Q4

Sales (in millions)

$200

$300

$250

$400

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 collections. First, any receivables that we have at the beginning of a quarter will be collected 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 X Sales

For example, in the first quarter, cash collections would be the beginning receivables of $120 plus half of sales, 1/2 X $200 = $100, for a total of $220.

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

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 Companies, 2002

CHAPTER 19 Short-Term Finance and Planning

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