Factor that complicate cash flow
- the business (pharmacy) usually buys inventory on credit
- pharmacies frequently sell on credit
- cash flows out of the business (pharmacy) to pay for expenses such as salaries, utilities & rent
- making there no longer be a direct relationship between sales and cash
purchasing inventory on credit
creates a time lag between the time inventory is received and the payment for it
selling on credit
creates a time lag between the time merchandise is sold and payment is received
cash used to cover salaries, utilities and rent
must come from the gross margin or the amount left over after the cost of inventory has been covered
the basic means of improving cash flow include:
- decrease the amount of cash invested in the pharmacy
- slow the amount & rate of cash flowing out of the pharmacy
- increase the amount & rate of cash flowing in
6 ways to accomplish improving cash flow
- proper control of inventory
- maintenance of GM
- investment of idle cash
- proper control of accounts receivable
- delay of disbursements for accounts payable
- minimization of operating expenses
carrying the proper inventory
- has the effect of reducing the demand for cash
- un-saleable inventory requires the same cash investment as saleable inventory
- un-saleable inventory decreases inventory turn over & increases total inventory investment
the 80/20 rule
- “80% of your inventory problems come from 20% of your inventory”
- “2-% of your inventory may account for 80% of sales”
applying the 80/20 rule to inventory management
- determine overall sales dollars produced by each category of items
- start by breaking dollar sales into 3 categories: class A (80% dollars), class B (15% dollars), class C(5%)
what becomes apparent after classification
a minority of the actual inventory creates the majority of the sales
define shrinkage
merchandise lost through breakage or theft
control shrinkage
- lost, stolen or broken merchandise must be paid for but generates no cash income
- shrinkage has a dramatic effect on cash flow
maintain adequate GM
- emphasize high-margin products
- selection of third party contracts
pharmacies can decrease product costs by
- taking cash discounts
- utilizing the lowest cost sources
- participating in buying groups
what to do with idle cash?
invest it!
liquidity
an investment that can be rapidly, readily and cheaply converted to cash
negatives of accounts receivable (selling merchandise on credit)
- represents a substantial investment of cash
- amount of cash invested = amount of outstanding AR
- slows the rate of cash flow into the pharmacy that may not be received for weeks or months
- a % of outstanding debts may become uncollectible & be regarded as bad debt, permanently reducing payment for merchandise sold & reducing cash flow
opportunity cost
the time that the pharmacy’s cash is tied up in AR or the time between when the sale is made and the customer pays the bill
opportunity cost of the investment of cash in AR or credit program is =
the interest that could be earned in the next best investment
minimizing AR
- carefully screen credit applicants
- send out bills promptly & regularly
- add a finance charge to overdue accounts
- follow up on overdue accounts
managing accounts payable
- slow down payments to supplies, but pay soon enough to receive cash discounts, but no sooner
- purchases made after suppliers close the books, will extend payments the longest
capital expenditures differ from ordinary expenditures in that they:
- usually involve very large sums of money
- are not as regularly recurring as are expenditures for payroll & inventory
- commit a firm to a long-term course of action which cannot be easily reversed
- involve large cash inflows * outflows over number of years
factors affecting the decision to invest in non-current assets
- external pressures: include effects of competition, demand and technology
- internal pressures: a firms cost structure & management expectations
types of investments
replacements
cost reduction
expansion
new products
steps for capital budgeting decision process
- ideas for projects developed
- projects are classified by type of investment
- expected future cash flows from a project are estimated (estimate outflows & inflows)
- the riskiness inherent in the project appraised
- financial value of proposed project is analyzed. projects are accepted when NPV>0
- final step is a post-audit, which involves comparing actual results to predicted result
borrowing is only worthwhile if
the return on the proposed project exceeds the cost of the borrowed funds
lending is only worthwhile if
the return is at least EQUAL to that which can be obtained from alternative risk opportunities in the same risk class
interest is determined by
- the receipt of money is preferred sooner rather than later
- the risk of the capital sum being repaid
- inflation
a dollar in hand today is worth
more than a dollar to be received in the future bc if you had it now you could invest it & earn interest
- “future value”
future value
- the amount to be received at the end of one period
- i.e. 2000+(1+0.12)=$2240
present value
the current value of specified amount to be received at some future date
-i.e. 2240/(1+0.12)=$2000
future value (FV) equation
FV=PV(1+i)^n
present value (PV) equation
PV=FV/(1+i)^n
PV=FVn(PVIFi,n)
PVIF
present value interest factor (found in the table)
net present value
method of adjusting the cash inflows and outflows for the time value of money so that they are comparable
to calculate the net present value,
the business must choose a required rate of return (RRR) in order to know how to discount the cash inflows & outflows
RRR
rate of return that an investment must earn to be financially attractive
- as RRR increases, PV of cash flows in future years decreases
RRR for a business should be
set equal to its cost of capital-debt & equity
higher the risk of a project
the higher the required rate of return
internal rate of return (IRR)
calculated by finding the interest rate at which the present value of the inflows from the investment is equal to the present value of the outflows