Short-Term Financial Planning
...it will if it does not have the cash to meet monthly payroll, quarterly taxes and overdue bills.. Short-Term Financial Planning How to do a lot right things and still get it wrong... Your firm has embarked on excellent positive NPV projects! Your firm has the optimal debt ratio! Your firm has the perfect dividend policy!...and yet the firm can still go under! Why?
Management with style! In order to be successful in the short term, net working capital has to be managed skillfully. Net working capital = current assets - current liabilities current assets: current liabilities: accounts receivable inventory cash and securities accounts payable
What exactly is your job? The financial manager's job is to forecast future sources and uses of cash for two reasons: 1. To foresee future cash needs. 2. To set a budget that future performance can be compared with. Financial managers strive to "match maturities" finance long-term assets with long-term borrowing finance short-term assets with short-term debt
How to do the job... How to prepare a quarterly cash budget in three easy steps: 1. Forecast the sources of cash (customer payments). 2. Forecast the uses of cash. 3. Calculate whether the firm will have a cash surplus or shortage.
How to finish the job... After the budget is done, the financial manager will construct a financial plan on how to finance future cash shortages or where to invest cash surpluses. Let's look at an example for Dynamic Mattress Company. First we look at the quarterly sales forecast for 2018...
Looking at forecasted sales... quarter first second third fourth Sales forecasted 87.5 78.5 116.0 131.0 After a slow start, sales are expected to increase every quarter and finish strong in the fourth quarter.. However, remember sales does not always mean cash... Some customers will buy on credit, so let's assume that 80% of quarterly sales will result in cash, 20% will be collected the following quarter.
So what does that 2018 cash budget look like? collections from current quarter = 0.8 collections from previous quarter = 0.2 previous fourth quarter sales = 75.0 quarter first second third fourth A. Accounts Receivable Receivables (beginning) 30.0 Sales forecasted 87.5 78.5 116.0 131.0 Collections on current sales on previous sales total collections Receivables (end) B. Cash Budget Sources of cash Collections of accounts receivable Other 1.5 0.0 12.5 0.0 Total collections Uses of cash Payments of accounts payable 65.0 60.0 55.0 50.0 Labor & other expenses 30.0 30.0 30.0 30.0 Capital expenses 32.5 1.3 5.5 8.0 Taxes, interest and dividends 4.0 4.0 4.5 5.0 Total uses Net cash inflow = Sources - Uses C. Short-term financing requirements Cash at start of period 5.0 + Net cash inflow = Cash at end of period Minimum operating balance 5.0 5.0 5.0 5.0 Cumulative financing required
Now we need a financing plan.. So we know what financing we need to make it to the end of the year...now we need to plan on how to get there. The firm has $5 million in securities it can sell. The firm can also borrow up to $40 million from the bank at an interest rate of 2% per quarter. Finally, the firm can hold off paying bills to suppliers but lose a 5% discount. Can the firm make it to the end of the year without running out of cash?
Let's see that 2018 financing plan! interest rate on bank loan = 0.02 interest on stretched payables = 0.05 quarter first second third fourth A. Cash requirements Cash required for operations Interest on bank loan Interest on stretched payables Total cash required B. Cash raised in quarter Bank loan Stretched payables Securities sold Total cash raised C. Repayments Of stretched payables Of bank loan D. Addition to cash balances E. Bank loan Beginning of quarter End of quarter
Here is the 2018 cash budget. collections from current quarter = 0.8 collections from previous quarter = 0.2 previous fourth quarter sales = 75.0 quarter first second third fourth A. Accounts Receivable Receivables (beginning) 30.0 32.5 30.7 38.2 Sales forecasted 87.5 78.5 116.0 131.0 Collections on current sales 70.0 62.8 92.8 104.8 on previous sales 15.0 17.5 15.7 23.2 total collections 85.0 80.3 108.5 128.0 Receivables (end) 32.5 30.7 38.2 41.2 B. Cash Budget Sources of cash Collections of accounts receivable 85.0 80.3 108.5 128.0 Other 1.5 0.0 12.5 0.0 Total collections 86.5 80.3 121.0 128.0 Uses of cash Payments of accounts payable 65.0 60.0 55.0 50.0 Labor & other expenses 30.0 30.0 30.0 30.0 Capital expenses 32.5 1.3 5.5 8.0 Taxes, interest and dividends 4.0 4.0 4.5 5.0 Total uses 131.5 95.3 95.0 93.0 Net cash inflow = Sources - Uses -45.0-15.0 26.0 35.0 C. Short-term financing requirements Cash at start of period 5.0-40.0-55.0-29.0 + Net cash inflow -45.0-15.0 26.0 35.0 = Cash at end of period -40.0-55.0-29.0 6.0 Minimum operating balance 5.0 5.0 5.0 5.0 Cumulative financing required 45.0 60.0 34.0-1.0
Here is the 2018 financing plan! interest rate on bank loan = 0.02 interest on stretched payables = 0.05 quarter first second third fourth A. Cash requirements Cash required for operations 45.00 15.00-26.00-35.00 Interest on bank loan 0.00 0.80 0.80 0.63 Interest on stretched payables 0.00 0.00 0.79 0.00 Total cash required 45.00 15.80-24.41-34.37 B. Cash raised in quarter Bank loan 40.00 0.00 0.00 0.00 Stretched payables 0.00 15.80 0.00 0.00 Securities sold 5.00 0.00 0.00 0.00 Total cash raised 45.00 15.80 0.00 0.00 C. Repayments Of stretched payables 0.00 0.00 15.80 0.00 Of bank loan 0.00 0.00 8.61 31.39 D. Addition to cash balances 0.00 0.00 0.00 2.98 E. Bank loan Beginning of quarter 0.00 40.00 40.00 31.39 End of quarter 40.00 40.00 31.39 0.00