Financial Management

Short-Term Financial Planning

Topics Covered
Links Between Long-Term and Short-Term Financing Decisions Tracing Changes in Cash and Working Capital Cash Budgeting A Short-Term Financing Plan Sources of Short Term Borrowing

Firms Cumulative Capital Requirement

Dollars A B C Cumulative capital requirement

Year 1

Year 2

Time

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

LA Gear Profit & Assets

Sales, income and assets of L.A.Gear 1989-1996 (figures in $ millions) 1989 1990 1991 1992 1993 Sales 617 820 619 430 398 Net income 55 31 -66 -72 -33 Cash & securities Receivables Inventory Current assets Total assets 0 101 140 257 267 3 156 161 338 364 1 112 141 297 326 84 56 62 230 250 28 73 110 220 225

1994 416 -22 50 77 58 194 225

1995 297 -51 36 47 52 138 160

1996 196 -62 34 24 33 93 101

LA Gear Debt & Equity

Figures in $millions

Bank debt Long-term debt Preffered stock Common equity

1989 37 0 0 168

1990 94 0 0 206

1991 20 0 100 132

1992 0 0 100 88

1993 4 50 100 47

1994 1 50 100 18

1995 1 50 108 -41

1996 0 50 116 -111

Working Capital
Simple Cycle of Operations
Cash

Receivables

Raw materials inventory

Finished goods 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
Assets Current Assets Cash Mark Securities Inventory Accts Recv Total Curr Assets Fixed Assets Gross investment less Depr Net Fixed Assets Total Assets 4 0 26 25 55 56 16 40 95 5 5 25 30 65 70 20 50 115 Total Liab and owner's equity 2003 2004 Liabilitie s & Equity Current Liabilitie s Bank Loans Accts Payable Total Curr Liab Long Term Debt Net Worth 5 20 25 5 65 0 27 27 12 76 2003 2004

95

115

Changes in Cash & W.C.

Example - Dynamic Mattress Company
Income Statement Sales Operating Costs Depreciation EBIT Interest Pretax income .Tax at 50% Net Income Rs.350 321 4 25 1 24 12 Rs.12

Assume dividend = Rs.1 mil R.E.=Rs.11 mil

Changes in Cash & W.C.

Sources

Example Dynamic Mattress Company

Issued long term debt Reduced inventories Increased accounts payable Cash from operations Net income Depreciation Total Sources Uses Repaid short term bank loan Invested in fixed assets Purchased marketable securities Increased accounts receivable Dividend Total Uses Increase in cash balance

7 1 7 12 4 Rs.31 5 14 5 5 1 Rs.30 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 Company Condensed Balance Sheet
2003 30 56 -16 40 70 5 65 70 2004 38 70 -20 50 88 12 76 88

Net working capital Fixed assets: Gross investment Less depreciation Net fixed assets Total net assets Long-term debt Net worth (equity and retained earnings) Long-term liabilities and net worth

Changes in Cash & W.C.

Example - Dynamic Mattress Company
Condensed Balance Sheet
Sources: Issued long-term debt Cash from operations: Net income Depreciation

7 12 4 23

Uses: Invested in fixed assets Dividend

14 1 15 8

Increase in net working capital

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.

Cash Budgeting
Example - Dynamic Mattress Company

Dynamic forecasted sources of cash

Quarter Sales, Rs.mil 1st 2nd 3rd 4th

87.50 78.50 116.00 131.00

AR ending balance = AR beginning balance + sales collections

Cash Budgeting
Example - Dynamic Mattress Company Dynamic collections on AR
Qtr 1st 30.0 87.5 70 15.0 85.0 Rs.32.5 2nd 32.5 78.5 62.8 17.5 80.3 Rs.30.7 3rd 30.7 116.0 92.8 15.7 108.5 Rs.38.2 4th 38.2 131.0 104.8 23.2 128.0 Rs.41.2

1. Beginning receivables 2. Sales 3. Collections . Sales in current Qtr (80%) . Sales in previous Qtr (20%) Total collections 4. Receivables at end of period .(4=1+2-3)

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 Sources of cash collections on AR other Total Sources Uses of cash payment of AP labor and admin expenses capital expenditures taxes, interest, & dividends Total uses of cash Net cash inflow (sources minus uses) 65.0 30.0 32.5 4.0 131.5 46.5 60.0 30.0 1.3 4.0 95.3 15.0 55.0 30.0 5.5 4.5 95.0 26.0 50.0 30.0 8.0 5.0 93.0 35.0 85.0 0.0 85.0 80.3 0.0 80.3 108.5 12.5 121.0 128.0 0.0 128.0 2nd 3rd 4th

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 46.5 61.5 35.5 .5 required (minimum cash balance minus 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

1st 2nd 45.0 0.0 0.0 45.0 40.0 0.0 5.0 45.0 15.0 0.0 0.0 15.8 0.0 15.8 0.0 15.8 3rd -26.0 0.8 0.8 -24.4 0.0 0.0 0.0 0.0 4th -35.0 0.6 0.0 -34.4 0.0 0.0 0.0 0.0

Example Dynamic Mattress CompanyFinancing Plan

A. Cash requirements Cash required for operations Interest on bank loan Interest on Stetched 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

0.0 0.0 0.0

0.0 0.0 0.0

15.8 8.6 0.0

0.0 31.4 3.0

0.0 40.0

40.0 40.0

40.0 31.4

31.4 0.0

Sources of Short Term Borrowing

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