8. Hand-to-Mouth is currently cash-constrained, and must make a decision about whether to delay paying one of its suppliers, or taking out a loan. They owe the supplier $10,000, but the supplier will give them a 2% discount if they pay by today (when the discount period expires). That is, they can either pay $9,800 today, or $10,000 in one month when the net invoice is due. Because Hand-to-Mouth does not have the $9800 in cash right now, it is considering three options: Alternative A: Forgo the discount on its trade credit agreement, wait and pay the full $10,000 in one month. Alternative B: Borrow the money from Bank A, which has offered to lend the firm $9,800 for one month at an APR (compounded monthly) of 12%. The bank will require a (no-interest) compensating balance of 5% of the face value of the loan and will charge a $100 loan origination fee, which means Hand-to-Mouth must borrow even more than the $9,800. Alternative C: Borrow the money from Bank B, which has offered to lend the firm $9,800 for one month at an APR of 15% (compounded monthly). The loan has a 1% loan origination fee. Forecasting Short-Term Financing Needs The first step in short-term financial planning is to forecast the company's future cach flows. This exercise has two distinct objectives. First, a company forecasts its cash flow 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, 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 are based on the actual numbers in the spreadsheet with all significant digits. As a result, occasionally there will be a small discrepancy between the Excel-calculated value shown and the hand calcule Given the coverage we have provided in Chapters 2 and 18 on how to construct pro forma financial ments, we do not discuss those details here. For simplicity, we have assumed Springfield has ne deland 630 Part 7 Financial Planning and Forecasting 20.1 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 per spective, 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. Application: Springfield Snowboards, Inc. To illustrate, let's assume that it is currently December 2017 and consider the case of Springfield Snowboards, Inc. Springfield manufactures snowboarding equipment, which it sells primarily to sports retailers. Springfield anticipates that in 2018 its sales will grow by 10% to $20 million and its total net income will be $1,950,000. Assuming that both sales and production will occur uniformly throughout the year, management's forecast of its quarterly net income and statement of cash flows for 2018 is presented in the spreadsheet in Table 20.1. (Also shown, in gray, is the income statement from the fourth quarter of 2017. From this forecast, we see that Springfield is a profitable company. Its projected terly net income is almost $500,000. Springfield's capital expenditures are equal to depre ciation. While Springfield's working capital requirements increase in the first quarter der to the increase in sales, they remain constant thereafter and so have no further cash flow consequences. Based on these projections, Springfield will be able to fund projected sales growth from its operating profit and, in fact, will accumulate excess cash on a continuing basis. Given stmilar growth forecasts for next year and beyond, this surplus is likely to be long-term Springfield could reduce the surplus by paying some of it out as a dividendor by repurchasing shares Let's now turn to Springfield's potential short-term financing needs. Firms require short-term financing for three reasons: negative cash flow shocks. positive cash flow shocks, and seasonalities. Negative Cash Flow Shocks Occasionally, a company will encounter circumstances in which cash flows are temporarily negative for an unexpected reason. These situations, which we refer to as negative cast flow shock, can create short-term financing needs. Returning to the Springfield Snowboards example, assume that during April 2015 management learns that some manufacturing equipment has broken unexpectedly replacing the equipment is costly enough, Springfield's cash reserves would be insufficient "In this table, and elsewhere in the chapter, we display rounded numbers. Calculations such as net income using the rounded numbers displayed. earns no interest on retained cash. TABLE 20.1 Projected Financial Statements for Springfield Snowboards, 2018, suring Level Sales Chapter 20 Short-Term Financial Planning 1 Quarter 2 Income Statement (0001 3 Sales 4 Cost of Goods Sol Selling General and Administrative 6 EBITDA 7 Depreciation 631 201701201801 201802 201803 201804 TOR 5.000 5.000 7.0 -3.250 3.250 -590 -500 1.250 1.250 -500 -500 2.500 70 900 188 5.000 5.000 -3.250 3.250 -500 -500 1.250 1250 500 --500 8 EBIT 9 Taxes 10 Net Income 11 Statement of Cash Flows 12 Net Income 13 Depreciation 14 Changes in Worlang Cape 15 Accounts Receivable 16 Inventory 17 Accounts Payable 18 Cash from Operating Activities 19 Capital Expenditures 20 Other investmere 21 Cash from Investing Activities 22 Not Borowing 23 Dividends 400 100 500 500 88 88 -500 500 op 500 24 Capital Contributions 25 Cash from Financing Activities 26 Change in Cash and Equivale 18-2020 -500 18 to pay for a replacement. Springfield will have to borrow for arrange for another financing source) to cover the shortfall. However, once the equipment is replaced, the company will continue to generate positive cash flow in subsequent quarters, and will soon have gener ated enough in cumulative cash flow to repay the loan. Therefore, this negative cash flow shock has created the need for short-term financing Behang Positive Cash Flow Shocks Next, we analyze a case in which a positive cash flow shock affects short-term financing needs. Although this surprise is good news, it still creates demand for short-term financing During the first quarter of 2018, a major sporting goods chain agrees to exclusively sell Springfield Snowboards. The opportunity to grow comes with large up-front marketing working capital, and production capacity expenses. The unexpected event in this case the opportunity to grow more rapidly-is positive, It would result, however, in a negative net cash flow during the first quarter, due primarily to the new marketing expenses and capital expenditures. Because the company will be even more profitable in subsequent quarters, this financing need is temporary Seasonalities For many firms, sales are seasonal. Figure 2011 shows the seasonal pattern of sales for department stores, sporting goods, and building materials. Department store and sport- ing good sales are concentrated during the Christmas holiday season, while for building materials, sales peak in the spring ahead of the summer building season. When sales are concentrated during a few months. sources and uses of cash are also likely to be seasonal Firms in this position may find themselves with a surplus of cash during some months national Corporate Finance that is sufficient to compensate for a shortfall during the months. However, because of timing differences, such firms often have short-term financing needs. To illustrate, let's return to the example of Springfield Snowboards. In Table 241. ity, for a snowboard manufacturer, sales are likely to be highly seasonal. Assume that 2% of sales occur during the first quarter, 10% during each of the second and third quarters (largely Southern Hemisphere sales), and 60% during the fourth quarter, in anticipation of the Northern Hemisphere winter snowboarding season. The spreadsheet in Table 2012 presents the resulting statement of cash flows. These forecasts continue to assume precum Part 7 Financial Planning and Forecasting FIGURE 20.1 Sales Seasonality (2010-2015) Monthly sales specified as a multiple of average monthly sales for each industry 1.8% 1 6x Sporting Goods and Hobbies Department Stores Building Materials and Garden 1.4% 1.2x 1.Ox 0.8x JAN FEB MAR APR MAY JUN JUL AUG SEP OCT NOV DEC management assumed that Springfield's sales occur uniformly throughout the year. In genom tion occurs uniformly throughout the year