Short Term Financial Planning

The first step in short-term financial planning is to forecast the company’s future cash flows.
This exercise has two distinct objectives. First, a company forecasts its cash flows to
determine whether it will have surplus cash or a cash deficit for each period. Second,
management needs to decide whether that surplus or deficit is temporary or permanent. If it is
permanent, it may affect the firm’s long-term financial decisions. For example, if a company
anticipates an ongoing surplus of cash, it may choose to increase its dividend payout. Deficits
resulting from investments in long-term projects are often financed using long-term sources
of capital, such as equity or long-term bonds.

In this chapter, we focus specifically on short-term financial planning. With this perspective,
we are interested in analyzing the types of cash surpluses or deficits that are temporary and,
therefore, short-term in nature. When a company analyzes its short-term financing needs, it
typically examines cash flows at quarterly intervals.

The cash budget often gives the best insight into the borrower’s short-term credit needs. If
maximum or peak borrowing needs over the forthcoming year are estimated at Rs. 800,000, a
company might seek a line of credit of Rs.1 million to give it a margin of safety. Whether the
bank will go along with the request will depend, of course, on its evaluation of the
creditworthiness of the firm. If the bank agrees, the firm then may borrow on a short-term
basis
usually through a series of specific promissory notes whose average maturity is around 90
days
up to the full Rs.1 million line.

Short-term financial planning begins with the sales forecast. From it, companies develop
production plans that take into account lead (preparation) times and include estimates of the
required raw materials. Using the production plans, the firm can estimate direct labor
requirements, factory overhead outlays, and operating expenses. Once these estimates have
been made, the firm can prepare a pro forma income statement and cash budget. With these
basic inputs, the firm can finally develop a pro forma balance sheet.

Cash Budget

The cash budget, or cash forecast, is a statement of the firm’s planned inflows and outflows
of cash. It is used by the firm to estimate its short-term cash requirements, with particular
attention being paid to planning for surplus cash and for cash shortages.

Typically, the cash budget is designed to cover a 1-year period, divided into smaller time
intervals. The number and type of intervals depend on the nature of the business. The more
seasonal and uncertain a firm’s cash flows, the greater the number of intervals. Because many
firms are confronted with a seasonal cash flow pattern, the cash budget is quite often
presented on a monthly basis. Firms with stable patterns of cash flow may use quarterly or
annual time intervals

PREPARING THE CASH BUDGET

The general format of the cash budget is presented in Table below:

 Particulars Jan. Feb. March
Opening Balance
Receipts:
Collections of A/R

Payments:
Paid to suppliers
Payment of expenses

Ending Balance

We will discuss each of its components individually.

Cash Receipts

Cash receipts include all of a firm’s inflows of cash during a given financial period. The most
common components of cash receipts are cash sales, collections of accounts receivable, and
other cash receipts.

Cash Disbursements

Cash disbursements include all outlays of cash by the firm during a given financial period.
The most common cash disbursements are Cash purchases Fixed-asset outlays Payments of
accounts payable Interest payments Rent (and lease) payments Cash dividend payments
Wages and salaries Principal payments (loans) Tax payments Repurchases or retirements of
stock It is important to recognize that depreciation and other noncash charges are NOT
included in the cash budget, because they merely represent a scheduled write-off of an earlier
cash outflow. The impact of depreciation, as we noted earlier,
is reflected in the reduced cash outflow for tax payments.

Net Cash Flow, Ending Cash, Financing, and Excess Cash

Look back at the general-format cash budget in Table above. We have inputs for the first two
entries, and we now continue calculating the firm’s cash needs. The firm’s net cash flow is
found by subtracting the cash disbursements from cash receipts in each period. Then we add
beginning cash to the firm’s net
cash flow to determine the ending cash for each period.
Finally, we subtract the desired minimum cash balance from ending cash to find the required
total financing or the excess cash balance. If the ending cash is less than the minimum cash
balance, financing is required. Such financing is typically viewed as short-term and is
therefore represented by notes payable. If the ending cash is greater than the minimum cash
balance, excess cash exists. Any
excess cash is assumed to be invested in a liquid, short-term, interest-paying vehicle—that is,
in marketable securities.

Q No.1
Cash Balance for Greenwell Corporation: The Greenwell Corporation collects 60% in the
quarter of sale and 40% in next quarter and wishes to maintain a $160 million minimum cash
balance. Based on this and the information given in the following cash budget, complete the
cash budget. What conclusions do you draw?

GREENWELL CORPORATION
Cash Budget (in millions)
Q1 Q2 Q3 Q4
Beginning receivables $240

Sales 150 $165 $180 $135

Total cash disbursements 170 160 185 190

Q No.2 Repeat above question by assuming that 75% collected in the quarter of sale and
25% in next quarter. What change you observed in cash budget?
Q No.3
Calculating the Cash Budget Here are some important figures from the budget of Nashville
Nougats, Inc., for the second quarter of 2015:

April May June

Credit sales $330,000 $372,000 $432,000
Credit purchases 132,000 150,000 185,000

Cash disbursements
Wages, taxes, and expenses 20,400 22,200 25,200
Interest 9,600 9,600 9,600
Equipment purchases 70,000 84,000 -------

The company predicts that 5 percent of its credit sales will never be collected, 35 percent of
its sales will be collected in the month of the sale, and the remaining 60 percent will be
collected in the following month. Credit purchases will be paid in the month following the
purchase.

In March 2015, credit sales were $210,000, and credit purchases were $156,000. Complete
cash budget for the month of April, May and June. Show June closing A/c Receivable
balance.

Q No.4
A company has a cash balance of Rs.27000 at the beginning of March and you are required to
prepare a cash budget for March, April and May having regard to the following information.
Creditors give 1 month credit
Salaries are paid in the current month
Fixed costs are paid one month in arrears and include a charge for depreciation of Rs.5000
per month.
Credit sales are settled as follows:
40% in month of sales
45% in next month and 12% in the following month. The balance represents bad debts.

Month Cash sales Credit sales purchases Salaries Fixed expense

Jan 74000 55200 9000 30000
Feb 82000 61200 9000 30000
March 20,000 80000 60000 9500 30000
April 22000 90000 69000 9500 32000
May 25000 100,000 75000 10000 32000

Q No.5

The opening cash balance on 1st Jan was expected to be Rs. 30,000. The sales budget was as
follows:
November Rs.80,000
December 90,000
January 75,000
February 75000
March 80000

Analysis of records shows that debtors settle according to the following pattern:
60% within the month of sales, 25% the month following, 15% the month following.

Extracts from the purchases budget were as follows:

 December Rs.60000
January 55000
February 45000
March 55000
All purchases are on credit and past experience shows that 90% are settled in the month of
purchases and the balance settled the month after.
Wages are Rs.15000 per month and overheads of Rs. 20,000 per month (including Rs.5000
depreciation) are settled monthly.
Taxation of Rs.8000 has to be settled in February and company will receive settlement of an
insurance claim of Rs.25000 in March.

Required: Prepare cash budget for Jan, Feb and March