Fn2640 Week 4 Management And Financing Analysis

Fn2640 Week 4 Management And Financinganalysis 42short Term Financi

Use the information below for this assignment. Comfin Company has estimates on its level of current and total assets for the next two years: Year 201X Jan Feb Mar Apr May June July Aug Sep Oct Nov Dec Total Assets $500,000 $475,000 $460,000 $470,000 $475,000 $485,000 $495,000 $555,000 $600,000 $650,000 $700,000 $750,000 Current Assets $250,000 $220,000 $199,900 $204,698 $204,392 $208,980 $213,459 $262,829 $307,085 $351,227 $395,251 $439,156 Year 201X + 1 Jan Feb Mar Apr May June July Aug Sep Oct Nov Dec Total Assets $600,000 $570,000 $552,000 $564,000 $570,000 $582,000 $594,000 $660,000 $720,000 $780,000 $840,000 $900,000 Current Assets $350,000 $350,000 $352,100 $359,302 $365,608 $373,020 $380,541 $397,171 $412,915 $428,773 $444,749 $460,844

Paper For Above instruction

The financial management of a company involves strategic decisions about the levels of assets, particularly current assets, and the sources of financing that support operational needs and growth. In this analysis, we evaluate Comfin Company’s short-term and long-term financing strategies over two years, employing concepts such as permanent and temporary current assets, and compare risk, profitability, and liquidity implications of different financing approaches.

Estimating Permanent and Temporary Current Assets

To analyze Comfin’s financing requirements, the first step involves distinguishing between permanent and temporary current assets. Permanent current assets refer to the baseline level of assets necessary to sustain core operations irrespective of seasonal fluctuations, whereas temporary current assets are additional assets needed to cover seasonal peaks and short-term fluctuations in business activity.

In Year 201X, the average current assets can be calculated as:

  • Average Current Assets (Year 201X) = (Sum of monthly current assets)/12

Similarly, for Year 201X+1, the same calculation applies. The permanent current asset level is typically taken as the average of the lowest months to reflect baseline needs, while the difference between peak and baseline indicates temporary assets.

Based on the given data, the lowest monthly current assets during 201X is $199,900 in March, and the highest is $439,156 in December. For 201X+1, the lowest is $350,000, and the highest is $460,844. Averaging these values provides estimates of permanent and temporary assets. The calculations reveal that Year 201X's permanent current assets approximate to $220,000 (lowest month average), while temporary current assets fluctuate with seasonal peaks, reaching up to approximately $219,156 (difference between peak and baseline). For Year 201X+1, baseline permanent assets are about $350,000, with seasonal variations reaching roughly $110,844.

Average Fixed, Permanent, and Temporary Current Assets

Calculating the averages over the respective years, we find:

  • Average Fixed Assets: This is the mean of total assets over the year, which increases proportionally based on given data. For 201X, the average total assets approximate to ($500,000 + $750,000)/2 = $625,000, with more precise calculations based on monthly data. Similarly, for 201X+1, the average is around $750,000.
  • Average Permanent Current Assets: Approximately $220,000 in 201X and $350,000 in 201X+1.
  • Average Temporary Current Assets: The seasonal peaks minus the permanent base, estimated at around $219,156 for 201X and $110,844 for 201X+1.

Determining Financing Needs Under Different Strategies

Financial strategies determine the composition of short-term (working capital) and long-term financing. For a maturity-matching strategy, the goal is to align the maturities of assets and liabilities. This approach entails financing permanent current assets and fixed assets with long-term funds, while covering temporary current assets with short-term funds.

Using the computed averages, Comfin should finance approximately:

  • Permanent current assets with long-term debt or equity, reflecting stable funding needs.
  • Temporary current assets with short-term financing to match seasonal requirements.

For the year 201X, the estimated financing needs are about $220,000 in permanent current assets and roughly $219,156 in temporary assets, requiring a balanced mix of long-term and short-term funding. In 201X+1, these figures increase to $350,000 (permanent) and approximately $110,844 (temporary).

Aggressive Financing Strategy

An aggressive strategy involves minimizing long-term financing, relying heavily on short-term sources for assets, which could lead to higher risk but potentially lower costs. In this case, Comfin would fund all of its assets, including fixed assets and permanent current assets, through short-term financing, accommodating seasonal needs with additional short-term borrowing.

This means in 201X, nearly all asset levels are financed via short-term debt, which might reduce interest expenses due to lower rates but increases liquidity risks. The strategy in 201X+1 would follow similar principles, with minimal long-term debt, relying mostly on short-term financing for all assets requiring quick maturities.

Cost Calculation of Strategies

The company's cost of funds is given as 8% for short-term and 15% for long-term financing. The total costs of each strategy are computed by multiplying the amount of financed assets by the respective interest rate and summing these costs.

For the maturity-matching strategy, the weighted average cost involves applying 15% to permanent assets (including permanent current assets and fixed assets) and 8% to temporary current assets. Conversely, the aggressive strategy incurs higher costs on almost all assets due to the reliance on short-term funds, but it benefits from the lower interest rate of 8% on the entire asset base for temporaries.

Quantitatively, the total annual cost for each strategy can be calculated by:

  • Long-term financed assets at 15% interest
  • Short-term financed assets at 8% interest

Applying these to the respective asset levels gives the overall financing costs, which are crucial for comparing profitability implications.

Pros and Cons of Each Strategy

The maturity-matching approach balances risk and profitability by ensuring long-term assets are financed with stable, long-term sources, thus reducing refinancing risk and enhancing liquidity. Its main advantage is stability, but it might incur higher interest costs, slightly reducing profitability.

The aggressive strategy minimizes long-term debt, capitalizing on lower-interest short-term debt, which can increase profitability in low-interest environments. However, it heightens liquidity risk and exposes the company to refinancing risk if short-term rates rise or if the firm faces cash flow issues. This strategy may be suitable when the company's cash flow is stable and interest rates are low, but it demands careful liquidity management.

Conclusion

In conclusion, the choice between these strategies depends on the company’s risk appetite, market conditions, and operational stability. The maturity-matching approach favors stability and reduced risk, aligning with conservative financial management, while aggressive financing prioritizes profitability but involves higher risk. Comfin’s optimal strategy should consider its cash flow stability, market interest rates, and risk management policies, balancing profitability with risk mitigation.

References

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