Advanced Corporate

Finance
Short-Term Finance and
Planning

Introduction
Sanjay Shanbhag
B.Tech I.I.T. Mumbai, MBA Chicago
Booth, CFA
Industry Experience: Corporate Finance,
Healthcare, Technology Sectors
Electives Offered:
Financial Markets and Services
Investment Banking
Private Equity
Equity Research

Contents
Short Term Finance and Planning

Cash Management

Chapter 26
[RWJK]
Chapter 27
[RWJK]

Credit Management

Chapter 28
[RWJK]

Long-Term Sources of Finance

Chapter 15
[RWJK]

Capital structure decisions and practices

Dividend and Payouts

Chapter 16& 17
[RWJK]
Chapter 19
[RWJK]

Introduction
10% Quiz Or Assignment Or Case
40% End Term
If you need to meet me:
Office Hours: 9 AM to 5:30 PM; Room
# 53; Ext 145
sshanbhag@imtnag.ac.in

Key Concepts and Skills

Understand the components of the cash
cycle and why it is important
Understand the pros and cons of the various
short-term financing policies
Be able to prepare a cash budget
Understand the various options for shortterm financing

Key Concepts and Skills

What is short term finance? How is it
different from long term finance?
What are some of the questions of short
term finance?
Why is there a need for short term finance?
How operating activities impact cash
position and working capital?
What is the optimum level of current
assets?
What is a flexible vs. a restrictive financing
policy?

Chapter Outline
26.1 Tracing Cash and Net Working Capital
26.2 The Operating Cycle and the Cash
Cycle
26.3 Some Aspects of Short-Term Financial
Policy
26.4 Cash Budgeting
26.5 The Short-Term Financial Plan

Balance Sheet Model of the

Firm
Current
Liabilities
Current
Assets
Fixed
Assets
1. Tangible
2.
Intangible

Net
Working
Capital

How much shortterm cash flow

does a company
need to pay its
bills?

Long-Term
Debt

Shareholde
rs Equity

26.1 Tracing Cash and Net Working

Capital
Current Assets are cash and other assets that are
expected to be converted to cash within the year.
Cash, Cash Equivalents
Marketable securities
Accounts receivable
Inventory
Current Liabilities are obligations that are expected to
require cash payment within the year.
Accounts payable
Notes Payable
Expenses Payable
Accrued wages
Taxes

Defining Cash in Terms of Other

Elements
Net
Working
Capital

LongFixed
+
= Term + Equity
Assets
Debt
Other
= Cash + Current
Assets

Net
Current

Working
Liabilities
Capital
LongNet Working
Fixed
Cash = Term + Equity Capital

Assets
(excluding
Debt
cash)

Defining Cash in Terms of Other

Elements
LongNet Working
Fixed
Cash = Term + Equity Capital

Assets
(excluding
Debt
cash)

An increase in long-term debt and or

equity leads to an increase in cashas
does a decrease in fixed assets or a
decrease in the non-cash components of
net working capital.
The sources and uses of cash follow from
this reasoning.

26.2 The Operating Cycle and the

Cash Cycle
Raw material
purchased

Finished goods sold

Cash
received

Order
Stock
Placed Arrives

Inventory period

Accounts receivable period

Time

Accounts payable period

Firm receives invoice

Cash paid for materials

Operating cycle
Cash cycle

The Operating Cycle and the Cash Cycle

Account
=Inventory Period+
s
Operating cycle
Receiva
ble
period
Account
Cash cycle=Operating cycle
s
payable
period
In practice, the inventory period, the
accounts receivable period, and the
accounts payable period are measured by
days in inventory, days in receivables,
and days in payables, respectively.

Example
Inventory:
Beginning =
200,000
Ending = 300,000

Accounts
Receivable:
Beginning =
160,000
Ending = 200,000

Accounts Payable:
Beginning = 75,000
Ending = 100,000

Net sales =
1,150,000
Cost of Goods sold
= 820,000

Example
Inventory period
Average inventory = (200,000+300,000)/2 = 250,000
Inventory turnover = 820,000 / 250,000 = 3.28 times
Inventory period = 365 / 3.28 = 111.3 days
Receivables period
Average receivables = (160,000+200,000)/2 = 180,000
Receivables turnover = 1,150,000 / 180,000 = 6.39
times
Receivables period = 365 / 6.39 = 57.1 days
Operating cycle = 111.3 + 57.1 = 168.4 days

Example
Payables Period
Average payables = (75,000+100,000)/2 = 87,500
Payables turnover = 820,000 / 87,500 = 9.37 times
Payables period = 365 / 9.37 = 38.9 days
Cash Cycle = 168.4 38.9 = 129.5 days
We have to finance our inventory for 129.5 days.
If we want to reduce our financing needs, we need to
look carefully at our receivables and inventory periods
they both seem excessive.

26.3 Some Aspects of Short-Term

Financial Policy
There are two elements of the policy that
a firm adopts for short-term finance.
The size of the firms investment in current
assets, usually measured relative to the firms
level of total operating revenues.
Flexible
Restrictive

Alternative financing policies for current assets,

usually measured as the proportion of shortterm debt to long-term debt.
Flexible
Restrictive

Size of Investment in Current

Assets
A flexible short-term finance policy would
maintain a high ratio of current assets to sales.
Keeping large cash balances and investments in
marketable securities
Large investments in inventory
Liberal credit terms

A restrictive short-term finance policy would

maintain a low ratio of current assets to sales.
Keeping low cash balances, no investment in
marketable securities
Making small investments in inventory
Allowing no credit sales (thus no accounts receivable)

Carrying Costs and

Shortage Costs
$

Minimum
point

Total costs of holding current

assets.
Carrying costs

Shortage costs
CA*

Investment in
Current Assets ($)

Appropriate Flexible Policy

$
Minimum
point

Carrying costs
Total costs of holding
current assets.
Shortage costs

CA*

Investment in
Current Assets ($)

Appropriate Restrictive
Policy
$

Minimum
point

Total costs of holding current assets.

Carrying costs

Shortage
costs
CA*

Investment in
Current Assets ($)

Alternative
Policies

Financing

A flexible short-term finance policy means a

low proportion of short-term debt relative to
long-term financing.
A restrictive short-term finance policy
means a high proportion of short-term debt
relative to long-term financing.
In an ideal world, short-term assets are
always financed with short-term debt, and
long-term assets are always financed with
long-term debt.
In this world, net working capital is zero.

Alternative Financing
Policies

Alternative Financing Policies

26.4 Cash Budgeting

A cash budget is a primary tool of short-run
financial planning.
The idea is simple: Record the estimates of
cash receipts and disbursements.
Cash Receipts
Arise from sales, but we need to estimate when
we actually collect

Cash Outflow

Payments of Accounts Payable

Wages, Taxes, and other Expenses
Capital Expenditures
Long-Term Financial Planning

Example
Pet Treats Inc. specializes in gourmet pet treats and
receives all income from sales
Sales estimates (in millions)

Q1 = 500; Q2 = 600; Q3 = 650; Q4 = 800; Q1

next year = 550
Accounts receivable

Beginning receivables = Rs.250

Average collection period = 30 days
Accounts payable

Purchases = 50% of next quarters sales

Beginning payables = 125
Accounts payable period is 45 days

Example
Other expenses

Wages, taxes and other expense are

30% of sales
Interest and dividend payments are
Rs.50
A major capital expenditure of Rs.200 is
expected in the second quarter
The initial cash balance is Rs.80 and the company
maintains a minimum balance of Rs.50

Example
ACP = 30 days, this implies that 2/3 of sales are
collected in the quarter made, and the remaining
1/3 are collected the following quarter.
Beginning receivables of Rs.250 will be collected in
the first quarter.

Beginning Receivables
Sales
Cash Collections
Ending Receivables

Q1
250
500
583
167

Q2
167
600
567
200

Q3
200
650
633
217

Q4
217
800
750
267

Example
Payables period is 45 days, so half of the
purchases will be paid for each quarter, and the
remaining will be paid the following quarter.
Beginning payables = Rs.125

Payment of accounts
Wages, taxes and other expenses
Capital expenditures
Interest and dividend payments
Total cash disbursements

Q1
275
150
50
475

Q2
313
180
200
50
743

Q3
362
195

Q4
338
240

50
607

50
628

Example
Q1

Q2

Q3

Q4

Total cash collections

583

567

633

750

Total cash disbursements

475

743

607

628

Net cash inflow

108 -176

26

122

188

12

38

Net cash inflow

108 -176

26

122

Ending cash balance

188

12

38

160

Minimum cash balance

-50

-50

-50

-50

Cumulative surplus (deficit)

138

-39

-12

110

Beginning Cash Balance

80

26.5 The Short-Term Financial

Plan
The most common way to finance a temporary
cash deficit is to arrange a short-term loan.
Unsecured Loans
Line of credit (at the bank)
Secured Loans

Accounts receivable can be either assigned or

factored.
Inventory loans use inventory as collateral.
Other Sources
Bankers acceptance
Commercial paper

Quick Quiz
How do you compute the operating cycle and the
cash cycle?
What are the differences between a flexible shortterm financing policy and a restrictive one? What
are the pros and cons of each?
What are the key components of a cash budget?
What are the major forms of short-term
borrowing?