

how dow we compute days of cash?

Well it's very simple, what I have in cash is enough to cover the expenses of

the next X days, because cash is there to pay expenses.

And what are the expenses?

Well, it's basically the sales minus the net income.

The basic formula for

the days of cash would be days of cash equal to minimum cash over daily expenses.

Do you remember the days of collection was receivables over daily sales.

Here is days of cash that would you having cash, minimum cash over daily expenses.

In the case of Polypanel, this was very simple.

You see that the last year, the 2007, there was sales,

daily sales was 8000 euro's.

Now how much cash do you have?

We have six in cash, right?

ROS is 1.5, so daily expenses was 7.88.

Now if you do the formula, it turns out the days of cash

is 0.76 days, which is less than one day of cash.

That's why the comp would normally set it to zero.

In a way, that's why we didn't include it in the NFO when we computed back for

the Polypanel.

But then it turns out that if we move on a little more complicated or

sophisticated, you would see some companies,

many companies that have a reasonable big amount of credit in the balance sheets,

and a big amount of cash in the balance sheet as well.

That amount of cash might not necessarily be the minimum cash flow ledgers.

It turns out, and this is not to confuse you.

So far we understood that you either have cash or credit, but you don't have both.

Now it turns out that some companies actually have both, and

they are big in both sides.

That does not mean that all the cash that is piling up there is necessary for

operations.

Some companies like to keep a lot of cash.

For example, Apple.

For two reasons, the first one is precautionary reasons, which is try to be

ready when a crisis hits, and when a crisis hits you have a lot of cash and

you're able to more or less wave the crisis, and

second one is have enough ability to enter into a merger.

Many m&a's mergers and acquisitions between companies are done through cash.

So if you have a good pile of cash, you are going to enter into m&a's.

So with this we finish with the cash,

but it turns out there are other elements in the NFO.

Specifically, the rule is whatever is needed for

operations in the short-term goes to the NFO.

For example, people that owe us money, but is not related to sales.

Or in other words, other spontaneous funds that are short term and

are free should go into the NFO as well, for example, accrued expenses or taxes.

What is the sale of taxes?

Let me tell you briefly when you finish the fiscal year

you owe some money to the authority, to the government you have to pay taxes.

Now the government instead of telling you pay me taxes right now

the 31st of December,

the government tells you well the 1st of April you're corporate taxes are due.

So, it turns out that you owe the government some money, but

you still have four months to pay that money.

That money is a source of finance that is for free, and

that source should go into the NFO.

So, the most complete version of the formula of the NFO would be minimum cash

for operations plus receivables plus inventory minus payables and

minus any other spontaneous source of funds.

And then with this we are done basically

with the understanding of the small other elements of the NFO.

Now in the next clip, what we're going to see is

what happens in the case of seasonal companies.

[MUSIC]

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