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WORKING CAPITAL MANAGEMENT AND SHORT-TERM PLANNING

Much of this material is devoted to long-term financial decisions such as capital budgeting and the choice of capital structure. These decisions are called long-term for two reasons. First, they usually involve long-lived assets or liabilities. Second, they are not easily reversed and thus may

commit the firm to a particular course of action for several years.

Short-term financial decisions generally involve short-lived assets and liabilities, and usually they are easily reversed. Compare, for example, a 60-day bank loan for $50 million with a $50 million issue of 20-year bonds. The bank loan is clearly a short-term decision. The firm can repay it 2 months later and be right back where it started. A firm might conceivably issue a 20-year bond in January and retire it in March, but it would be extremely inconvenient and expensive to do so. In practice, such a bond issue is a long-term decision, not only because of the bond`s 20-year maturity, but because the decision to issue it cannot be reversed on short notice.

A financial manager responsible for short-term financial decisions does not have to look far into the future. The decision to take the 60-day bank loan could properly be based on cash-flow forecasts for the next few months only. The bond issue decision will normally reflect forecast cash requirements 5, 10, or more years into the future. Short-term financial decisions do not involve many of the difficult conceptual issues encountered elsewhere in this book. In a sense, short-term decisions are easier than long-term decisions but they are not less important. A firm can identify extremely valuable capital investment opportunities, find the precise optimal debt ratio, follow the perfect dividend policy, and yet founder because no one bothers to raise the cash to pay this year`s bills. Hence the need for short-term planning.

We will review the major classes of short-term assets and liabilities, show how long-term financing decisions affect the firm`s short-term financial planning problem, and describe how financial managers trace changes in cash and working capital. We will also describe how managers forecast month-by-month cash requirements or surpluses and how they develop short-term investment and financing strategies.

After studying this material you should be able to

_ Understand why the firm needs to invest in net working capital.

_ Show how long-term financing policy affects short-term financing requirements.

_ Trace a firm`s sources and uses of cash and evaluate its need for short-term borrowing.

_ Develop a short-term financing plan that meets the firm`s need for cash.