Short-term financial planning involves forecasting cash flows over the next 12 months to ensure a business has sufficient funds to pay bills. A key part of short-term planning is understanding a business's cash cycle, which is the time between paying for inventory and collecting payment from customers. Cash budgets are an important tool that estimate quarterly cash inflows and outflows. If a cash budget identifies upcoming cash shortfalls, businesses may take steps like negotiating longer credit terms, obtaining short-term bank loans, or selling assets to fund short-term needs.

1. Short-Term Financial Planning
Short-Term Financial Planning:
Short-term financial planning Short-term financial planning is important for virtually all businesses from small startups to large established businesses. Even large businesses with seemingly healthy
income statements have gone bankrupt, simply because they couldn't meet their current obligations.
Short term planning helps answer important questions like:
How much cash should you have available in the bank to pay bills?
How much inventory should you keep on hand?
How much credit should you extend to customers?
Short-Term Finance Defined:
The main difference between short-term and long-term finance is the timing of cash flows. Usually,
short-term financial decisions are defined as those that involve cash flows within the next 12 months.
The long-term is usually defined as longer than one year.
Operating Cycle and Cash Cycle – Unsynchronized!
A common reason firms get into cash flow problems is because of the timing of cash flows during shortterm operating activities.
To illustrate, we can look at some typical short-run operating activities of a manufacturing firm:
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Buying raw materials
Paying for raw materials → cash out
Manufacturing the product.
Selling the product
Collecting cash → cash in
The operating cycle is the time between the arrival of inventory and the date when cash is collected
from receivables. As we can see, cash is usually paid out before it is collected.
The cash cycle starts when cash is paid out for materials and ends when cash is collected from accounts
receivable.
Imagine a company could buy inventory, sell its product, collect payment, and pay suppliers all in one
day. The company would have a cash cycle of zero days. It's hard to think of many examples of this type
of firm because most companies have a positive cash cycle. The longer the cash cycle, the more the
need for financing.

2. Strategies for Reducing Cash Flow Problems:
Decrease cash cycle time:
Decreasing cash cycle time can help significantly reduce the chances of cash flow problems. This is why
companies frequently try to decrease their inventory and receivables time periods. Cash cycle time can
be decreased further if payments to suppliers can be delayed.
Cash reserves:
Keeping cash reserves and few short-term liabilities can go a long way to help avoid financial distress.
However, this comes at a cost. Having idle cash that is not put to work or invested means future revenue
is foregone.
Maturity hedging:
Maturity hedging is a fancy term that simply means paying for short-term costs, like inventory, with
short-term loans. It is usually better to avoid financing long-lived assets (such as machinery) with shortterm borrowing. That type of maturity mismatching requires frequent refinancing, and is riskier because
short-term interest rates are more volatile than long-term rates. Maturity mismatching also increases
risk because short-term financing may not always be available.
It's important to note that short-term interest rates are normally lower than long-term rates. This means
that it's generally more expensive to use long-term borrowing than short-term borrowing.
Cash Budgeting:
The primary tool for short-term financial planning is the cash budget. It gives managers a “heads-up”
about when short-term financing may be needed. A cash budget simply records estimates of cash
receipts and payments.
Cash budgeting starts with a sales forecast, usually by the quarter, for the upcoming year. By using the
sales forecast and factoring in the receivables period, we can get an estimate of the timing of cash
collections by quarter.
Next, cash payments are taken into account. Cash payments are often put into four categories:
Payments of accounts payable
Capital expenditures (cash payments for long-term assets)
Long-term financing costs (interest, dividends etc.)
Salaries, taxes and other expenses
Finally, the quarterly cash balance is found by subtracting the quarterly cash inflows with the cash
outflows. Financing arrangements have to be made for quarters with a net cash outflow.

3. Larger companies often go beyond the “best guess” outlined above and use multiple “what if” scenario
analysis, and sensitivity analysis.
For more details, see our article that covers cash budgeting in depth.
Common sources of short-term borrowing:
Operating loans:
Operating loans from banks are the most common way to finance temporary cash deficits. It's an
agreement where the company can borrow up to a certain amount for a given period - almost like a
credit card. Operating loans can be unsecured or secured by collateral.
Interest is charged on the loan and is set by the bank. It's usually the bank's prime lending rate plus an
additional percentage. The bank may increase the rate over time as it assesses the borrower's risk.
Banks lend mainly to low-risk borrowers. This is why they often decline risky business loans. Many loan
requests that banks turn down come from small businesses, particularly startups. These startups then
often turn to alternative financing sources.
Financial institutions may require collateral (called security) for a loan, such as property, accounts
receivable, or equipment. These are called secured loans. For secured loans, the interest rate charged is
often less than with unsecured loans.
Letter of credit:
Letters of credit allow borrowers to pay off a balance and borrow funds as needed. This differs from a
short-term loan where the borrower receives a lump sum of cash and can borrow more only after the
short-term loan is repaid.
Other sources:
Larger companies use a variety of other sources of short-term funds. Commercial paper is short-term
notes issued by highly rated firms. Banker's acceptances are similar to commercial paper except that
they are guaranteed by a bank in exchange for a fee charged by the bank.
Short-term plans:
Short-term plans often are amended as financial and investment goals change. Businesses and
individuals alike use short-term plans to manage short-term cash deficits.
Components:
For many businesses, elements of working capital have the largest impact on their short-term cash
flows. These elements generally include raw or finished inventory, debtors, creditors and cash. The
movement in working capital sometimes creates large voids or deficits of cash that threaten a business’
going concern. This occurs because of the difference in the accounts payable and cash cycles. The

4. accounts payable cycle is the time a company takes to pay for its inventories, and the cash cycle is the
time debtors take to pay for products.
Cash Shortages:
There are varied reasons that significant cash shortages occur. For example, a business might be
following an aggressive marketing policy in which it allows its debtors to pay their dues over a longer
period. Such a policy might dent the company’s cash-flows from two perspectives. First, it locks up
money in receivables with debtors, and second, the company might fund additional inventories for
newer sales, without recourse to business-based cash inflows. Enterprises also face such challenges
when they buy new machinery, are assessed heavy court fines or while fighting natural calamities, such
as hurricanes.
Cash-Flow Forecast:
When it becomes evident that severe cash shortages will occur, a cash-flow forecast becomes necessary.
The forecast should estimate total cash collections and total cash payments during each quarter in at
least three various scenarios: worst case, most likely and best case. You'll need to know the difference
between the total collections and total payments to ascertain whether there is a deficit in any quarter of
the year. For each cash-inflow and outflow item, you must account for all relevant increases and
decreases. This includes early payment discounts from creditors, deferred expense payments and cash
sales.
Funding Shortages:
If the cash-flow forecast shows that shortages are likely to occur during the year, you must make
arrangements to cover them. One way to fund short-term deficits is through other short-term measures,
such as increases in current liabilities, which can include negotiations for longer credit terms and shortterm bank loans. You also can sell certain unwanted assets and offer discounts to debtors to encourage
quicker payments.