This document provides an overview of short-term financial planning. It discusses links between long-term and short-term financing, working capital, cash budgeting, short-term financing plans and sources. Specific topics covered include calculating a firm's cash conversion cycle, forecasting changes in cash and working capital, preparing a cash budget, and the costs of bank loans and sources of short-term financing. Examples are provided to illustrate key concepts.

1. Chapter 19
Fundamentals of
Corporate
Finance
Fifth Edition
Slides by
Matthew Will
McGraw-Hill/Irwin Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved
Short-Term Financial
Planning

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Topics Covered
Links Between Long-Term and Short-Term
Financing
Working Capital
Tracing Changes in Cash and Working Capital
Cash Budgeting
A Short-Term Financing Plan
Sources of Short-Term Financing
The Cost of Bank Loans

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Firm’s Cumulative Capital Requirement
Lines A, B, and C show alternative amounts of long-term finance.
Strategy A: A permanent cash surplus
Strategy B: Short-term lender for part of year and borrower for
remainder
Strategy C: A permanent short-term borrower
A
B
C
Year 2
Year 1
Dollars
Cumulative
capital requirement
Time

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Working Capital
Net Working Capital - Current assets minus current
liabilities. Often called working capital.
Cash Conversion Cycle - Period between firm’s
payment for materials and collection on its sales.
Carrying Costs - Costs of maintaining current
assets, including opportunity cost of capital.
Shortage Costs - Costs incurred from shortages in
current assets.

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Working Capital
Simple Cycle of operations
Cash
Finished goods
inventory
Receivables
Raw materials
inventory

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Working Capital
Inventory period =
average inventory
annual COGS / 365
Receivables period =
average accounts receivable
annual sales / 365
Payable period =
average accounts payable
annual COGS / 365

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Working Capital
Example - Cash Conversion Cycle
Given the aggregate balance sheet and income
statement for US Manufacturing firms, calculate
the cash conversion cycle.
382
335
A/P
552
500
A/R
4,451
COGS
490
453
Inventory
4,951
Sales
'04
qtr
4th
of
End
'03
qtr
4th
End
04
'
3
Sheet
Balance
Statement
Income
rdQtr

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Working Capital
Example - Cash Conversion Cycle
Given the aggregate balance sheet and income statement
for US Manufacturing firms, calculate the cash conversion
cycle.
days
38.7
4,451/365
453)/2
(490
=
COGS/365
annual
inventory
average
=
period
Inventory



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Working Capital
Example - Cash Conversion Cycle
Given the aggregate balance sheet and income statement
for US Manufacturing firms, calculate the cash conversion
cycle.
days
38.8
=
4,951/365
500)/2
(552
=
sales/365
annual
receivable
accounts
average
=
period
s
Receivable


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Working Capital
Example - Cash Conversion Cycle
Given the aggregate balance sheet and income statement
for US Manufacturing firms, calculate the cash conversion
cycle.
days
29.4
=
365
/
4,451
335)/2
(382
=
COGS/365
annual
payable
accounts
average
=
period
Payable


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Working Capital
Example - Cash Conversion Cycle
Given the aggregate balance sheet and income statement
for US Manufacturing firms, calculate the cash conversion
cycle.
days
7
.
38
period
Inventory 
days
29.4
=
period
Payable
days
38.8
=
period
s
Receivable

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Changes in Cash & W.C.
Example - Dynamic Mattress Company
115
95
equity
s
owner'
115
95
Assets
Total
and
Liab
Total
50
40
Assets
Fixed
Net
20
16
Depr
less
70
56
investment
Gross
Assets
Fixed
76
65
Net Worth
65
55
Assets
Curr
Total
12
5
Debt
Term
Long
30
25
Recv
Accts
27
25
Liab
Curr
Total
25
26
Inventory
27
20
Payable
Accts
5
0
Securities
Mark
0
5
Loans
Bank
5
4
Cash
s
Liabilitie
Current
5
4
Assets
Current
2006
2005
Equity
&
s
Liabilitie
2006
2005
Assets

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Changes in Cash & W.C.
Example - Dynamic Mattress Company
Income Statement
Sales $350
Operating Costs 321
Depreciation 4
EBIT 25
Interest 1
Pretax income 24
. Tax at 50% 12
Net Income $12
Assume
dividend = $1 mil
R.E.=$11 mil

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Changes in Cash & W.C.
Example -
Dynamic
Mattress
Company
1
$
balance
cash
in
Increase
$30
Uses
Total
1
Dividend
5
receivable
accounts
Increased
5
securities
marketable
Purchased
14
assets
fixed
in
Invested
5
loan
bank
short term
Repaid
Uses
$31
Sources
Total
4
on
Depreciati
12
income
Net
operations
from
Cash
7
payable
accounts
Increased
1
s
inventorie
Reduced
7
debt
term
long
Issued
Sources

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Changes in Cash & W.C.
Example - Dynamic Mattress Company
Dynamic used cash as follows
Paid $1 mil dividend.
Repaid $5 mil short term bank loan
Invested $14 mil
Purchased $5 mil of marketable securities
Accounts receivable expanded by $5 mil

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Cash Budgeting
Steps to preparing a cash budget
Step 1 - Forecast the sources of cash.
Step 2 - Forecast uses of cash.
Step 3 - Calculate whether the firm is facing a cash
shortage or surplus.

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Cash Budgeting
Example - Dynamic Mattress Company
Dynamic forecasted sources of cash
AR ending balance = AR beginning balance + sales -
collections
Quarter 1st 2nd 3rd 4th
Sales, $mil 87.50 78.50 116.00 131.00

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Cash Budgeting
Example - Dynamic Mattress Company
Dynamic collections on AR
Qtr
1st 2nd 3rd 4th
1. Beginning receivables 30.0 32.5 30.7 38.2
2. Sales 87.5 78.5 116.0 131.0
3. Collections
. Sales in current Qtr (80%) 70 62.8 92.8 104.8
. Sales in previous Qtr (20%) 15.0 17.5 15.7 23.2
Total collections 85.0 80.3 108.5 128.0
4. Receivables at end of period
. (4 = 1 + 2 - 3) $32.5 $30.7 $38.2 $41.2

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Cash Budgeting
Example - Dynamic Mattress Company
Dynamic forecasted uses of cash
Payment of accounts payable
Labor, administration, and other expenses
Capital expenditures
Taxes, interest, and dividend payments

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Cash Budgeting
Example - Dynamic Mattress Company
Dynamic
cash budget
Qtr
1st 2nd 3rd 4th
Sources of cash
collections on AR 85.0 80.3 108.5 128.0
other 1.5 0.0 12.5 0.0
Total Sources 86.5 80.3 121.0 128.0
Uses of cash
payment of AP 65.0 60.0 55.0 50.0
labor and admin expenses 30.0 30.0 30.0 30.0
capital expenditures 32.5 1.3 5.5 8.0
taxes, interest, & dividends 4.0 4.0 4.5 5.0
Total uses of cash 131.5 95.3 95.0 93.0
Net cash inflow
(sources minus uses)
$45.0 $15.0 $26.0 $35.0

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Cash Budgeting
Example - Dynamic Mattress Company
Dynamic short term financing requirements
Cash at start of period 5 - 40 - 55 - 29
+ Net cash flow - 45 - 15 + 26 + 35
= Cash at end of period - 40 - 55 - 29 + 6
Min operating cash balance 5 5 5 5
Cumulative short term financing
required (minimum cash balance
minus caash at end of period)
$45 $60 $34 - $1

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A Short Term Financing Plan
Example - Dynamic Mattress Company
Dynamic forecasted deferrable expenses
Quarter 1st 2nd 3rd 4th
Amount Deferrable, $mil 52 48 144 40

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A Short Term Financing Plan
Example -
Dynamic
Mattress
Company-
Financing Plan
Qtr
1st 2nd 3rd 4th
Cash Requirements
1. Cash for operations 45 15 - 26 - 35
2. Interest on bank loan 0 .8 .8 .6
3. Interest on stretechd payables 0 0 .8 0
4. Total cash required 45 15.8 - 24.4 - 34.4
Cash Raised
5. Bank loan 40 0 0 0
6. Stretched payables 0 15.8 0 0
7. Securities sold 5 0 0 0
8. Total cash raised 45 15.8 0 0
Repayments
9. Of stretched payables 0 0 15.8 0
10. Of line of credit 0 0 8.6 31.4
Increase in cash balances
11. Addition to cash balances 0 0 0 3
Line of credit
12. Beginning of quarter 0 40 40 31.4
13. End of quarter 40 40 31.4 0

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Sources of Short Term Financing
Bank loans
Commercial paper
Secured loans

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Cost of Bank Loans
Simple Interest
Amount of loan X
annual interest rate
number of periods in the year
)
(1 +
quoted annual interest rate
n
n
- 1
Effective annual rate

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Cost of Bank Loans
Discount Interest
)
(
Face value of loan X 1 -
quoted annual interest rate
number of periods in the year