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

19-2 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.

19-3 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.

19-4 Short-Term Planning As the business grows, it is likely to need additional fixed assets and current assets.

19-5 Planning Strategies Three approaches: a)Relaxed Strategy -permanent cash surplus b)Middle-of-the-road Policy c)Restrictive Policy -permanent need for short-term borrowing

19-6 Planning Strategies Managers 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

19-7 Liquidity Some 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?

19-8 Working Capital Much of short-term financial planning focuses on variations in working capital.  Components of Working Capital:  Current Assets  Current Liabilities

19-9 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?

19-10 Current Assets  Common current assets:  Accounts Receivable Trade Credit Consumer Credit  Inventory  Cash & Marketable Securities Demand Deposits Time Deposits Commercial Paper Treasury Bills

19-11 Current Liabilities  Common current liabilities:  Accounts Payable  Short-term Borrowing

19-12 The Cash Conversion Cycle Typically, most firms have positive net working capital. But why do they need working capital at all? Simple Cycle of Operations

19-13 The Cash Conversion Cycle Cash Conversion Cycle Inventory Period Receivables Period Accounts Payable Period = + -

19-14 Useful Ratios Why are these ratios useful?

19-15 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 =+ -

19-16 The Working Capital Trade-Off Working 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.

19-17 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.

19-18 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.

19-19 Sources of Cash Ending Accounts Receivable = 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?

19-20 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

19-21 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

19-22 Short-term Financing Plan: Example (with calculations)

19-23 Sources of Short-Term Financing  Bank loans  Lines of Credit  Secured Loans  Commercial Paper

19-24 Bank Loans The 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.

19-25 Secured Loans If 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.

19-26 Commercial Paper Large companies bypass the bank and issue commercial paper directly to large investors. Is commercial paper typically secured debt or unsecured debt?