Financial Management

Short-Term Financial Planning

Topics Covered

Links Between Long-Term and Short-Term Financing Decisions

Tracing Changes in Cash and Working CapitalCash BudgetingA Short-Term Financing PlanSources of Short Term Borrowing

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 2Year 1

Dollars

Cumulativecapital requirement

Time

LA Gear Profit & Assets

1989 1990 1991 1992 1993 1994 1995 1996Sales 617 820 619 430 398 416 297 196Net income 55 31 -66 -72 -33 -22 -51 -62

Cash & securities 0 3 1 84 28 50 36 34Receivables 101 156 112 56 73 77 47 24Inventory 140 161 141 62 110 58 52 33Current assets 257 338 297 230 220 194 138 93Total assets 267 364 326 250 225 225 160 101

Sales, income and assets of L.A.Gear 1989-1996 (figures in $ millions)1989 1990 1991 1992 1993 1994 1995 1996

Sales 617 820 619 430 398 416 297 196Net income 55 31 -66 -72 -33 -22 -51 -62

Cash & securities 0 3 1 84 28 50 36 34Receivables 101 156 112 56 73 77 47 24Inventory 140 161 141 62 110 58 52 33Current assets 257 338 297 230 220 194 138 93Total assets 267 364 326 250 225 225 160 101

Sales, income and assets of L.A.Gear 1989-1996 (figures in $ millions)

LA Gear Debt & Equity

1989 1990 1991 1992 1993 1994 1995 1996Bank debt 37 94 20 0 4 1 1 0Long-term debt 0 0 0 0 50 50 50 50Preffered stock 0 0 100 100 100 100 108 116Common equity 168 206 132 88 47 18 -41 -111

Figures in $millions

Working Capital

Simple Cycle of Operations

Cash

Finished goodsinventory

ReceivablesRaw materials

inventory

Cash Conversion Cycle

Cash conversion cycle = (inventory period + receivables period – accounts payable period)

Inventory period = average inventory /annual cost of goods sold / 365

Account receivable period = average account receivable / annual sales/365

Account payable period = average account payable /annual cost of goods sold / 365

Changes in Cash & W.C.

Example - Dynamic Mattress Company

11595equity sowner'11595Assets Total

and Liab Total5040Assets FixedNet

2016Depr less

7056investment Gross

Assets Fixed

7665Net Worth6555AssetsCurr Total

125Debt Term Long3025Recv Accts

2725LiabCurr Total2526Inventory

2720Payable Accts 50SecuritiesMark

05LoansBank 54Cash

sLiabilitieCurrent AssetsCurrent

20042003Equity & sLiabilitie20042003Assets

Changes in Cash & W.C.

Example - Dynamic Mattress Company

Income Statement

Sales Rs.350

Operating Costs 321

Depreciation 4

EBIT 25

Interest 1

Pretax income 24

.Tax at 50% 12

Net Income Rs.12

Assume

dividend = Rs.1 mil

R.E.=Rs.11 mil

Changes in Cash & W.C.Example -Dynamic Mattress Company

Sources

Issued long term debt 7

Reduced inventories 1

Increased accounts payable 7

Cash from operations

Net income 12

Depreciation 4

Total Sources Rs.31

Uses

Repaid short term bank loan 5

Invested in fixed assets 14

Purchased marketable securities 5

Increased accounts receivable 5

Dividend 1

Total Uses Rs.30

Increase in cash balance Rs.1

Changes in Cash & W.C.

Example - Dynamic Mattress Company

Dynamic used cash as follows:

Paid Rs.1 mil dividend. Repaid Rs.5 mil short term bank loan Invested Rs.14 mil Purchased Rs.5 mil of marketable securities Accounts receivable expanded by Rs.5 mil

Changes in Cash & W.C.

Example - Dynamic Mattress CompanyCondensed Balance Sheet

2003 2004Net working capital 30 38Fixed assets:Gross investment 56 70Less depreciation -16 -20Net fixed assets 40 50Total net assets 70 88Long-term debt 5 12Net worth (equity and retained earnings) 65 76Long-term liabilities and net worth 70 88

Changes in Cash & W.C.

Sources:Issued long-term debt 7Cash from operations:Net income 12Depreciation 4

23

Uses:Invested in fixed assets 14Dividend 1

15

Increase in net working capital 8

Example - Dynamic Mattress CompanyCondensed Balance Sheet

Cash Budgeting

Steps to preparing a cash budgetStep 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.

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, Rs.mil 87.50 78.50 116.00 131.00

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) Rs.32.5 Rs.30.7 Rs.38.2 Rs.41.2

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

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 0.0 0.0 12.5 0.0

Total Sources 85.0 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 46.5 15.0 26.0 35.0

(sources minus uses)

Cash Budgeting

Example - Dynamic Mattress Company

Dynamic short term financing requirements

Cash at start of period 5 -41.5 -56.5 -30.5

+Net cash flow -46.5 -15 +26 +35

=Cash at end of period -41.5 -56.5 -30.5 +4.5

Min operating cash balance 5 5 5 5

Cumulative short term financing

required (minimum cash balance

m

46.5 61.5 35.5 .5

inus caash at end of period)

A Short Term Financing Plan

Example - Dynamic Mattress Company

Dynamic forecasted deferrable expenses(80% of payable)

Quarter 1st 2nd 3rd 4th

Amount Deferrable, Rs.mil 52 48 44 40

A Short Term Financing Plan

We assume that Dynamic can borrow up to 40mn from bank at 8% annual or 2% per quarter.

Now if we deferred the payment then minimum of 5% loss will incur due to early payment discount, Or you have to pay 54.6mn instead of 52mn next quarter.

i-e 20% annually simple interest Or 21.6% annually compounded

interest(1.05pow4 – 1 =21.6%)

A Short Term Financing Plan

Example -

Dynamic

Mattress

Company-

Financing Financing PlanPlan

1st 2nd 3rd 4thA. Cash requirements

Cash required for operations 45.0 15.0 -26.0 -35.0Interest on bank loan 0.0 0.0 0.8 0.6Interest on Stetched payables 0.0 0.0 0.8 0.0Total cash required 45.0 15.8 -24.4 -34.4

B. Cash raised in quarter Bank loan 40.0 0.0 0.0 0.0Stretched payables 0.0 15.8 0.0 0.0Securities sold 5.0 0.0 0.0 0.0Total cash raised 45.0 15.8 0.0 0.0

C. RepaymentsOf stretched payables 0.0 0.0 15.8 0.0Of Bank Loan 0.0 0.0 8.6 31.4

D. Addition to cash balances 0.0 0.0 0.0 3.0

E. Bank LoanBeginning of quarter 0.0 40.0 40.0 31.4End of quarter 40.0 40.0 31.4 0.0

Sources of Short Term Borrowing

Bank loans Commitment Maturity Rate of interest Syndicated loans Security Commercial paper