Chap019

McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

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Short-Term Financial Planning

Short-term financial planning focuses on managing a firm’s current assets and liabilities.

This chapter examines a number of short-term planning strategies and provides a greater understanding of how firms develop short-term financial plans.

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Short-Term Planning

Short-term financing needs are tied to the firm’s long-term decisions.

Total Capital Requirement• The total cost of the assets that a firm needs to run

efficiently.

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Short-Term Planning

As the business grows, it is likely to need additional fixed assets and current assets.

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Planning StrategiesThree approaches:

a)Relaxed Strategy-permanent cash surplus

b)Middle-of-the-road Policy

c)Restrictive Policy-permanent need for short-term borrowing

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Planning StrategiesManagers typically list three considerations when determining

the “best” mix of short-term and long-term financing:

Matching Maturities

Permanent Working Capital Requirements

The Advantages of Liquidity

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LiquiditySome firms choose to hold more liquidity than others.

Why do many high-tech companies hold huge amounts of short-term securities while many manufacturers (ex. steel) hold much smaller reserves?

What are the costs associated with holding excess cash?

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Working CapitalMuch of short-term financial planning focuses on

variations in working capital.

Components of Working Capital: Current Assets Current Liabilities

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Working Capital: Example

What will be the change in net working capital if current assets increase by $170,000 and current liabilities decrease by

$60,000?

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Current Assets

Common current assets: Accounts Receivable

• Trade Credit• Consumer Credit

Inventory Cash & Marketable Securities

• Demand Deposits• Time Deposits• Commercial Paper• Treasury Bills

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Current Liabilities

Common current liabilities: Accounts Payable Short-term Borrowing

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The Cash Conversion CycleTypically, most firms have positive net working

capital. But why do they need working capital at all?

Simple Cycle of Operations

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The Cash Conversion Cycle

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Useful Ratios

Why are these ratios useful?

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Cash Conversion Cycle: Example

What is the cash conversion cycle for a firm with $3 million average inventories, $1.5 million average accounts payable, a receivables period of 40 days, and an annual cost of goods sold of $18 million?

Cash Conversion

Cycle (CCC)

Inventory Period

Receivables Period

Accounts Payable Period

= + -

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The Working Capital Trade-OffWorking capital can be actively managed; it is not set in

stone.Carrying Costs

Costs of maintaining current assets, including opportunity cost of capital.

What are some carrying costs associated with holding inventory?

Shortage Costs Costs incurred from shortages in current assets.

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Changes in Working Capital: Example

How would the following affect cash and net working capital?

The firm repurchases outstanding shares of stock. Both cash and net working capital will decrease.

The firm uses cash on hand to buy raw materials. Cash will decrease; net working capital will be unaffected.

The firm sells long-term bonds and puts the proceeds

in its bank account. Both cash and net working capital will increase.

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Cash Budgeting 3 Steps to preparing a cash budget:

1. Forecast the sources of cash.

2. Forecast the uses of cash.

3. Calculate whether the firm is facing a cash shortage or

surplus.

The financial plan gives the strategy for investing cash surpluses or financing any deficit.

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Sources of Cash

Ending AccountsReceivable

=Beginning Accounts

Receivable+ Sales - Collections

Example:What was the sales volume in the current quarter if beginning accounts receivable, at

$5,000, was $1,000 higher than ending, and $20,000 was collected?

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Uses of Cash Uses of cash can be split into four broad categories:

Payments of Accounts Payable

Labor, Administrative, and Other Expenses

Capital Expenditures

Taxes, Interest, and Dividend Payments

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The Cash Balance

Are large cash outflows in early periods generally a sign of trouble for a firm?

Our calculations only give us a best guess about future cash flows.

Undertake scenario analysis for better planning

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Short-term Financing Plan: Example (with calculations)

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Sources of Short-Term Financing

Bank loans Lines of Credit

Secured Loans

Commercial Paper

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Bank LoansThe simplest and most common form of short-term finance is a bank

loan.

Line of Credit• Agreement by a bank that a company may borrow at any time up to an

established limit.

Term Loans• A loan that lasts for an extended period of time.

Self-liquidating Loans• A loan that provides the cash to repay itself with the sale of goods.

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Secured LoansIf a bank is concerned about credit risk, it will demand that

a firm provide collateral for the loan.

Accounts Receivable Financing• The firm assigns its receivables to the bank.

Inventory Financing• The bank accepts the firm’s inventory as collateral.

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Commercial Paper

Large companies bypass the bank and issue commercial paper directly to large investors.

Is commercial paper typically secured debt or unsecured debt?