Ignacio Lezaun

English edition
2021

Fundamentals of Finance

1
 2

Contents of the course

1. The role of the Chief Financial Officer

2. Statement of cash flows
3. Working capital management
4. Short-term finance instruments
5. The time value of money
6. Conclusions

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Unit 3: Working Capital 3

Management UNIT 3

OBJECTIVES
1. Background
2. Managing and Measuring Liquidity
3. Managing Accounts Receivable
4. Managing Accounts Payable
5. Managing Inventory
6. Working Capital Management
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Operating and cash cycles of a
firm UNIT 3

+ Manufacturing
 UNIT 3

3.2 Managing and measuring

liquidity
 Recap Exercise 1: Average collection
period
Calculate the average collection period for the year 2020 of the company ARCELUS if the
following data is available:

• Quarterly sales (excluding VAT) are as follows:

Q1 Q2 Q3 Q4

Year 2020 250,000 € 325,000 € 200,000 € 285,000 €

• 100% of sales are domestic and the applicable VAT is 21%

• The balance of the Accounts Receivable as of December 31 is € 96,500
Solution:

• The total sales for the year 2020 is € 1,060,000.

• It should be remembered that they are VAT excluded, so these sales will have to be
increased in VAT since the balance of the customer account does include VAT.
• The total sales (VAT included) will therefore be 1,282,600.- €.
• The average collection period of the company will be 27.5 days. The calculation is as
follows:

Average collection period = (96,500/1,282,600) x 365

TEMA 3: Gestión del Circulante I 6
 Recap Exercise 2: Balance of Accounts
Receivable
• Calculate the balance of the Accounts Receivable as of December 31, 2020 of the
company ARCELUS if the following data is available:

• The expected quarterly sales (excluding VAT) are as follows:

Q1 Q2 Q3 Q4

Year 2020 250,000 € 325,000 € 200,000 € 285,000 €

• 100% of sales are domestic and the applicable VAT is 21%

• The average collection period is 45 days
Solution:

• The total sales for the year 2020 is € 1,060,000

• It should be remembered that they are VAT excluded, so these sales will have to be
increased in VAT since the balance of the customer account does include VAT
• The total sales (VAT included) will therefore be 1,282,600.- €.
• The average collection period is 45 days, so the Accounts Receivable balance will be €
158,128.77

Accounts Receivable balance = (45 x 1,282,600) / 365

TEMA 3: Gestión del Circulante I 7
 Exercise 3: Financial cost
• Let's imagine that the company FUNFIN S.A. has had during the year 2020 an average of
daily sales of € 75,000.00
• The average collection period of the company is established at 60 days, and yet the
actual average collection of FUNFIN S.A. has been 72 days
• The General Director of the company calls them to a meeting to find out what the
financial cost of this delay has been, knowing that the company has a financing cost of
5%
• What is the financial cost FUNFIN S.A. has suffered during the year 2020 on an average
delay of 12 days?

TEMA 3: Gestión del Circulante I 8

 Exercise 3: Financial cost
• Let's imagine that the company FUNFIN S.A. has had during the year 2020 an average of
daily sales of € 75,000.00
• The average collection period of the company is established at 60 days, and yet the
actual average collection of FUNFIN S.A. has been 72 days
• The General Director of the company calls them to a meeting to find out what the
financial cost of this delay has been, knowing that the company has a financing cost of
5%
• What is the financial cost FUNFIN S.A. has suffered during the year 2020 on an average
delay of 12 days?

Solution:

• As we know that the average daily sales has been € 75,000 and the delay is 12 days with
a financing cost of 5%, the answer is € 45,000.00

Cost = 75,000€ x 5% x (72-60) = 45,000€

• Another way to fix this is to see how much total sales are for the year and calculate the
cost of financing those sales for 12 days.

Cost = 75,000€ x 365 = 27,375,000€ x 5% x (12/365) = 45,000€

TEMA 3: Gestión del Circulante I 9
 UNIT 3

3.4 Managing accounts payable

Management of payments UNIT 3

 The payment management policy includes both the term and the means of payment. It is
necessary to take into account the possible surcharges for late payment as well as the
discount for advanced payments.

 The objective should be to achieve the longest average payment term within the law and
what´s agreed.

 Currently the current legislation in Spain establishes a maximum term for the payment of
invoices, 60 days as a general rule (in the case of the agri-food industry, the primary sector,
the term is 30 days).

 To facilitate the administrative task, it is possible to negotiate the invoicing of our suppliers
on established dates as well as grouping the purchases made in the period, establishing
payment dates

 Avoid at all times to carry out reprehensible practices when delaying payments:
missing signature, sending wrong payment data,…. These practices represent
unethical behaviour (and can also lead to a very negative image of the company.
Management of payments UNIT 3

 In 2004, the first Law against late payment was published in Spain, Law 3/2004, which
established a series of conditions that companies should comply with. This Law was
modified by Law 15/2010 and among the most outstanding measures:

 Suppliers must send the invoice to their clients within 15 days from the date of receipt of the merchandise or
provision of the service.
 The payment term is 30 days from the receipt of the merchandise or service. A maximum of 60 days can be
agreed.
 Invoices can be grouped over a specified period of no more than 15 days by means of a summary invoice of
all deliveries made during that period.
 In the electronic invoice, the beginning of the calculation of the payment term will be made from the receipt
of the invoice.
 The debtor is in default and must pay the interest agreed in the contract or the legal interest on the money if
the established term is breached.
 The default interest is the one agreed, and failing that, the legal interest of the money. The clauses agreed
between the parties on the date of payment and the consequences of the delay that differ from those legally
established will be void.
Accounts payable UNIT 3

Accounts payable are amounts due to vendors or

suppliers for goods or services received that have not
yet been paid for
As with accounts receivable, methods of
management are:
1. Accounts payable turnover
2. Number of days of payables
Accounts payable: Apple example
UNIT 3
Accounts payable turnover UNIT 3

ACCOUNTS PAYABLE TURNOVER = PURCHASES÷ AVERAGE ACCOUNTS PAYABLE

WHERE PURCHASES =ENDING INVENTORY + COST OF SALES – BEGINNING INVENTORY

 Measures how many times a firm theoretically pays off suppliers

over a period
 A higher ratio implies the firm may not be making full use of credit
facilities
 A lower ratio implies the firm could be struggling to make
payments in time
 VAT must be consistently considered (as disclosed for accounts
receivable)
 Accounts payable turnover:
example Apple UNIT 3

Purchases = 4,061 + 169,559 – 4,106

= 169,514

Accounts payable turnover = 169,514/42,296

= 4.01
Number of days of payables UNIT 3

NUMBER OF DAYS OF PAYABLES =

AVERAGE ACCOUNTS PAYABLE ÷ AVERAGE PURCHASES PER DAY
= 365 ÷ ACCOUNTS PAYABLE TURNOVER

 Also known as Days Payable Outstanding (DPO)

 Measures how long the firm takes to pay its suppliers

 VAT consideration: as previously disclosed.

 Benchmark versus sector:

• If average days payables is too high indicates that your business may be paying
suppliers beyond the accepted collections periods, meaning that you are paying
interest on your purchases, which in turn could affect your business’s credit rating

• If your average days payable is too low, this indicates that your business is not
taking advantage of your suppliers’ payment terms and that you are unable
to take full advantage of their purchase credit
 Number of days payables:
example Apple UNIT 3

Purchases = 4,061 + 169,559 – 4,106

= 169,514

Number of days payables = 42,296 / (169,514/365)

= 91.07
Operating and cash cycles of a
firm UNIT 3

DIO
DSO

DPO

Cash Cycle = DIO + DSO - DPO

Apple case: DIO + 21,4 - 91,07

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 Exercise 1: Average payment period
• Calculate the average payment period for the year 2020 of the company ARCELUS if the
following data is available: Quarterly purchases (without VAT) are as follows:

Q1 Q2 Q3 Q4

Year 2020 125,000 € 275,000 € 195,000 € 175,000 €

• 100% of purchases are domestic and the applicable VAT is 21%

• The balance of Accounts Payable at December 31 is € 112,500.00.

TEMA 3: Gestión del Circulante I 20

 Exercise 1: Average payment period
• Calculate the average payment period for the year 2020 of the company ARCELUS if the
following data is available: Quarterly purchases (without VAT) are as follows:

Q1 Q2 Q3 Q4

Year 2020 125,000 € 275,000 € 195,000 € 175,000 €

• 100% of purchases are domestic and the applicable VAT is 21%

• The balance of Accounts Payable at December 31 is € 112,500.00.

Solution:

• The total purchases for the year 2020 is € 770,000

• It must be remembered that these purchases will have to be increased in VAT
• The total of purchases (VAT included) will therefore be 931,700.- €.
• The average payment period of the company will be 44.1 days.
• The calculation is as follows:

Average payment period = (112,500/931,700) x 365

TEMA 3: Gestión del Circulante I 21
 Exercise 2: Balance of supplier account
• Calculate the balance of the supplier account as of December 31, 2020 of the company
ARCELUS if the following data is available:

• Expected quarterly purchases (excluding VAT) are as follows:

Q1 Q2 Q3 Q4

Year 2020 125,000 € 275,000 € 195,000 € 175,000 €

• 100% of purchases are domestic and the applicable VAT is 21%

• The average payment period of the company is 30 days

TEMA 3: Gestión del Circulante I 22

 Exercise 2: Balance of Account Payable
• Calculate the balance of the Accounts Payable as of December 31, 2020 of the company
ARCELUS if the following data is available:

• Expected quarterly purchases (excluding VAT) are as follows:

Q1 Q2 Q3 Q4

Year 2020 125,000 € 275,000 € 195,000 € 175,000 €

• 100% of purchases are domestic and the applicable VAT is 21%

• The average payment period of the company is 30 days

Solution:

• The total purchases for the year 2020 is € 770,000

• It must be remembered that they are VAT excluded, so these purchases will have to be
increased in VAT since the balance of the supplier account does include VAT
• The total of purchases (VAT included) will therefore be 931,700€.
• The average collection period is 30 days, so the customer balance will be € 76,578.08

Accounts Payable balance = (30 x 931,700) / 365

TEMA 3: Gestión del Circulante I 23
 Exercise 3: Average payment period
• The company FUNFIN S.A. starts its activity on January 1, 2020.
• As of December 31, 2020, the balance of the supplier account shows a balance of € 250,500.
• The final stocks of the company are valued at € 415,000 and the cost of the merchandise sold has
amounted to € 1,635,000
• What has been the average payment period of FUNFIN in 2020?

TEMA 3: Gestión del Circulante I 24

 Exercise 3: Average payment period
• The company FUNFIN S.A. starts its activity on January 1, 2020.
• As of December 31, 2020, the balance of the supplier account shows a balance of € 250,500.
• The final stocks of the company are valued at € 415,000 and the cost of the merchandise sold has
amounted to € 1,635,000
• What has been the average payment period of FUNFIN in 2020?

Solution:

• First of all, we must know what purchases have been in 2020 through the already known equation
of Initial Stock + Purchases - Consumption = Final Stock.
• Purchases for the year amount to € 1,635,000 + € 415,000= € 2,050,000
• Remember that they do not include VAT, VAT included purchases amount to 2,480,500€
• If the balance of suppliers is 250,500€ the average payment period is 36.9 days

Average payment period = (250,500 /2,480,500) x 365

TEMA 3: Gestión del Circulante I 25