Much of corporate finance focuses on longer-term finance.  In this section we will focus more on the day to day operations and see how they can affect the long-run health of the business.
 

When we say short-term financing we are looking at short-term assets and short-term liabilities.

Terms used in conjunction with Short term Financial Management

1. Working Capital:  Current Assets
2. Net Working Capital:  Current assets - current liabilities.
3. Factoring: Selling of A/R

Cash:

Must know if you are talking about cash or cash and other safe, liquid securities such as money market securities

Advantages: Flexibility, liquidity,
Disadvantages: low return, slack might lead to agency costs,

Inventory-- both finished good and work in process
 

•  Advantages: fewer "outs", might be able to take advantage of volume discounts, more economical production runs
•  Disadvantages: Must be financed, spoilage, it can hide problems

• Advantages: credit sales may increase sales
• Disadvantages: May not be paid, must be financed

All three must be managed.  Costs of having too much include excess need for financing, possible increased agency costs, and "spoilage."
 

Current Liabilities

Short-term financing can come from banks, commercial paper markets, and trade credit.

Advantages: Speed, Flexibility, often lower rate
Disadvantage: Volatile, downside if you can not refinance
 

Accounts Payable:  The reverse of accounts receivables

This is the most important source of short-term financing for many firms.

Beware that increased use of Accounts payables (such as by not paying off when you should) can be expensive as most firms offer favorable terms for prompt payment and delaying payments can also upset your suppliers.

Short-term loans:
  Bank Loans
  Commercial paper

Commercial paper vs Bank Loans

Large, credit-worthy, firms generally prefer to issue commercial paper as the rates are cheaper, but for most smaller firms bank and trade credit are the only sources of short-term debt financing.

Banks often require compensating balances for these unsecured loans.
 

Link between Long-term and short- term financing

(Fig 29.1 from Brealey and Myers text)

 All firms need capital.  This capital requirement can be met with either long term or short term capital.  Since it is cheaper to issue long-term capital in "big chunks" and the total needs are not totally predictable, the financing tends to be out of sync with the actual needs.

Firms can choose to always have enough excess cash on hand so that they never need to borrow short-term, or firms can arrange their financing such that they are always borrowing short-term.  Other firms manage their financing needs such that there will be occasional surpluses and occasional deficits.

Focus on cash:
 

Cash Budgeting: Cash is arguably the most important of the current assets so we will begin off looking at cash forecasting.

 Much pro-forma financials are used to develop the long term financing requirements, short-term cash forecasting begins with the firms financial statements.

Must make adjustments for credit sales, non-cash expenses, and accruals.  Thus it is effectively cash-basis accounting.

If cash is not sufficient to meet needs, a firm can factor its accounts receivable.   This involves selling the accounts receivable to a third party.  This third party will pay a percentage of the face value.  The percentage varies by credit quality of the customers and the firm's track record.

We can also do this forecasting for total working capital.
 

Appraising any Short-term plan:

Credit Scoring: example do you own a home, have a car, etc.

Warning flags often arise if short-term financing increases too dramatically.  This can show up in either the current or the quick ratio.  Both are widely watched by credit agencies and banks.

Altman Z-score is a common way that banks forecast bankruptcy.

        Z= 3.3 (EBIT /TA) + 1 (sales/TA) + .6 (Mkt. Value of Equity/Book value of debt) + 1.4(RE/TA) + 1.2(WC/TA)

Managing Accounts Receivables
 
Must decide on who to lend to, for how long, under what terms.

decision tree approach to find expected profitablity (and more importantly cash flow consequences)  of credit policy.  More profitable, the more you can afford to have some not pay.

Do not let A/R build up too much without careful monitoring.  Are people paying on time?  To track this use an again schedule as well as tracking Days Sales Outstanding.

You can speed up collection with Lock boxes (also called concentration boxing) or electronic payments.

Factoring: selling Accounts receivable
        used frequently in textiles and toys

    Maturity Factoring: the factor helps to collect etc.

Factoring can be in a better position to gauge credit worthiness

Money Markets Securities

T-Bills
Federal Agency Discount Notes
Bankers' Acceptances
Negotiable CDs
Commercial Paper-IOUs

Some are discount instruments (example T-Bills) while others (such as Munis) generally have interest payments.