Page 484 - Introduction to Business

458 PART 5 Finance

source of cash if net cash flow becomes negative. Accounts receivables can be
factoring The sale of accounts quickly converted to cash using factoring. A financial institution that buys
receivables to a financial institution that accounts receivables from a firm is a factor. In this case customers pay the factor
then collects payments by customers
instead of the firm.
Of course, many times customers pay in cash on receipt of a product or service. If
a firm’s sales are on a national or international level, a problem arises in consolidat-
ing all of the cash payments as quickly as possible in a centralized bank account. A
lock box system A way for firms to popular way to do this is to use a lock box system. Customers make payments to post
speed the collection of payments from office boxes in local postal service facilities, and the payments are regularly collected
customers, who submit payments to by local banks in the area. Cash is then wired by local banks via computer telecom-
local post offices, where the payments
are picked up by local banks and munications equipment to a settlement bank in which the cash is concentrated.
forwarded to the firm’s bank Since the settlement bank typically is the disbursing agent to make bill payments, it
can compare cash inflows and cash outflows to get net cash flow at any moment.
Current liabilities are short-term debts, accrued wages and other accrued
expenses (such as taxes), and accounts payables. Accounts payables come about as
the firm purchases materials used in the production of products or services. It is
common practice for supplier firms to offer the producing firm trade credit terms
that allow the firm to pay the supplier within 30 to 90 days from the date of pur-
trade credit A credit system that allows chase. Trade credit gives the firm time to make products and services and sell them
a firm to buy goods and services from in the marketplace. Cash inflows on sales can then be used to meet cash outflows
another firm and pay within 30 to 90
days from the date of purchase on current liabilities. In general, financial managers seek to pay bills as late as pos-
sible without missing a payment deadline.
Sometimes a discounted price on purchased materials (for example, 2 percent
lower cost) is allowed if the firm promptly pays within 10 or 15 days of the date of
purchase. Timely payment of bills is cost efficient if the discount can be obtained.
However, because cash inflows from sales occur later, the firm likely will need some
debt financing to cover the early payment for materials. Financial managers must
weigh the benefits of trade discounts versus the costs of debt financing.

Matching Assets and Liabilities

A basic principle of financial management is to match the maturities of assets and
liabilities. As discussed previously, if the firm is going to invest in a machine with a
life of five years, it should finance this investment with five-year bonds. Shorter-life
assets, such as inventory that is held for, say, 30 days on average before it is sold,
should be financed with 30-day bank loans or commercial paper.
What if you did not do this? Let’s assume that you financed a five-year
machine with a one-year bank loan. At the end of the year, you would have to ask
the bank for another loan. But what if the firm’s financial condition had deterio-
rated during the year? Under these circumstances, the bank may well not want to
renew the loan. Cut off from another loan, the firm would have to pay off the old
loan out of cash and near-cash assets. If the firm could not access enough cash
to make the interest and principal payments on the debt, it could default and
end up in bankruptcy.
Another reason to match the maturities of assets and liabilities is that net cash
flows in each month or quarter can be planned out in advance. Using five-year
bonds to finance a five-year machine allows the financial manager to better under-
stand net cash flows for each period in the future.

reality If you owned some common stock of a company, what percentage of
CH ECK your earnings would you wish to receive in dividend payments versus
capital gains? How would this affect the company’s sources of funds
and related financing decisions?

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