Short-term financial planning is crucial for managing a company's cash flows and working capital over a 12-month period. It involves creating cash budgets, optimizing working capital, and analyzing different scenarios to assess risks and opportunities in the near future.

Forecasting financing needs is a key part of short-term planning. Companies use pro forma financial statements and cash flow forecasting techniques to project their future financial position and identify potential funding requirements. This helps businesses prepare for growth and manage their finances effectively.

Short-Term Financial Planning

Cash Budget and Working Capital Management

• Short-term financial planning manages cash flows, working capital, and financing needs over 12 months or less
• Cash budget projects cash inflows and outflows over specific periods (monthly or quarterly)
  • Components include beginning cash balance, cash receipts, cash disbursements, net cash flow, and ending cash balance
• Working capital optimization strategies focus on accounts receivable, inventory, and accounts payable management
• Operating cycle and cash conversion cycle concepts help understand short-term financing requirements
  • Operating cycle (time to convert inventory to cash through sales and collections)
  • Cash conversion cycle (time between paying for inventory and collecting cash from sales)
• Effective planning requires coordination between sales, production, and finance departments
  • Ensures accurate projections and alignment with business objectives

Scenario Analysis and Risk Assessment

• Scenario analysis assesses impact of different assumptions on cash flows and financing needs
  • Example: Analyzing effects of 10% increase or decrease in sales on cash position
• Sensitivity testing evaluates how changes in key variables affect financial outcomes
  • Example: Testing impact of extending payment terms to customers on cash flow
• Techniques help identify potential risks and opportunities in short-term financial planning
• Stress testing examines company's ability to withstand adverse economic conditions
  • Example: Simulating effects of economic recession on cash flows and financing needs

Forecasting Financing Needs

Pro Forma Financial Statements

• Pro forma statements project future financial position (income statement, balance sheet, cash flow statement)
• Percent of sales method forecasts line items assuming direct relationship with sales
  • Example: If cost of goods sold is historically 70% of sales, it's projected at 70% of forecasted sales
• Pro forma balance sheets identify potential short-term financing needs
  • Projects changes in current assets and current liabilities
• External funds needed (EFN) formula calculates additional financing required for sales growth
  • $EFN = (A/S * ΔS) - (L/S * ΔS) - (RR * S1 * PM)$
    • A = assets, S = sales, L = liabilities, RR = retention ratio, PM = profit margin
• Pro forma financial ratios provide insights into projected liquidity and financing requirements
  • Current ratio = Current assets / Current liabilities
  • Quick ratio = (Current assets - Inventory) / Current liabilities

Cash Flow Forecasting Techniques

• Direct method projects cash receipts and disbursements
  • Example: Estimating cash collections from customers and cash payments to suppliers
• Indirect method adjusts projected net income for non-cash items and changes in working capital
  • Example: Adding back depreciation expense and adjusting for changes in accounts receivable
• Sensitivity analysis on pro forma statements assesses impact of assumption changes
  • Example: Evaluating effect of 5% change in projected sales growth on cash flow

Sales Growth Impact on Financing

Working Capital and Cash Conversion Cycle

• Sales growth increases working capital requirements
  • Higher sales volumes lead to increased inventory and accounts receivable balances
• Cash conversion cycle typically lengthens with rapid sales growth
  • Creates need for additional short-term financing to bridge cash flow gaps
• Sustainable growth rate (SGR) determines maximum sales growth without external financing
  • $SGR = ROE * Retention Rate / (1 - ROE * Retention Rate)$
    • ROE = Return on Equity
• Analyze relationship between sales growth and financial ratios
  • Days Sales Outstanding (DSO) = (Accounts Receivable / Annual Sales) 365
  • Inventory Turnover = Cost of Goods Sold / Average Inventory

Operating Leverage and Cash Flow Management

• Operating leverage influences how sales growth impacts financing needs
  • Companies with higher fixed costs experience larger changes in cash flows relative to sales growth
• Scenario analysis comparing different sales growth rates identifies financing "tipping points"
  • Example: Analyzing cash flow impacts of 5%, 10%, and 15% annual sales growth
• Managing timing of cash inflows and outflows critical during rapid growth
  • Strategies include negotiating favorable payment terms with suppliers and incentivizing early customer payments

Evaluating Short-Term Financing Sources

Types of Short-Term Financing

• Trade credit (accounts payable financing from suppliers)
• Commercial paper (unsecured short-term debt issued by large corporations)
• Short-term bank loans (term loans with maturities under one year)
• Lines of credit (flexible borrowing arrangements with banks)
• Factoring (selling accounts receivable at a discount)

Cost Comparison and Decision Factors

• Effective Annual Rate (EAR) compares true cost of financing options
  • $EAR = (1 + r/m)^m - 1$
    • r = stated annual rate, m = number of compounding periods per year
• Trade credit cost calculated when early payment discounts are foregone
  • Example: 2/10 net 30 terms have an implicit annual cost of about 37%
• Commercial paper typically offers lower interest rates than bank loans
  • Only available to companies with strong credit ratings
• Lines of credit costs include interest on borrowed funds and commitment fees
  • Example: 1% commitment fee on unused portion of $1 million credit line
• Factoring costs determined by factoring fee and interest on cash advances
  • Example: 2% factoring fee plus 8% annual interest on advanced funds
• Financing source selection considers availability, flexibility, cost, financial ratio impact, and alignment with overall strategy