LDP 4.2 Seasonality Flashcards
Name three seasonal business patterns that can cause seasonal borrowing
1) Seasonal sales that increase daily average sales or cost of sales and sometimes cause a mismatch of cash receipts and disbursements
2) Level sales and cash receipts but uneven seasonal cash disbursements that lengthen the cash cycle
3) Level sales and cash disbursements but uneven seasonal cash receipts that lengthen the cash cycle
Manufacturer Inventory Strategies
1) Level production: A company produces a consistent amount each period, gradually building up the finished goods it will need for its peak sales
2) Peak production: A company produces all the goods it needs for peak sales by adding a second or third shift during its peak season or immediately before.
In order to analyze a company’s seasonality, you need to analyze its interim financial statements that report monthly or quarterly on its financial condition and performance. The benefits of interim financial statements include:
1) They are the best way to understand a company’s historical pattern of seasonality
2) They allow you to monitor a company’s financial condition and performance more frequently than annually
3) They give you a more current picture of a company’s financial condition or performance than an annual statement
Some limitations of interim financial statements are:
They are usually prepared internally by the company, without independent verifications
They are usually based on estimated inventories
Companies do not always make interim accruals for some expenses
You should require interim financial statements when:
You are considering a loan to a seasonal company, and you want to estimate its seasonal needs You are considering a loan to a company, and you do not know if it is seasonal
You have made a loan to a company, and you want to follow the company’s progress more often than annually You are considering a loan to a company, and the most recent fiscal year-end statement you have is more than three months old
To increase the value of interim statements, look for disclosures on the following topics:
General financial disclosures
Balance sheet
Income statement Contingencies
How to calculate seasonal vs. base-level assets
Seasonal Assets = Difference between Peak and Low Point = 300 – 130 = 170
How to calculate temporary liabilities
Difference between Peak and Low Point = 270 – 115 = 155
Lending to finance fixed-asset acquisitions often involves large sums and long repayment periods. Fixed-asset expansions often trigger related but unanticipated additional borrowing needs, such as:
Set-up and installation of new equipment
Out-of-pocket costs and lost production time when moving to a new building
Distraction of management from other tasks
Increase in inventory
Capacity increases that lead to sales increases
Increased property maintenance expense
Lending to finance fixed-asset acquisitions often involves large sums and long repayment periods. Fixed-asset expansions often trigger related but unanticipated additional borrowing needs, such as:
Set-up and installation of new equipment
Out-of-pocket costs and lost production time when moving to a new building
Distraction of management from other tasks
Increase in inventory
Capacity increases that lead to sales increases
Increased property maintenance expense
Loans caused by decreases in net worth carry additional risks for three reasons:
- Decreases in net worth diminish a company’s resources, which may damage a company’s capacity to generate repayment. They do not “reverse” or carry the seeds of their own repayment.
- Repayment usually depends on change rather than continuation of a trend.
- Replacing net worth with debt has a double impact on leverage. The increase in leverage weakens the lender’s margin of protection in asset values.
Cash Budget
- Quite similar to a company’s check register, in that it shows a monthly opening cash balance; records collections from accounts receivable; deducts cash outlays for business expenses, capital expenditures, loan payments, and taxes; and typically balances any cash shortfall or excess by borrowing or repaying a short-term loan.
- Companies often prepare a cash budget to anticipate their short-term borrowing needs
- A company that submits a cash budget demonstrates that it understands and is in control of its cash cycle.
Base-level current assets
- Lowest point of receivables + inventory
- permanent base-level current assets should be supported by net worth or long-term debt.
- Should be supported by operational cash flow or long-term liabilities
Seasonal assets
- Difference between Peak and Low Point of receivables + inventory
- Seasonal assets should be supported by temporary current liabilities (ie. A/P. short term borrowing)
