AS The first step in short-term financial planning is to forecast the company's future flows. This exercise has two distinct objectives. First, a company forecasts its cash to determine whether it will have surplus cash or a cash deficit for each period. Sel 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 comple, 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 Returning to the Springfield Snowboards example, assume that during April 2008 management learns that some manufacturing equipment has broken unexpectedly I replacing the equipment is costly enough, Springfield's cash reserves would be insufficiel In this table, and elsewhere in the chapter, we display onded numbers. Calculations such as ning there will be a small discrepancy between the Excel-calculated value shown and the hand-calcube are hased on the actual numbers in the spreadsheet with all significant digits. As a result occasion Given the coverage we have provided in Chapter 2 and 18 on how to construct pro forma ments, we do not discuss those details here. For simplicity, we have assumed Springfield is dit 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-tere 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 sells primarily to sports retailers. Springfield anticipates that in 2018 its sales will groels 10% to $20 million and its total net income will be $1,950,000. Assuming that both ples and production will occur uniformly throughout the year, management's forecast is 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 projecte que terly net income is almost $500,000. Springfield's capital expenditures are equal to de ciation. While Springfield's working capital requirements increase in the first quarter to the increase in sales, they remain constant thereafter and so have no further cases consequences. Based on these projections, Springfield will be able to find projected sale growth from its operating profit and, in fact, will accumulate excess cash on a continuing basis. Given similar 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 dividendo 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 for 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 rapotiv cest flour shock, can create short-term financing needs. using the rounded numbers displayed earns no interest on retained cash. Chapter 20 Short-Term Financial Planning TABLE 20.1 Acted Financi Statements for Springfield Symboards, 2018 ning Level Sales 631 201704201001201809 201009 201004 1 Quarter 2 Income Statement (5000) 3 Sales 4 Cost of Goods Sold 5 Selling General, and Administrative 6 EBITDA 7 Depreciation 8 EBIT 9 10 Net Income 11 Statement of Cash Flows 12 Net Income 13 Depreciation 14 Changes in Working Capital 15 Accounts Recente 16 Inventory 17 Accounts Payable 10 Cash from Operating Activities 10 Capital Expenditures 15 5.000 5.000 5.000 TOM-3.250 3.250 3.250 3.250 5,000 m -500 - 3045 -500 -500 1259 1250 120 1.250 - 500 500 500 -500 750 750 750 750 DOT -263 -260 23 2590 AB 500 500 500 -130 300 500 -500 500 90 500 20 Other investment 21 Cash from investing Activities 22 Net Borowing 23 Dividende 24 Capa Contoutons 25 Cash from Financing Activities 20 Change in Can and Equivalent --- 500 400 488 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 be 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. change 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 20.1 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 that is sufficient to compensate for a shortfall during other months. However, because of timing differences, such firms often have short-term financing needs. International Corporate France 532 Part 7 Financial Planning and Forecasting Monthly sales specified as a multiple of average monthly sales for each industry. FIGURE 20.1 Sales Seasonality (2010-2015) 1.8% 1.6X Sporting Goods and Hobbies Department Stores Building Materials and Garden 1.4x 1.2x 1.Ox 08x 0.6x JAN FEB MAR APR MAY JUN JUL AUG SEP OCT NOV DEC To illustrate, let's return to the example of Springfield Snowboards. In Table 20.1. management assumed that Springfield's sales occur uniformly throughout the year. In real- ity, for a snowboard manufacturer, sales are likely to be highly seasonal. Assume that 20% 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 20.2 presents the resulting statement of cash flows. These forecasts continue to assume produc tion occurs uniformly throughout the year. TANIA X] Putting It All Together: Creating a Short-Term Financial Plan 20. Construct a short-term financial plan for Springfield Snowboards based on its expan- sion opportunity described in the "Positive Cash Flow Shocks part of Section 20.1. Base the plan on the following table, which forecasts additional capital expenditures, marketing (SG&A), and working capital in Q1 and Q2 along with higher sales in Q2-04. Assume that Springfield ends 2017 with $1 million in cash and that its bank will offer it a short-term loan at the rate 2.5% per quarter (see MyFinanceLab for the data in Excel format). 201704 2018Q1 2018Q2 2018Q3 201804 4,545 5,000 6.000 6,000 6,000 -2,955 -3,250 -3.900-3.900 -3.900 -455 -1,000 --600 -600 ---600 1,136 750 1,500 1,500 1,500 -455 -525 -525 -525 682 250 975 975 975 -239 -88 -341 -341 -341 443 162 634 634 634 -500 162 500 634 525 634 525 634 525 1 Quarter 2 Income Statement (5000) 3 Sales 4 Cost of Goods Sold 5 Selling. General, and Administrative 6 EBITDA 7 Depreciation BEBIT Taxes 10 Net Income 11 Statement of Cash Flows 12 Net Income 13 Depreciation Changes in Working Capital 13 Accounts Receivable 18 Inventory 17 Accounts Payable Cash from Operating Activities Capital Expenditures Other Investment Cosh from Investing Activities 22 Net Borrowing 29 Dividends 24 Capital Contributions 25 Cash from Financing Activities 28 Change in Cash and Equivalents (1821 +25) -136 --300 105 48 574 1,500 1.159 -525 1.159 -525 -525 - 1,500 -525 -525 -926 439 634 634 AS The first step in short-term financial planning is to forecast the company's future flows. This exercise has two distinct objectives. First, a company forecasts its cash to determine whether it will have surplus cash or a cash deficit for each period. Sel 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 comple, 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 Returning to the Springfield Snowboards example, assume that during April 2008 management learns that some manufacturing equipment has broken unexpectedly I replacing the equipment is costly enough, Springfield's cash reserves would be insufficiel In this table, and elsewhere in the chapter, we display onded numbers. Calculations such as ning there will be a small discrepancy between the Excel-calculated value shown and the hand-calcube are hased on the actual numbers in the spreadsheet with all significant digits. As a result occasion Given the coverage we have provided in Chapter 2 and 18 on how to construct pro forma ments, we do not discuss those details here. For simplicity, we have assumed Springfield is dit 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-tere 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 sells primarily to sports retailers. Springfield anticipates that in 2018 its sales will groels 10% to $20 million and its total net income will be $1,950,000. Assuming that both ples and production will occur uniformly throughout the year, management's forecast is 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 projecte que terly net income is almost $500,000. Springfield's capital expenditures are equal to de ciation. While Springfield's working capital requirements increase in the first quarter to the increase in sales, they remain constant thereafter and so have no further cases consequences. Based on these projections, Springfield will be able to find projected sale growth from its operating profit and, in fact, will accumulate excess cash on a continuing basis. Given similar 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 dividendo 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 for 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 rapotiv cest flour shock, can create short-term financing needs. using the rounded numbers displayed earns no interest on retained cash. Chapter 20 Short-Term Financial Planning TABLE 20.1 Acted Financi Statements for Springfield Symboards, 2018 ning Level Sales 631 201704201001201809 201009 201004 1 Quarter 2 Income Statement (5000) 3 Sales 4 Cost of Goods Sold 5 Selling General, and Administrative 6 EBITDA 7 Depreciation 8 EBIT 9 10 Net Income 11 Statement of Cash Flows 12 Net Income 13 Depreciation 14 Changes in Working Capital 15 Accounts Recente 16 Inventory 17 Accounts Payable 10 Cash from Operating Activities 10 Capital Expenditures 15 5.000 5.000 5.000 TOM-3.250 3.250 3.250 3.250 5,000 m -500 - 3045 -500 -500 1259 1250 120 1.250 - 500 500 500 -500 750 750 750 750 DOT -263 -260 23 2590 AB 500 500 500 -130 300 500 -500 500 90 500 20 Other investment 21 Cash from investing Activities 22 Net Borowing 23 Dividende 24 Capa Contoutons 25 Cash from Financing Activities 20 Change in Can and Equivalent --- 500 400 488 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 be 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. change 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 20.1 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 that is sufficient to compensate for a shortfall during other months. However, because of timing differences, such firms often have short-term financing needs. International Corporate France 532 Part 7 Financial Planning and Forecasting Monthly sales specified as a multiple of average monthly sales for each industry. FIGURE 20.1 Sales Seasonality (2010-2015) 1.8% 1.6X Sporting Goods and Hobbies Department Stores Building Materials and Garden 1.4x 1.2x 1.Ox 08x 0.6x JAN FEB MAR APR MAY JUN JUL AUG SEP OCT NOV DEC To illustrate, let's return to the example of Springfield Snowboards. In Table 20.1. management assumed that Springfield's sales occur uniformly throughout the year. In real- ity, for a snowboard manufacturer, sales are likely to be highly seasonal. Assume that 20% 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 20.2 presents the resulting statement of cash flows. These forecasts continue to assume produc tion occurs uniformly throughout the year. TANIA X] Putting It All Together: Creating a Short-Term Financial Plan 20. Construct a short-term financial plan for Springfield Snowboards based on its expan- sion opportunity described in the "Positive Cash Flow Shocks part of Section 20.1. Base the plan on the following table, which forecasts additional capital expenditures, marketing (SG&A), and working capital in Q1 and Q2 along with higher sales in Q2-04. Assume that Springfield ends 2017 with $1 million in cash and that its bank will offer it a short-term loan at the rate 2.5% per quarter (see MyFinanceLab for the data in Excel format). 201704 2018Q1 2018Q2 2018Q3 201804 4,545 5,000 6.000 6,000 6,000 -2,955 -3,250 -3.900-3.900 -3.900 -455 -1,000 --600 -600 ---600 1,136 750 1,500 1,500 1,500 -455 -525 -525 -525 682 250 975 975 975 -239 -88 -341 -341 -341 443 162 634 634 634 -500 162 500 634 525 634 525 634 525 1 Quarter 2 Income Statement (5000) 3 Sales 4 Cost of Goods Sold 5 Selling. General, and Administrative 6 EBITDA 7 Depreciation BEBIT Taxes 10 Net Income 11 Statement of Cash Flows 12 Net Income 13 Depreciation Changes in Working Capital 13 Accounts Receivable 18 Inventory 17 Accounts Payable Cash from Operating Activities Capital Expenditures Other Investment Cosh from Investing Activities 22 Net Borrowing 29 Dividends 24 Capital Contributions 25 Cash from Financing Activities 28 Change in Cash and Equivalents (1821 +25) -136 --300 105 48 574 1,500 1.159 -525 1.159 -525 -525 - 1,500 -525 -525 -926 439 634 634